How construction clients could be taking on too much risk

If you place insurance for construction clients, they could be signing contracts that saddle them with risks that they should not be taking on.

“We are beginning to see tenders coming out where not enough design work has been done for prospective contractors to properly price their bids, yet contracts are awarded anyway, leaving the contractor to fight for additional compensation due to changes in design after the bid,” Bob Landy, vice president of corporate surety and specialty at Intact Insurance, said in a recent interview.

It’s an issue that is on the radar screen for providers of surety bonds, because some bonds cover the risk that the client fails to complete a construction project or pay its contractors.

One trend in the construction market is a tendency for construction project owners to have a contract wording that transfers more risk to the construction contractors, compared to how contracts would tend to have been worded in the past, Landy said.

The risks in a construction contract are very different from the kind the companies are used to, John Macomber wrote in an earlier article for Harvard Business Review. “It is often impossible to predict exactly what a project will cost and how long it will take to complete, and it is always difficult to coordinate a dozen professionals—architects, engineers, contractors, bankers, lawyers, consultants, many with their own hidden agendas—and scores of subcontractors, suppliers, and workers,” he wrote.

Suppose, for example, that the design work is not detailed enough for a contractor to properly price its bid. After the work starts, a contractor might realize that once the design is finished, there is going to be “significant cost-creep to remedy some of these design shortfalls,” Landy said.

“That always ends up with a lot of finger-pointing and disputes, which clog up the payment process in the construction food chain,” said Landy. “Owners are getting frustrated with this mess, and they are looking at coming up with new partnering arrangements with designers, engineers, general contractors and maybe key subtrades, to work together to design and identify the costs for what the contract will provide.”

One example is the integrated project delivery model of building contract. “It’s really changing the whole relationship structure and taking out the adversarial approach,” said Landy. “Each of the parties sign on to this sort of ‘group hug’ process and they set aside the profit to the project and a bit extra that sits off to the side.”

The parties only get this profit back when the whole project is completed.

“If some of that profit has to go back into the project to clean up some things that didn’t go so well, everybody is on board with that, including the owner,” said Landy.

Construction projects can have hidden risks. For example, the site could turn out to have hazardous waste that neither the owner nor the contractor were aware of when the contract was signed, Macomber noted in Harvard Business Review.

Delays due to bad weather is another example of a risk that could be borne either by the project owner or by the contractor, depending on how the contract is worded, Altus Group noted in a paper submitted earlier to Infrastructure Ontario.

Other examples of risk cited by Altus include defects being discovered during the construction process, strikes and lockouts, and not getting a building permit from the municipality.

In one contract dispute that went to court, a project owner specified what type of pipe the contractor had to supply, the Canadian Construction Documents Committee noted. The pipe turned out to be defective. The contractor was on the hook – even though the contractor had to supply pipe according to the owner’s specifications – because the contract stipulated that the contractor also “warrants and guarantees that the goods are free from all defects arising at any time from faulty design in any part.”