ASSIGNMENT-1

COURSE
218.763
ADVANCE CONSTRUCTION LAW,2019

BY
Suresh Govindaraj
STUDENT ID:19026136

COURSE COORDINATOR
DR. NASEEM AMEER ALI
 RISK ALLOCATION IN
CONSTRUCTION CONTRACTS
Contents
1. Introduction

2. The fundamentals of a contract

a) Agreement
b) Intention
c) Consideration
d) Legal Capacity

3. Risk management
a) How to deal with the risks
 Transferring the risk
 Accepting the risk
 Avoiding the risk
 insurance

4. Procurement Methods
a) Traditional
 Lump-sum contract
 Measurement Contract
 Cost-Plus Contract
b) Integrated
 Design and Build Contract
 Package Deal Contract
c) Management Contracting

5. Conclusion

6. References
 1. INTRODUCTION

The modern age of construction is witnessing rocket-high growth and holds a

relatively big slice in the Gross Development Product of majority of the countries.
Particularly, with an increase in the opportunities created and the advanced
influence of technology. The usage of technology has been complementing the
opportunities created by making the construction works more efficiently at a
higher rate compared to the olden days. Moreover, the growing demands have
been of a great assistance to the growth.

However, the “opportunities” are accompanied by corresponding risks which

may potentially lead to a domino effect. In the worst-case scenario it might lead
to shutting down the company. The risks in a project is an undefined array of
negative or undesirable outcomes. In a construction project, the risk ultimately
lies with either of the party based on how the contract is drafted or in other
words, how the contract apportions the risk. Generally, the parties come
forward to take the risks that they are capable of and lay off the ones that are
not acceptable.

The risks are broadly classified into three groups. The first type is the pure and
particular risk. It inscribes the risks that cause damage to people and property
such as explosion or any other natural calamity. These are generally covered by
the insurance and its mandatory have them under the contract obligations. The
second type is called as fundamental risks and they include government
policies, malicious damage, etc. and the insurance cover isn’t necessary as they
are all subject to statutory liabilities. The third category is referred to as
speculative risks. This category includes risks that can be apportioned during the
pre-contract stage. The common risks under this category are cost, schedule
and performance risks. In addition, there are other risks which are less common
yet equally significant. They are strategic risks, governance risks, market risks,
legal risks and operational risks.

The following sections will guide through the basic understanding of contracts,
how to deal with the contractual risks followed by the ideal risk allocation
recommendations for the common procurement types.
 2. THE FUNDAMENTALS OF A CONTRACT

Contract is defined as a binding document between two or more parties

addressing mutual obligations enforceable by law. It acts as the basic tool used
by the parties to manage the relationship between them. The term contract
encompasses into the following four components:

 AGREEMENT
It is a negotiated arrangement among the parties that provides an
acceptable offer to each other to do particular work. The offer is
awarded by the client and the contractor acts as receiver and in return
the contractor develops the client’s vision.

 INTENTION
It is defined as the purpose to enter into a contract by a party and is
expected to be genuine and unbiased and intentions are enforceable
by law

 CONSIDERATION
It is the outcome that each of the parties benefit from entering into
contract and has to be valued reasonably. Considerations are preferred
to be kept in a balance between the benefit and burden between the
two parties.

 LEGAL CAPACITY
The parties entering into a contract must be legally admissible to do so.
Some basic criteria are age, mental capacity, etc. Basically, the parties
entering the contract must be in a position to understand that they are
taking an ownership of responsibility enforceable by law.

All the contracts must have these four-criterion satisfied and that forms the basis
of a contract. These criteria are expressed as terms of contract which is broadly
classified into two groups, conditions and warranties.

Conditions are the fundamental parts of a contract that defines all the major
works. In the case of a construction contract, conditions include the clauses the
furnish the information on cost, quality, schedule, bills of quantities, specifications
and other major factors of the project. The conditions of a contract are legally
binding by default unless the contract says otherwise. Whereas, warranties are
supplemental terms in a contract that does not contribute any major
significance in making or breaking a contract. On the other hand, conditions, if
breached may even lead to termination of contract.

