Risk Mitigation Through Contracts

By Lars Theil-Lardon (MBA)

In my years as project manager, one thing my clients have valued most is the security of their funds or at least the knowledge of the last final figure.

At university they teach us that through planning 70% of the total expenditure of a project can be predetermined and secured. Life teaches us that clients usually do not want to go the extra mile in the planning process either due to time constrains or overconfidence.

Under these circumstances risk management helps to determine potential risks, which deviate from the desired project goal, and eliminate, isolate or minimize them. In the current market, dealing with risks and their potential influences can’t make up for inefficient planning.

In my personal opinion risks are best managed, some even avoided, through a solid written contract. However, this can only be achieved if the planning phase has been correctly and robustly executed. I have been in the construction sector for the last 6 years and I can recall that the most project issues came through wrong client expectations and sloppy written contracts. Many of my fellow engineers and project managers dealing with Local Government Agencies are using NZS3910 as their contract construct, but forgetting to personalise the contract with the particular project they dealing with. Sometimes recommendations made by the Engineers or Project Managers are rejected by the Clients as they are different to their standard contract conditions.

Now most of the readers will ask themselves, ‘why is this guy talking about contracts and risks avoidance in the same moment?’ The answer is easy. With a good and solid contract the client can avoid additional risks and with a sloppy written contract they will create additional risks. For example, if you predetermine your design in detail, you can anchor all the items in the contract document. As a client you will rely on the knowledge and experience of your consultants to get an understanding of the construction period. Even if the suggested timeframe is longer than your anticipated plans allowed for, try not to restrict the time by specifying the contract period shorter than it actually takes. Most contractors will still sign contracts with overly short contract periods, but they will work on potential extension of time from the early days. One piece of major advice is that a client shouldn’t change any plans or objectives after the contract is signed. A move like this will expose the client to a risk that the price for the variation is no longer the lowest market price and an extension to the contract period will be added.

Another catastrophic risk which can be eliminated with a contract is the reserves for any damages. Every construction contract has retentions placed on the suppliers. The maximum should be within 5% to 10% of the construction sum. This money can be used as funding source for any claimed damages after the project is practically complete and payment has occurred. I remember one of my contracts, where a maximum retention sum of $100K (equal to 1%) was specified. Three payments before the contract finished, potential applied damages were identified as being in the order of $300K to $500K. As you can imagine, the client got very nervous due to the fact that he was exposed to the risk of having to claim the damages from the contractor as invoices. This situation is not a single case - rather a regular thing.

A last but major risk is ambiguity of the contract. Some contracts are rushed and therefore mistakes, minor as well as major ones, slip into the contract. These ambiguities are risks which can cause financial implications to the client and frustrations on all sides of the contract. As a guideline to good management practice, all contract documents should be proof read at least 3 times preferably by 3 different people. At best one of these people should have had no involvement in the design process at all. With the increase in complexity and value the number should be increased too.

In my current project a lot of frustration between the contractor, client and consultant could have been avoided, if the document would have been closer examined before it was released for tender.

But every contract has its limitations and some unforeseen issues, such as unexpected ground conditions, can’t be eliminated. For these events and many others like delivery issues, theft, vandalism and so on, a well prepared risk management plan will govern the way through the risk world.

Lars Thiel-Lardon (MBA)

Professional Management Services 2009 Ltd

Lars studied at the University of Rostock and graduated in 2004 with a MBA. In 2005 he immigrated to New Zealand and works since in the construction sector.

Lars is specialised in civil and building construction projects and managed a number of construction projects in New Zealand. For the last 15 months he is involved with the Morrinsville Wastewater Plant Upgrade on behalf of Matamata Piako District Council.

Lars is also the Bay of Plenty Sub-Branch Coordinator.