Risk allocation in construction contracts

By Marcus Beveridge and Tina Hwang from Queen City Law

Risk allocation is a pivotal point in negotiating construction contracts and all parties approach this with centrifugal force and persistent attempts to drive risk away from oneself.

There are several parties involved in the successful completion of a construction contract including the principal developer, contractor, project manager, engineer to the contract (if any) and various consultants.  Being aware of the risks and managing this in a fair way is imperative for a successful project. If the parties have not already asked (and answered) questions such as “who will be responsible if there are design variations required by Council?”, “who will be responsible if the soil is found to be contaminated with asbestos?”, “who will be responsible for delays in the CCC (Code Compliance Certificate)?”, or “who will be responsible for delays to the critical path due to inclement weather?”, then the project is not necessarily in good hands.
A healthy level of friction between the parties is normal, but if this is not balanced, and there is no tension at all, or alternatively too much tension, this could adversely impact on the development.
We have seen some parties aggressively negotiating to the point that they have no risk at all, and virtually transfer all risk to the other parties. This is obviously not a fair allocation of risk and is likely to detonate
in unexpected ways including, for example, the contractor increasing their costs with a premium margin to cover the accepted risks.
Improper risk allocations can also cause damage by way of protracted negotiations and therefore a delay to the commencement date and practical completion, resources being wasted (where workers may be waiting in limbo to start), and increase the chances of disputes later.
For instance, many days, weeks, or even months could be spent on deciding whether to sign an NZS 3910 contract (where the owner is responsible for the design and therefore the risk of design), or whether to sign an NZS 3916 (where the design risks sit with the contractor).
Further time can easily be wasted on prolonged negotiations on qualifications/exceptions to tenders, bonds, retentions, liquidated damages, basis for extensions of time, what constitutes “inclement weather”, variations, insurance, allowances, provisional sums, (non)payments for off-site/on-site materials, requirements for practical completion, defects liability periods, and the list goes on.

Parties will try to best protect themselves against uncertainty and hence the consequent risks associated with the unknown. Producer statements will also form a major basis for who ultimately took on the responsibility and signed off and approved the works, as will the CCC which has resulted in what may be the billion-dollar leaky building crisis that ratepayers have had to fund through the relevant territorial authorities.
Unlucky individuals who signed producer statements, drawings, or plans may find themselves caught in litigation proceedings several years thereafter while their employer/companies may have been dissolved, struck off, or liquidated.
Recent instances of liquidation/receiverships have resulted in case law enshrining further protective measures for payments of materials stored off site and the devastating effects of not registering your priority on the PPSR (Personal Property Securities Register).
As lawyers, we are trained to always think of the worst situation and how to best protect our clients in such instances, so our brains are naturally wired to be risk-adverse and negotiate/advise accordingly.
However, this often contradicts the market reality and the limited bargaining powers our clients may have in circumstances where resources (financial and labour) are constant drivers in the industry with cash-flow commonly being quoted as the blood flow of the industry.
Therefore, it may be necessary for all  parties to take on some risk in the game of fair risk allocation. While an owner may demand that the price under the construction contract be the “fixed lump sum price, not a penny more with no variations whatsoever”, the reality is that all projects will result in variations and it  is best that all parties are prepared to accept their fair share of the associated risks and uncertainty.
This will likely result in the parties  spending their money on the project and not their lawyers.

If you have any construction or litigation queries, please feel free to contact Tina Hwang or Marcus Beveridge at Queen City Law.