Principles of Risk Management

Risk is an aspect of particular importance both to client and to building contractors in the management of contracts. Risk affects the cost of the work since the contractor’s return on investment is closely linked to the risk involved. In addition, the decision as to whether to proceed with the project, and the contractual and financial structure of the work, are closely influenced by the perceived risk.


The procedures for analysis of risk involve:


1. Identifying the risks associated with the project;

2. Analysing the potential impact of each risk, whether significant or not;

3. Reducing or offsetting risks in so far as practicable;

4. Arranging for risk abatement as applicable.


Risk Abatement and Risk Allocation

Risk abatement is the process of minimising the potential impact of a risk where it is not possible to completely eliminate it. As a general principle the risk should reside with the party best able to control the risk, or to control the results flowing from the risk should it occur. This may be either the client or the building contractor. This results in the most economical costing of the project overall, and encourages care on the part of the organisation carrying the risk. Ideally, a risk should not be passed to an organisation which has no power to control the consequences of that risk. Moreover, a risk should be allocated to one party or another, but not to both. Nothing is gained by doubling the number of risk bearers other than an increase in overall project cost. Risk is not reduced by creating additional liability.


From the client’s viewpoint it is good practice to minimise the risk passed onto the building contractor as far as possible. This generally results in more competitive tendering, a larger field of tenderers, and a reduction in the client’s administration costs on the subsequent contract. Risks which are liable to result in small, frequent losses are best retained by the client or building contractor respectively, rather than being insured for.


The client’s approach to risk allocation may take the following forms:


1. Self-retention of the risk;

2. Insurance, either by the client or by the building contractor;

3. Passing the risk to the building contractor via the contract documents.


Risk transfer under the contract may be covered by the conditions of contract, or by common-law. A degree of protection for the client can be gained by the use of:


1. Monetary deposit or bank guarantee;

2. Surety payment bond or surety performance bond;

3. Liquidated damages provisions;

4. Warranty clause provision;

5. Indemnity provisions.


However, the compensation provided for the client is frequently inadequate and the building contractor may still bear responsibility for risks.


The major risks which are liable to be encountered on a project can be categorised as:


1. Technical and construction risks;

2. Commercial risks;

3. Environmental and social risks.


These may affect both the client and the building contractor. Typical risks are summarised below.



Technical and Construction Risks

Typical technical and construction risks which may apply on a project include:


1. Materials, not estimated correctly, not correctly specified, or unexpectedly variable, etc.;

2. Technical problems at site;

3. Defective system design;

4. Defective material and workmanship;

5. Unavailability or late delivery of plant and material;

6. Delays in program leading to late completion;

7. Site conditions differing from those originally determined;

8. Damage to property during construction;

9. Bodily injury during construction;

10. Accidents on site, safety related delays and need to upgrade safety requirements;

11. Industrial relations problems;

12. Problems during commissioning;

13. Plant fails to perform as guaranteed;

14. Substantial problems during the defects liability period;

15. Failure to instruct adequately;


Commercial Risks

Typical commercial risks which may apply on a contract include:


1. Failure to obtain funds;

2. Construction plant owner goes into receivership;

3. Original project or contract estimate defective;

4. Client goes into liquidation;

5. Contractor or major subcontractor goes into liquidation;

6. Cash flow delay;

7. Regulatory authority delays;

8. Cost increases and overruns;

9. Extreme exchange rate fluctuations;

10. Inflation in excess of estimate;

11. Interest rate increases;

12. Changes to taxation rate and tax structure;

13. Changes to market demands;

14. Inadequate insurance.



Environmental and Social Risks

Typical environmental and social risks which may apply on a project include:


1. Political instability;

2. Changes to government regulations;

3. Unexpected competition in market;

4. Force majeure natural events, e.g. fire, flood, storm, earthquake, subsidence etc.;

5. Force majeure social factors, e.g. civil war, insurrection, strike, lockouts, etc.;

6. Non-availability of skilled and unskilled labour;

7. Increased environmental protection requirements or failure to adequately liaise with environmental authorities;

8. Deficiencies in infrastructure, e.g. transport, communication, etc.;

9. Extreme weather conditions;

10. Difficulties with access to site;

11. Problems with transportation of plant and equipment, or of end-products;

12. Adverse reactions by local interest or residents groups.



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