April 1, 2010

Risk Management in a Competitive Market


By John Hickey and Katie Jeremiah

Spring 2010

The lack of available construction work has increased competition among contractors. While contractors may be tempted to shortcut the basics of risk management to remain competitive, some simple strategies will help manage risk without jeopardizing the ability to stay competitive.

Read the Fine Print

Construction contracts distribute risk among the parties to a project. For example, most prime contracts have a clause saying that the owner will pay for additional costs if the site conditions turn out to be different from those shown in the plans. Without such a clause, the contractor pays the additional costs.

Some frequently overlooked and misunderstood risk-shifting clauses include those that address claims, insurance, and the contract documents. Most modern prime contracts have notice and claim clauses that govern requests for additional compensation and time. Subcontracts have two layers of requirements — meaning that a subcontractor must satisfy the notice and claim requirements of its own contract with the prime contractor and also the prime contractor's contract with the owner.

To avoid inadvertently waiving the right to recover additional compensation and time, contractors should make sure that all management personnel for a project read the notice and claim requirements and know whether there is a second (and often overlooked) deadline for submitting supporting documentation.

Long and complicated insurance clauses should not be ignored. Failing to name a party as an additional insured or to comply with other requirements buried in the multiple paragraphs governing insurance may cause an insurance company to deny coverage. A simple way to manage insurance risk is to send your insurer a copy of all contracts you intend to sign, and confirm with it before you sign the contract that your insurance policy is sufficient.

All documents specified as being part of the "contract documents" will be considered part of the contract — and will be enforced even if they were not read. Contractors should not sign a contract until they have read all documents listed as "contract documents" and have evaluated how those documents taken together distribute risk.

Surety Relationship

While bonding requirements are not new to public construction projects, surety requirements are tougher now in response to the current economic times. As a result, it is more important than ever for contractors to maintain a good relationship with their surety. Communicate frequently and accurately. In addition to providing year-end financial statements, periodically send interim financial statements and progress reports for all ongoing projects. Take the time to review everything you give your surety because unreliable information will negatively affect your bonding capacity. Also consider delivering information in person. Meetings allow for questions to be answered quickly and for you to learn about your surety's expectations. Most important, tell your surety about problems early. Remember, sureties have no interest in seeing a contractor default on a project, and they may be a source of help.

Smart Growth

While few contractors have considered growing recently, many have considered expanding their scope of work, project types, and geographic territory. For example, contractors who formerly worked only for private developers are now bidding on public highway projects. With unfamiliar projects come unfamiliar risks — and those newly-minted highway contractors may be unpleasantly surprised by the hidden costs associated with the formalities of a public project.

Before taking on an unfamiliar project, contractors should consider how they can gain experience in a new area without taking on unreasonable risk. Partnering or joint-venturing with a contractor who has more experience with a different market may be a way for a contractor to mitigate its risk while gaining valuable experience. Although partnering has risks of its own, careful consideration of a partner's financial statements, reputation, and any joint venture or partnering agreement (by your lawyer) will minimize such risks.

A contractor's risk management policies are always driven by facts unique to each contractor. Considering those facts and the strategies described above will help contractors manage risk while staying competitive.

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