The person who manages the contract is generally known as contract

administrator or project management consultant or engineer as per the
colloquial trend. The contract admin is a very influential person in a construction
project. He is normally nominated by the client and is expected to be highly
reliable and professional throughout the contract life cycle period. All major
decisions in a project must involve the acceptance of a contract admin as he
acts as the representative of the client. Moreover, if there are any amendments
from the client side, it will be communicated through the contract admin to the
contractor and the contract admin takes the responsibility to manage variations
in contract. In addition, the contract admin is also entitled to delegate his
powers to a person who is involved in the project and can be revoked at any
time. The decisions made by the person who is nominated by the contract
admin is valid only for that particular period of time.

A contract is tailor made based on the inputs from the client/contractor to suit
best to their interests. Clients and the contractors can be grouped based on
their previous endeavors, nature and their business strategy. The client will be on
the deciding end to choose a particular type of procurement method and
eventually find a contractor who specializes in that procurement method.

As we speak about procurement methods, its essential to mention that it acts as

the base of any contract. It basically means, the method of organizing the
scheduled work, processing payments and setting up milestones in a project.
The common procurement practices are discussed in section 4. The following
section will guide through some key information on contractual risks and how it
can be mitigated.
 3. RISK MANAGEMENT
As some of the basic concepts of risks were discussed in the above sections, this
section will feature on how to manage the risks in a construction project.

There are various strategies that have been appreciated with regards to risk
management, but the most used strategy would be identifying the risk and
tagging a price for it.

Pricing the risk for is a universally accepted practice and its application is
adopted in almost all the risks that people take in their day-to-day life. For
instance, let’s consider the famous Chinese casino game ‘sic-boo’, where three
dice are rolled in an enclosed chamber and the players must guess the number
on the dies. The game works in such a way that, the least probable outcome
would bag the highest reward and the ones that can be easily guessed will get
the minimum reward.

This particular example is considerate to understand how to handle risks in a

construction project as well. The main idea that lies behind risk-taking is
identifying the value of the risks taking into consideration of factors such as
magnitude of risks, probability, individual’s capacity and willingness. Willingness is
emotional aspect of taking a risk and it is a very personal quality and differs from
person to person invariably.

The parties that enter into a contract, the contractor and the client have to
considerably allocate the risks among themselves based on the above
mentioned factors. To make the allocation more effective, there is another
factor called “frequency of risks” which would indicate who ought to take the
responsibility of the risks.

In some cases, such that the client an active builder it is good to take few risks
and retain the financial benefit for it. The one who builds repeatedly might have
a deeper understanding of the risks, therefore bearing the financial liability for a
particular risk (provided that its occurrence is very rare on the account of
projects taken) can be borne by the client himself.

It is essential to mention that, failing to have a contractual provision for the risk,
that is, if the contract is silent on who takes responsibility for it, the risk is sided on
either party eventually. Therefore, it is better to identify the risk on the pre-tender
stage and apportion it.
How to deal with the risks?
Dealing with is risks is not dealing with the uncertainty, which is usually
misinterpreted by most of professionals in the industry. It is the art of
maturely handling the identified risks. This art is the heart and soul of every
successful business person, whose strategy is viewing the risks from the
commercial point of view and it is often coined as “calculated risks” in the
business forums. As the earlier sections spoke about identifying and
analyzing the risks, this section will highlight the ways to ‘respond’ to these
risks.

The choice of response for the contractual risks revolve around

transferring, accepting, avoiding, insuring, or doing nothing about the
risks.

Transferring the risk

The risks in a construction contract are transferred by cautiously wording
the clauses of the contract. Transferring of risk typically means transferring
the financial liability of the risk to the 2nd party or a 3rd party. Here, the 2nd
party refers to the party that is in contract with the person who wishes to
transfer it and the 3rd party refers to a person or an organisation who isn’t
forming the contract. It can be a nominated individual or an insurance
company. In most of the cases it is the insurance company that takes the
liability. But it’s not as easy it sounds as the insurance officers pay high
attention to every single word that forms the contract to accept the
liabilities, so the contract wordings must be straight and non-ambiguous.
In the case of client transferring it to the contractor, it is advised that the
terms are discussed beforehand, and contractor is aware of it. Say
suppose if the contractor is blindsided and the eventuality of risk occurs,
they may try to pass it on the client. On a failure attempt, the contractor
goes into liquidation. Either ways, it is not good for the client’s business.

