Managing risk on building projects
The impact on any business or organisation caused by construction works (whether constructing new premises, or extending, refurbishing or fitting out existing) is always significant. Minimising the impact of the works on day-to-day activities during the planned duration of the works takes careful planning. Putting in place the right construction contracts is an absolute, if this is to be achieved.
The main contract
Inevitably, on any project, there will be changes which impact upon the cost, duration and quality of the works. Seldom will a project reach practical completion entirely in accordance with the “day 1” plan. Proper construction documentation is essential to manage the project risk. This is so both in setting the framework for the agreed obligations at the outset, and providing sufficiently certain but flexible mechanisms to deal with changes.
Like any contract, the prime function of a good construction contract is two-fold: to create certainty as to the division of responsibilities and to apportion risk between the parties. A competent contractor’s price will ultimately reflect the degree of risk it faces under the contract. Contracts will generally either be based on one of the standard forms of contracts. The most commonly used are the suites produced by the Joint Contracts Tribunal (JCT) and the National Engineering Contract (NEC). In our experience an employer will usually seek to amend them to adjust the balance of risk.
Negotiations of the contract’s terms, and a proper understanding of the end product, are fundamental to risk management of the project. Too often the building contract is not agreed until well after works have been commenced on site. Even signed contracts are often consigned to the fire proof cabinet of the site office, and seldom referred to. Because the contract can set out many “use it or lose it” remedies, it should be regarded as akin to a compliance manual for the management of the project, rather than a retrospective point of reference to determine a dispute.
The main contract terms will determine how issues that arise during construction are dealt with, and their financial effect. For example, it will deal with:
- The quality of workmanship and materials required – and how any defects are dealt with
- Responsibility for design issues (in the case of design & build contracts)
- How variations instructed by the employer are dealt with, and how they affect the cost and timing of the project, and who bears responsibility for that
- Whether, in certain circumstances, part of the building can be handed over prior to completion of all of the works (and on what terms)
- How interim valuations are dealt with (including the valuation of any variations)
Inevitably, a number of parties besides the contractor and the client will be involved in a construction project, including sub-contractors and professional consultants.
Whilst the contractor should ensure that he contracts on “back to back” terms with his subcontractors, to ensure they are committed to the same standards of work as the contractor under the main contract, frequently subcontractor documentation is inadequate or incomplete. Although theoretically, from the client’s point of view, this is the contractor’s problem, the risk of any dispute down the line increases risk for the client that the project of delay and increased costs.
It is usually prudent for a client to seek collateral warranties from the subcontractors with a design responsibility, to be enable a direct claim against them should the need arise (for example, because of the contractor’s insolvency). It is essential that the requirement for collateral warranties and their terms are agreed at the outset, so that the contractor is clear as to what his subcontractors must sign up to. Warranties are relatively straightforward to negotiate at an early stage, but problems arise where they are requested too late in the day, particularly if neither the contractor nor subcontractor is under any obligation to provide them.
The client will also need to agree appropriate terms of engagement for its professional team and these should contain obligations to provide collateral warranties.
Lenders will generally require collateral warranties which include step-in rights to enable them to take over as employer in circumstances where the contract could otherwise be terminated. Parent or group companies may also want such rights, or require guarantees, to maximise flexibility moving forward and to protect against the risk of a party becoming insolvent.
Having the necessary contracts and appointments, along with any associated documentation, agreed and in place at the earliest opportunity, and certainly before any works start on site, coupled with proper management of the process as the project progresses, is the best way to manage risk and minimise the potential for problems.
Chris Whittington, Head of Construction and Engineering on 01322 623706 or