Risk management in construction projects

Like anything in life, a construction project involves risk, and if you don’t manage that risk then there is a far greater chance that it will turn to custard.

In fact, by their very nature, construction projects tend to be at the upper end of the risk spectrum, not far behind warfare, free solo climbing and betting all your worldly assets on the underdog in a horse race.

Humans have a natural tendency to manage risk, some far more effectively than others. So, you could leave risk management to the people involved in the project in the expectation that they will all behave rationally.

Unfortunately life isn’t like that. In fact, the most common human risk management strategy by far, is to do nothing and hope that nothing will go wrong.

And so we have a number of established mechanisms for managing risk in construction projects. The most effective of those is central government regulation and local government oversight.

The Building Act, the Building Code, and various related pieces of legislation set minimum standards for construction and penalties for non-compliance.

Building Consent Authorities are our specialist police force who supervise and enforce the observance of these minimum standards. And on top of that, the common law holds parties accountable if they are negligent.

Many of those parties are insured, so their insurers try to get them to minimise their exposure as well.

Faced with those potential penalties, asset owners and builders take logical steps to stay out of trouble. And so they hire qualified and experienced staff, and engage expert architects, engineers, quantity surveyors and the like, to avoid making serious mistakes.

But that in itself isn’t enough, because if serious mistakes do happen, no-one is going to voluntarily own up to them. That is why you need another level of risk management, and that is the building contract, which is written primarily by construction lawyers.

The purpose of that contract is to make it very clear who is responsible for what. If you don’t put the effort into doing that at the outset, then when disputes arise, it is significantly more expensive and timeconsuming to sort out the rules retrospectively.

One of the functions of the building contract is to manage risk, and there are a number of ways to dealing with it. Here are some of the most common risks, and the most common ways of dealing with them.

1. The building or facility does not meet the required standards

The first safeguard is to have the building or facility designed in comprehensive detail by competent professionals.

Then have the project inspected periodically by those professionals, the engineer to the project, and the building consent authority. Knowing that defects are still going to emerge, contract for a lengthy defects notification period and a head contractor obligation to rectify notified defects promptly.

In case the contractor fails to do so, insist on a third-party bond at the beginning of the project that can be called upon if that happens.

As an added precaution, deduct retentions from progress payments and only release them on satisfactory rectification of the notified defects Finally, obtain comprehensive warranties and guarantees that can be enforced up to 10 years after completion.

2. The project takes too long

First, require the head contractor to submit and regularly update a chronological programme of when milestones are to be achieved. Then specify dates for commencement and completion and strictly define the circumstances in which the contractor is entitled to extensions of time. Provide for liquidated damages to be paid for any unjustified delays. Contract for rights to require acceleration of the pace of work at a defined cost to the asset owner, and reserve rights to terminate the contract and bring in alternative contractors if progress is unsatisfactory.

3. The head contractor charges more than it is entitled to

Have all payment claims scrutinised by the engineer to the contract, and reject any unjustified components. Respond to Construction Contracts Act payment claims with valid Construction Contracts Act payment schedules within the required timeframe. And resolve any disputes concerning payment promptly and cost-effectively.

4. The head contractor becomes insolvent or otherwise incapable of performing its obligations

Obtain a third-party bond that can be called upon if the contractor defaults. Reserve rights to terminate the contract and bring in alternative contractors if progress is unsatisfactory.

And obtain continuity guarantees from subcontractors and building material suppliers so that they can be required to work for the asset owner directly.

5. The asset owner runs out of money

Obviously this is a risk that affects both parties, but it is the head contractor who will want safeguards inserted into the contract.

Those safeguards would be superfluous (and consequently unavailable) when the asset owner is a government agency or a well-established, financially sound private sector organisation.

However, it’s a different story when you are dealing with a shaky developer. In that case the contractor can insist on a thirdparty bond that can be called upon if the principal defaults.

6. Force majeure events prevent the economic completion of the project

These are risks that typically aren’t attributable to the acts or omissions of either party, but rather to forces of nature or the intervention of some third party.

Recent examples are the Auckland floods (where nature intervened), and Covid-19 (where the government intervened). These types of events sometimes sabotage the project completely (for example the building site slides down a cliff, or building on it becomes unlawful) – in which case it is known as frustration. But most commonly they just slow it up, and add cost. It may be that the head contractor is simply delayed unexpectedly, or it may be that the structure is damaged and has to be reinstated.

The building contract can deal with this in a number of ways. For a start, events beyond the reasonable control of the contractor usually justify an extension of time, so at least liquidated damages don’t kick in. And sometimes the contract contains a force majeure clause which has much the same effect.

Often the contract provides that the flow-on effects of events like this are to be treated as a variation, which means the contractor qualifies not only for time relief, but also compensation for all the extra costs that arise as a result. The COVID-19 pandemic was a good example of that.

Of course, events like this always cost someone – be it the asset owner or the contractor – and that is where insurance comes in.

Contract works insurance covers damage that isn’t attributable to the acts or omissions of either party. Damage that is attributable to the acts or omissions of the contractor (whether the “victim” is the asset or owner, or some third party such as a neighbour), is covered by professional indemnity or public liability insurance.

It is also common for the contractor to be required to insure critical items of plant and equipment.relied upon as legal advice.

Geoff Hardy has 46 years’ experience as a commercial lawyer and is a partner in the Auckland firm Martelli McKegg. He guarantees personal attention to new clients at competitive rates. His phone number is (09) 379 0700, fax (09) 309 4112, and e-mail geoff@martellimckegg.co.nz.

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