Acceptance of risk
Certain risks have to be accepted by the client in and steal the
advantage of it. The occurrence of these risks such as war, earthquakes
and seizure, are very less. Its is unwise for the client to expect the
contractor to pay the premium for these risks as they clearly don’t hold
control over it. Avoidance of paying premium for these risks in short term is
not a brilliant decision considering the good probability of these risks on a
long term basis. Similarly, the contractor has to own the responsibilities for
certain risks such as health and safety of labors etc.
Avoidance of risk
When the results of the initial risk management process suggest that the
risk is unacceptable by either of the parties, then its good to just avoid it.

“Avoiding it” does not mean ignoring the risk. It means redefining the
process in such a way that the risk is not avoided. For instance, if there are
two ways to make a payment to purchase a product, one is online
payment and the other one paying buy cash in the nearby store. Assume
that there is a prolonged network issue in the neighborhood. Now, making
a payment online is risky business because if the transaction fails it gets 30
days to get a refund. So, the wise option is to manually walk to a store and
pay it. In this example it is a good alternative as the person is walking,
which is a physical exercise and also pays less tax.

Insurance
Insurance is a great way of dealing with the risks but unfortunately, there
are some situation’s that insurance fails to cover or it simply cannot be
insured at all. The design consultant of a design and build contractor is
very unlikely to get a professional indemnity insurance because the liability
owed by the design consultant is fitness of purpose and one with a very
minimum knowledge about how an insurance works can figure that out,
provided they are aware of the term “fitness of purpose”. Besides, most of
the construction works are insured by either of the parties in a contract.
Professionals shall cover them through a professional indemnity insurance
against the risk of failing to perform their duties aligning with the expected
level of skill and quality.
4. PROCUREMENT METHODS
 TRADITIONAL

As the name suggests it’s the oldest procurement method. The other
name for traditional procurement is separated procurement method. This
method lets the client appoint an architect who will be presenting the
ideas of the client in a drawing format. Once the outline structure is
finalized the client or the architect himself outsources for a working
design and the cost estimation. These groups can be individual or
collaborative and are liable to client. Upon framing a brief scope of the
project, the client invites tenders from the contractors. The lowest bidding
contractor and the client enters into a contract. The terms of the
contract will be made according to the type of separated procurement
method. Separated procurement is classified as follows:

o LUMP SUM CONTRACT

In this type of contract, the contractor agrees to complete the
defined work within quoted budget. In this type of contract, the
essential information and documents to determine the cost of work
will be provided along with the tender invite. The contractor will be
given enough time to plan and analyze the best possible way that
is sustainable and is of minimum risk and quotes his price. This type
of contract is usually recommended for the construction of public
buildings and services and it suits a contractor who is well
experienced, highly potent and resourceful. The risk meter of the
client is relatively lesser as the price is fixed. Although, the cost
might vary due to changes in scope but not as much the other
contracts, and that explains that change orders from the client is
not restricted. On the other hand, the risks on the contractor end is
high as they will have minimum provisions to include the culpable
delay or error in construction. Moreover, the interpretation of risks in
each and every clause is subjective to the stakeholder. According
to a study featured by Hartman, the commonly misinterpreted
clauses are the payment clause, delays, temporary structures,
mutual responsibilities and damages, rejection of work, disputes
and changes. He suggests an effective risk allocation and
communication between the parties prior to signing the contract
 so that the relationship between the parties remain harmonic.
(Hartman, 1996)

