Contractual Risk Management Tips for Construction Companies
ALM Media
Updated
When contractors hear the phrase "risk management" they often think of on-the-job duties first. Do I have the correct safety protocols in place? Am I managing our project timelines accurately? Are my workers being compensated fairly? While these questions are all important to ask, what many companies fail to realize is that most risk-management planning begins before the first shovel of dirt is overturned.
Managing the potential for risk during the contractual phase of a project is the best way to avoid costly and sometimes catastrophic consequences in the long run. The contract is the foundation of the agreement it determines who is responsible when the unthinkable becomes reality. Yet, despite their importance, many companies avoid seeking legal counsel when finalizing contracts to save the additional time or financial commitment that comes along with employing extra support.
Regardless of the project, it's critical to remember that no one can predict the future almost every issue that arises is unexpected and finding ways to limit your potential for risk contractually can make all the difference. To assist with this process, we've mapped out four key areas that typically require additional attention from legal counsel when finalizing construction contracts.
Insurance
Insurance is one of the tools most often used to manage risk on construction projects. Depending on the policy, construction insurance can provide coverage for materials, liability exposure (including risk transfer), natural disasters, labor issues and even loss of use. Surprisingly, however, the insurance parameters within a contract are often overlooked as most company leaders mistakenly assume they already have the coverage required by the contract. In determining insurance requirements for construction contracts, it is important to identify all potential risks associated with the project to make sure the policy terms and limits are adequate to cover any potential losses. Companies also may consider partnering with an insurance expert that has specialized knowledge with respect to construction insurance.
Indemnity Provisions
Simply put, an indemnity clause is a provision that seeks to transfer risk from one party (indemnitee) to another (indemnitor). In construction contracts, it is common for a contractor to be required to indemnify the owner against claims and liability. Subcontractors also are typically required to indemnify the main contractor as well as the owner against claims and liability. Under an indemnity provision, the indemnitor agrees to reimburse the indemnitee for losses resulting from a claim or claims brought by a third party. This agreement may or may not include any attorney fees and costs incurred in defending against such claim or claims. These provisions often are broadly drafted, and many times the drafter of the contract will attempt to skew it in his or her favor. Unfortunately, this means that if companies are not careful, they could sign a contract that has substantial implications if there is a problem. Also, indemnity provisions are often inserted throughout various provisions of a contract document, which means reviewers should take extra care not to skip over any clauses outside the titled "indemnity" section.
Damages
Damages clauses within a construction contract help to manage these occurrences by providing a limit on recovery or eliminating certain liability from either party altogether. In a contractual situation, there are a number of different categories of damages that may be addressed. These categories may include: actual damages, or the amount of money a party lost as a direct result of a contract breach; consequential damages, which are the financial losses a party suffered that were not a direct result of a contract breach, but are related to the breach; and liquidated damages, which set in advance the amount of damages that a party can recover for a particular breach of the contract in situations where quantifying the actual loss may be difficult. Liquidated damages are essentially a way to ensure financial protection in situations where actual damages are difficult to ascertain or prove, and often are linked to project milestones, such as substantial or final completion.
Managing damages provisions is extremely critical during the contract drafting phase. If left open-ended, the resulting cost implications could be astronomical and potentially threaten the viability of the company should something on the project go awry. If the recovery of damages is overly restricted, a party may not be able to seek adequate compensation for any losses it incurs as a result of a contract breach.
Ideally, the insurance, indemnity and damages provisions of a contract should work together to provide a comprehensive plan for managing and allocating risk. A contractual gap in addressing a particular category of risk (and the resulting damages that could ensue) or an over- or under-allocation of that risk to one of the parties could have dire consequences.
Dispute Resolution
When a dispute does arise and counsel becomes involved, the construction contract should dictate how the dispute is to be handled. Typically, when working through contract parameters, parties are left with either arbitration or litigation, which often is first preceded by mediation (facilitated settlement negotiation). Most entities involved in a construction project will opt for arbitration as it is perceived as the faster, more efficient, and more private alternative to litigation. For obvious reasons, owners, contractors and subcontractors alike often prefer to keep any disputes out of the public eye, and with arbitration the only public-facing component is the final decision. However, arbitration can be more expensive than traditional litigation, notably because the parties must pay the arbitrator(s), and may be more difficult to resolve given that things such as the rules of civil procedure and the court system aren't part of the equation. Conversely, arbitration might be the more cost-effective approach for larger claims, especially where parties are looking to minimize discovery and pre-hearing expenses. Taking time to predict what disputes might arise on a specific project and how best they can be handled will help direct the dispute resolution provisions set forth in the contract.
Projects in the construction industry are inherently unpredictable, and problems can occur for any number of reasons making it crucial to protect your company from potential liability. When embarking on any project, large or small, it is important that a qualified legal professional review the contract documents to ensure that the risks are known, accounted for and allocated appropriately.
