Construction Project Risk-Management Strategies in a Challenging Market

DISPUTES LESS LIKELY WITH A CUSTOMISED APPROACH

Managing disputes is always a significant risk when it comes to major construction projects. However, with the current decades-high inflation rates and the continued impact of COVID-19 pandemic and the Russo-Ukraine War, principals and contractors must also deal with additional challenges.

We have highlighted three crucial ways to avoid disputes in construction projects:

1. 1. Realistic cost assessment: This involves accurately assessing the project’s ultimate cost and the contract price to avoid unrealistic expectations.
2. 2. Engaging delivery teams: It is essential to ensure that delivery teams are adequately informed and prepared when contracts are awarded.
3. 3. Flexibility and creativity in addressing risks: Specific risks should be dealt with creatively and flexibly, with a focus on better sharing of high-risk areas of the project.

 

 

BE REALISTIC ABOUT COSTS IN A DISTRESSED MARKET

Over the past two years, there has been a noticeable increase in the number of construction companies going bankrupt, with many contractors struggling to deliver projects on schedule and at a profit due to a range of challenges. Despite the media attention given to prominent collapses like Probuild, Grocon, Condev, and Clough, the issue is widespread. Between January and July 2022, 918 construction firms went into administration, which is a 55% increase from the previous year.

A PERFECT STORM

The issue of inflation is significant for contractors as they continue to face multiple headwinds, making it challenging to deliver projects within the budget and on time. Over the last year, contractors have reported cost increases of 70% for structural steel, 30% for asphalt supply and placement, a 100% increase in the cost of cable supply, and a 15% increase in skilled and general labor costs. Besides, the current infrastructure boom has resulted in a shortage of labor, leading to a spike in labor costs and inefficiencies in project works. Additionally, the procurement of materials remains unpredictable and delayed, causing legitimate delays and disruptions to contractors.

This has created a “perfect storm” for contractors, as they complete fixed-price projects initiated several years ago, where their tendered costs were well below the true cost of the project. Consequently, many contractors are submitting large claims towards the end of projects, seeking additional time or money from principals to be compensated for their work. Although principals may initially reject such claims, they must be realistic and consider outside-the-contract mechanisms, such as variation payments or settlement deeds, to avoid prolonged disputes and complete the project successfully.

To achieve this, contractors must be nimble and work flexibly, both in terms of program and staging, to fulfill the principal’s reasonable project requirements. In return, principals must avoid simply rejecting contractor claims and collaborate with them to address the challenges that might threaten the project or the contractor’s viability. Early collaboration and open communication are crucial to confront such difficulties and avoid difficult issues that might jeopardise the project or the contractor.

 

 

ENGAGE THE DELIVERY TEAM

After highlighting the significance of effective communication in contract negotiations, handover phase, and contract administration, we now emphasize its importance during project delivery, specifically in terms of:

1. Maintaining clear and consistent communication channels among the technical, commercial, and legal teams of the principal to ensure smooth coordination and collaboration.
2. Encouraging proactive engagement of the principal’s delivery team with the contractor to overcome any potential project obstacles or challenges and prevent disputes from escalating.
3. In the present situation, contractors are dealing with a challenging environment, and as a result, they are resorting to two distinct methods of handling claims. The first approach involves issuing several claims during the delivery phase of the project, creating a lot of noise without making meaningful attempts to resolve them. The second approach entails not raising any claims or disputes during the delivery phase but making significant claims following the project’s completion. These methods pose similar difficulties and lead to ongoing uncertainty and the potential for high costs for the principal.Effective communication is essential to mitigate or avoid these challenges, yet it is often overlooked. Principals need to have strong communication policies in place within their teams and with the contractor to manage the risks. The delivery team must plan ahead and maintain good communication by scheduling regular check-ins, meetings, and updates to keep the commercial, legal, and technical teams aligned. In case of project difficulties, the delivery team should seek input and guidance across the business before taking any action.Moreover, principals can foster a culture of early engagement and constructive communication with contractors to overcome challenges. Contractors will inevitably rely on the principal to share some of the burden due to the ongoing disruptions in the industry. While the principal may adopt a black-letter contract approach and stick rigidly to the risk allocation agreed between the parties, a more collaborative, adaptive, and flexible approach to contract management is less likely to result in costly and protracted disputes.

 

 

ADDRESS SPECIFIC RISKS

Given the current market conditions, traditional approaches to allocating contractual risks may not be appropriate. To accurately estimate project costs, it is important to take into account current market factors, such as supply chain disruptions, as well as past experiences in the Australian market, including common issues that have resulted in cost overruns on major projects.

One area where the market approach has evolved is in the handling of sub-surface issues. For instance:

• Sharing of risks associated with contamination, particularly when the contamination migrates onto the project site through no fault of the contractor.
• Relief for the contractor in unforeseen geotechnical risks, such as when geotechnical conditions differ from the assumptions made in geotechnical baseline reports.
• Sharing of utilities risk where utility locations are outside agreed tolerances.

 

It has become common and beneficial for principals and contractors to discuss these issues during the procurement process. In addition, there is no reason why other challenging risk issues cannot be resolved creatively and flexibly. Input costs are one such challenge that is currently being addressed differently in the Australian market.

For example, the approach to allocating input cost risk has changed significantly in 2022. Traditionally, major infrastructure projects in Australia did not include ‘rise and fall’ mechanisms. Contractors bore the risk that their pricing would sufficiently allow for escalation of input costs, such as materials and labor, during the project’s delivery. However, this traditional approach is changing.

To successfully develop an escalation-risk-sharing mechanism, it is important that:

• The contractor recognizes that sharing escalation risk involves a reduction in contract price and is transparent about how it has calculated its price buildup for inputs proposed for the mechanism.
• The principal accounts for its assumption of escalation risk in the project’s probable ‘ultimate cost.’
• The parties identify and agree upon the factors that should be considered when negotiating a risk-sharing mechanism, particularly given that many parties may be unfamiliar with the development of an escalation mechanism for a significant project.