o MEASUREMENT CONTRACT
In this type of contract, the actual cost of the project cannot be
determined in the tendering stage, but a re-measurement of the
works done is finally calculated and the bill is settled. Let’s consider
an Eco-park project to understand this type of procurement. The
project brief states that an eco-park must be constructed on
barren land that features a man-made lake along with other
normal facilities of a park. The land has to be excavated in order
to build a man-made lake. Considering this situation, the land that
has to be excavated cannot be accurately determined in the
initial stage. Therefore, in these type of construction works, a
measurement contract is preferred. The contractor and the client
have to document the amount of land excavated for future
references and also to maintain a healthy relationship between
the parties. Measurement contract may lead to fraudulent
activities if the client fails to pay proper attention. So, this contract
expects that extra attention from the client. However, risks are still
high in the contractor end. The possible risk the contractor might
face in the above-mentioned project would be because of
natural calamities. Let’s assume that over 75% of excavation is
completed and now the site is experiencing heavy rainfall that
eventually leads to flood. The contractor is safe if the contract has
a provision for such calamities. Even though, it is very difficult to
anticipate the real time situation well in advance to extend the
provisions of contract to such uncertainties. It is suggested to have
a proper risk allocation considering these situations and also draft
a contract that clearly explains it.

o COST PLUS CONTRACT

It is one of the traditional methods of contracting which is defined
as contract where a contractor is paid for all of its allowed
expenses, plus additional payment to allow for a profit. The
additional cost can be recovered in various forms such as cost plus
fixed-fee, cost plus incentive-fee, cost plus award-fee and cost-
plus percentage-fee. The usage of this contract evolved during the
early 19th century by the US Government. They saw huge potential
in adapting cost plus contract as contractor does not have to
 inflate the price to cover the risks. Moreover, this contract features
a good quality outcome with very minimum compromise in
aspects of performance.
The final costs of cost plus contract is expected to be lesser and
more efficient compared to other forms of contract and also it is
flexible in allowing changes to the project("cost plus contract,").
Despite of having a good oversite and control over the significant
aspects of the project, there exists feebler certainty on what the
final cost is going to be. Poole suggests that the client must
exercise administrative measures to make sure that contractor is
controlling the overall cost of the construction. In case of cost plus
percentage type of contract, the more the construction cost, the
more the contractors profit.

 INTEGRATED

In this type of procurement method, the contractors own the

responsibility for the design and construction of the project. Unlike
traditional methods, this method enforces good cost benefits and
reduces the risk on the owner’s side. The major highlight of this method of
procurement is that, it consumes lesser time compared to other methods
as it facilitates the construction and the design work to happen
concurrently.
The processes can be broadly classified into client’s and contractor’s
responsibility. The client’s responsibility includes the initial stages of a
project such as forming the project brief, a feasibility study and tender
documentation. On the other hand, the contractor’s responsibilities
include concept design, tendering and contracting, design,
construction, commissioning and handover.
The integrated procurement method provides the client with a single
point of contact to develop his idea and it also excludes the client from
participating in the disputes between the contractor and the design
consultant as both the services are offered by a unilateral group. The key
point supporting the contractor in design and build procurement is that
greater degree of cost planning and estimation.
Furthermore, the construction process is expected to speed with this
procurement method which is a mutual benefit for the owner and the
contractor.
Integrated methods are adapted when the building is functional, simple
and the responsibility should be taken by unilaterally operating
organisation.
Some of the variants of integrated procurement are as follows:

o DESIGN AND BUILD

Considering this method from the owner’s perspective it is easier as
the responsibility is held with a single organisation, which means
the quality of communication amongst the stakeholders is high
and the owner’s contingencies are less.
As we speak about the responsibility, risks are also a part of it. The
builder takes the ownership of risk, but the history says that it is
reflected in a sustainable form where the time and money used for
construction is highly conserved. In this system, the client contracts
Fluor Intercontinental, Inc. v. Department of State, CBCA Nos. 490, 491,
492, 716, 1763, 1555, 12-1 BCA ¶ 34,989

