november 2013 brochure

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  • Whats your appetite for risk?

    November 2013

    Much of this, our third brochure of 2013, is dedicated to the topic of risk allocation in construction contracts, and in particular, the practice of risk shifting. It is a practice which appears to have increased markedly in recent times, perhaps as a result of the slowed activity in the sector over the last few years. As Director, Alastair Oxbrough, explains in his paper on the subject which he presented to a gathering of the Building Dispute Practitioners Society in June 2013 shifting risk down the supply chain, in the absence of any proper analysis, can lead to unintended results for the procuring party and does not necessarily protect such a party from the financial consequences of risk.

    The debate surrounding proper risk allocation has been ongoing for some time and is set to continue. Industry leaders and academics are starting to talk about a thorough review of the Australian Standards suite of contracts in the next few years. Research projects

    are also being considered in order to evaluate how successful the current suite of contracts has been in delivering construction projects, particularly in terms of the financial outcomes and the impact on the parties commercial relationships. As Alastair explains in his paper, risk allocation can have a significant influence on both of these areas.

    Keeping with the risk theme of this edition, we have also included an article on the subject of no-fault indemnities. This type of indemnity is now regularly being used as an alternative to the traditional liability-based remedies of breach of contract and negligence. Whether you are a principal, contractor or consultant, it is important to know how to spot these provisions and the elements they are likely to contain, so that you can negotiate them effectively.

    We hope that you find the articles in this edition of interest.

    Risk shifting in building contracts 2

    No-fault indemnities 14

    Discussed inside:

  • Risk is part and parcel of carrying out construction work. While it has always been and will continue to be a hot topic during contract negotiations, a careful and considered apportionment of risk in the construction contract, along with good risk management practices during project execution, can go a long way to mitigating any adverse consequences for the parties if risks do eventuate.

    In recent times, we have noticed a strong tendency in the industry towards more one-sided contracts, where the vast majority of the risk is sought to be shifted onto one of the parties. In order to achieve this, contract drafting has become more sophisticated, with lengthy, bespoke building contracts being preferred over standard forms, such as the Australian Standards. In those instances where standard forms are still being used, they are being amended heavily. The risks are often then flowed down the contractual supply chain to some of the more vulnerable subcontractors and suppliers.

    Risk shifting in building contracts

    Author Alastair Oxbrough

    Based on papers presented to the

    Building Dispute Practitioners

    Society (Victoria) in June 2013

    and the Law Society of South

    Australias Construction Law

    Conference in October 2012.

    2

  • 3As this research suggests, onerous contracts and clauses can lead to disputation and a general breakdown in the commercial relationship between the contracting parties. The cost of these disputes, both in terms of the legal expenses and lost management time, can be significant.

    In exploring the utility or otherwise of risk shifting, it is instructive to consider the following issues:

    (a) What are the traditional concepts of risk allocation and risk transfer, their underlying principles and are they still being applied in todays industry?

    (b) What are some examples of onerous provisions that currently appear to be popular in the market and are they onerous, when one has regard to traditional risk allocation principles?

    (c) What are some of the reasons why the perceived increase in onerous provisions might be occurring and what are the consequences?

    This trend has not gone unnoticed by other players in the industry. For example, consultants AECOM conducted a global survey of development costs recently and found that Sydney ranked as the fifth most expensive place in the world in which to build commercial developments, high rise and hotels.1 AECOM cites high labour costs and a less collaborative approach between stakeholders as the key reasons behind its finding. It also suggested that Australias construction market is the most adversarial in the world.2

    A similar trend may be emerging in the United Kingdom. Global built asset consultants, EC Harris, in their latest Global Construction Disputes report, titled A Longer Resolution, state that:

    UK disputes tend to be attributable to parties taking a less collaborative approach to projects than in other markets. For example, the employer imposing change and conflicting party interests feature highly.

    2012 saw an increase in disputes arising from parties failing to understand their contractual obligations which on the larger, mega projects often arise as a result of clumsy, sometimes over legalistic, drafting of the generally bespoke contracts. If owners / employers adopted standard forms with less amendments this problem could be reduced. 3

    The outcome of onerous contracts is often disputes and a breakdown in the parties commercial relationship.

    1 AECOM, Blue Book 2013 (15th Edition), 2013.2 Blue Book 2013, above n 1 at 6. See also AECOM & Davis Langdon, Infrastructure Construction Sentiment Australia Survey, June 2012.3 EC Harris, Global Construction Disputes: A Longer Resolution, 2013, at 10.

  • 4All construction projects involve risk and there are many risks which are common to most construction projects, for example, inclement weather and ground conditions.

    If these risks eventuate on a construction project, adverse consequences are likely to result. The immediate consequence might be delay to the completion of the works, but almost always the ultimate consequence is a financial one.

    One of the primary purposes of a construction contract is to record the parties agreement as to who is to bear the responsibility for these risks and their financial consequences, or whether the risks are to be shared in some way. The process of risk allocation is simply the determination of which project party is to bear the responsibility for the risks that have been identified in respect of the particular project at hand, which is then recorded in the construction contract.

    An appropriate allocation of risk can become an important part of a projects risk management strategy.

    An appropriate allocation of risk in a construction contract can become an important part of a construction projects overall risk management strategy.

    This responsibility for a risk is typically reflected in a contractual obligation; for example, the contractor might be obliged to complete the works by a specified date, which carries with it the risk for delays other than those for which it might be entitled to an extension of time.4 Those delays for which an extension of time may be granted are at the principals risk. If the contractor does not achieve completion on time because of a risk it agreed in the contract to bear, then it is likely to be liable to pay damages (liquidated or otherwise) to the principal as a consequence.

    Risk allocation and transfer

    4

  • The concept of risk allocation has been around for some time, and a number of principles have been developed. Arguably the most well-known set of principles are those expounded by construction lawyer Max Abrahamson, commonly referred to as the Abrahamson Principles5. The principles were also adopted and championed by the Joint Working Party of the National Public Works Conference and the National Building and Construction Council in their 1990 report No Dispute: Strategies for Improvement in the Australian Building and Construction Industry (No Dispute). Page 6 of No Dispute sets out the Abrahamson Principles, as follows:

    a party to a contract should bear a risk where:

    The risk is within the partys control;

    The party can transfer the risk, e.g. through insurance, and it is most economically beneficial to deal with the risk in this fashion;

    The preponderant economic benefit in controlling the risk lies with party in question;

    To place the risk upon the party in question is in the interests of efficiency, including planning, incentive and innovation;

    If the risk eventuates, the loss falls on that party in the first instance and it is not practicable, or there is no reason under the above principles to cause expense and uncertainty by attempting to transfer the loss to another.

    While there has been some debate about the particular application of some of these principles in practice,6 their main thrust namely, that risks should be allocated to the party best able to deal with them, both physically and economically in the authors view, still holds true today. Indeed, they are still reflected at State and Federal Government level within the National Public Private Partnership Guidelines, in which a full risk analysis is recommended for all PPPs.7

    The adoption of sound risk allocation methods is also seen as one way of reducing cost and the incidence of claims and disputes in the industry. For example, Young and Bhuta in their paper Effective Risk Apportioning in Contracts, list a number of benefits of good risk allocation, such as the following:

    a. Those most capable of controlling a risk have the ultimate capability of minimising the risk eventuating.