The department of state had awarded a fixed price design/build

contract to Fluor to construct an embassy in Astana, Kazakhstan in the
year 2003. The contract documents contained Standard Embassy
Design, Site utilization Plan and Engineering Feasibility study report.
Flour’s representatives made a pre-proposal site visit. The plaintiff
(Flour) applied for a 24 million dollar claim that consists of infrastructure
claims, pile encasement claims and perimeter wall claim. The Civilian
Board of Contract Appeal (CBCA) declined all the claims raised by
the claimant. The infrastructure claim was denied as Flour was aware
of the site conditions before entering into a contract with the
Department of State. Pile encasement was executed by Flour as the
initial design exceeded the local subcontractors driving capacities,
which was notified to the Department of State after construction to
get the respective approval and ended up with a partial approval.
The CBCA rejected under the grounds of “negligence to get approval
before execution” according to the contract document. The
perimeter wall and the foundation encroached the neighboring
property, failing to abide by the international building code of footings
below the frost line. The CBCA categorized claimant to be “seek[ing]
to distance itself from the responsibilities that it took on as the
design/build contractor…. The risks, and the consequences, of Fluor’s
design choices fall solely upon Fluor.” (Stuart, June 19, 2013)
 with the builder that can either be a joint venture of a contractor
and a designer or the designer can be a consultant of the
contractor or a single firm that acts as designer and builder.

The risks in design/build contract could be adversarial if the

contractor fails to adhere to the conditions of the contract which is
explained in Flour’s case.

o PACKAGE DEAL
Some of the basic ideas are similar to design/build type of contract
but the involvement of client is even more lesser compared to DB.
This method offers the client with a standardized set of buildings
that are functional type. Moreover, the contractor follows a
repetitive theme and minimize the scope for innovation in the
project. This will suit the clients who are willing to buy a property
that is completely based on the ideas of the contractor complying
to half baked satisfaction. Some examples of such constructions
are townships, retirement village, etc. These contracts
predominantly exist in highly populated countries and the target
clients are lower middle class to upper middle class people. The risk
allocation is entirely on the developer’s shoulders as he/she is solely
responsible for the entire package.

While the other types of contracting under integrated procurement are

turnkey contract, develop and construct contract and Novated design
contract. These contracts and the corresponding risk allocation are similar
to design/build or package deal or in-between both. The speculative risks
in these types of contract ultimately fall on the contractor’s shoulders.

Although project delivery methods for design-building have existed since

before the pyramids (and have reportedly been used to build them), they
are only beginning to re-emerge significantly into our modern high-speed
business and litigation society. In the crucible of the twentieth century,
traditional construction contracts have been tested for fire for almost 100
years. Design-build contracts have received only a fraction of that
scrutiny, so their risks and problems are less well understood and the
contractual arrangements for their resolution are less well-settled. The
model contract documents of the Design Build Institute of America
represent an interesting and useful allocation of risks for design-building
projects and may actually become an industry standard for such
contracts similar to AIA documents in traditional projects.(Poole, 2013)
  MANAGEMENT CONTRACTING

Illustration of management contracting and construction management

(Friedlander, October 2003 )

Management Contractor and Construction Management are both suitable for

large projects that require early on-site start-up. These are costs–contracts that
can be reimbursed, with a fee being paid to the management contractor and
the construction manager. The main difference between the two procurement
systems is that all the works are carried out by the sub-contractors and are
contracted to the management contractor. whereas, in the other hand in a
construction management procurement method, the trade contractor who
carries out the work is entitled to the employer directly.

The management contractor acts as a principal in legal terms, while the

construction manager acts as an agent. This means that the customer has only
one contract to administer on a management contract (whereas there can be
many contracts for the customer to administer with construction management),
but they might want work contractors ' guarantees so that they can make a
direct claim. It is likely that the agreement between the client and the
management contractor will cover both pre-construction and construction
activities, with a notice to proceed between the two, before which contracts for
works cannot be allowed. It is also likely that collateral guarantees will be
required. Moreover, the customer is likely to define contract terms for the works
and any work contract warranties requirement.

There is an opinion that believes that if a management contractor operating on

a cost plus fee arrangement pursues a non-performance works contractor in
court, the management contractor cannot prove loss and damage. This is
because the loss is simply passed on to the customer, so the damage has been
incurred by the customer. This has increased the tendency of customers to
require direct guarantees from each contractor of works.

A management contractor may be reimbursed based on fixed or variable costs

(the contract costs of the works), plus either a percentage fee, a fixed fee, or on
a target cost basis. The terms of the appointment must be clear about what the
Management Contractor will provide (such as the provision of site facilities) and
whether activities are pre-construction or construction services.
 5. CONCULSION
Almost all the construction contract is provisioned with risks in various forms and
in most of the cases the contractor or the client goes without fully understanding
the risks. The darker side of the construction contract can be brought to light, by
simple using plain language drafting. Even though, sometimes there is an
escalation due to unforeseen reasons. The following are the keen clauses and
their applications that a contractor or client must pay attention to avoid
disputes and maintain a harmonic relationship.

• Responsibility for pre-construction site conditions and provisions on differing site

conditions discovered throughout construction.

• Optimally, the development documents ought to fully-disclose all the

knowledge illustrious to the owner and style skilled and indicate however bidders
and also the contractor could get such info and indicate that info on that
bidders and also the contractor could swear.

• Indemnification provisions. Such provisions ought to be affordable and may

cowl solely losses incurred due to the indemnifying party’s negligence. •
Insurance provisions, together with that entities area unit to be extra insureds,
and a demand for a discharge of exchange by the insurance carrier(s).

• Contract time provisions, together with liquidated damages and

bonus/penalty clauses. several non-standard contracts contain “no-damages-
for-delay” provisions that area unit clearly is unlikable by contractors. Some
contracts embody associate escalating schedule of liquidated damages
amounts, typically that there's no rational basis.
• Clauses that ensures site safety conditions.
• Provisions on the work control. This can be usually the contractor’s
responsibility; however, several non-standard contracts disrupt the owner into
evaluating the contractor’s employees’ fitness and competence of
subcontractors, judgement the satisfactoriness of the work on a concurrent basis
which transfers the risks to the owners for which the contractor has to held
responsible.
 6. References

1. Baccarini, P. D. P. L. D. Building Procurement Methods. In. Melborne

Cooperative Research Centre for Construction Innovation
2. cost plus contract. wikipedia. Retrieved from
https://en.wikipedia.org/wiki/Cost-plus_contract
3. Friedlander, M. C. (October 2003 ). Risk Allocation in Design-Build.
4. Hartman, F., & Snelgrove, P. (1996). Risk Allocation in Lump-Sum Contracts—
Concept of Latent Dispute. Journal of Construction Engineering and
Management, 122(3), 291-296. sci-hub.tw/10.1061/(asce)0733-
9364(1996)122:3(291)
5. Keating, E. (2015). The 10 riskiest industries for 2015-16 – and the 10 safest.
Retrieved from https://www.smartcompany.com.au/
6. Masurier, E. H. J. L. (Sept 2002). The Contract In Sucessfull Project
Management. Christchurch: Centre for advanced engineering.
7. Poole, W. S. (2013). Adapting to Flexible Response 1960-1968. History of
Acquisition in the Department of Defense., 50-52.
8. Savage, D. (Producer). (2015, march 27). UK: Procurement Options For Your
Middle East Project.
9. mondaq. Retrieved from
http://www.mondaq.com/uk/x/383966/Government+Contracts+Procurement+P
PP/Procurement+Options+For+Your+Middle+East+Project
10. Stuart, S. (June 19, 2013). Risk Allocation in design/build contracts.
www.smithcurrie.com.
cost plus contract. wikipedia. Retrieved from https://en.wikipedia.org/wiki/Cost-plus_contract
Friedlander, M. C. (October 2003 ). Risk Allocation in Design-Build.
Hartman, F., & Snelgrove, P. (1996). Risk Allocation in Lump-Sum Contracts—Concept of Latent Dispute.
Journal of Construction Engineering and Management, 122(3), 291-296. sci-
hub.tw/10.1061/(asce)0733-9364(1996)122:3(291)
Poole, W. S. (2013). Adapting to Flexible Response 1960-1968. History of Acquisition in the Department
of Defense., 50-52.
Stuart, S. (June 19, 2013). Risk Allocation in design/build contracts. www.smithcurrie.com.