Society of Construction Law (UAE)

Risk in Construction Projects

A paper delivered at the inaugural meeting of the Society of Construction Law (UAE) on
the topic of Tendering and Risk.

Peter Shaw
Key & Dixon
P O Box 33675
Dubai
UAE

Tel: +971 4 332 3324

Fax: +971 4 332 3325

Email: Peter.Shaw@keydixon.com
Web: www.keydixon.com
1. Managing Risk

1.1 There are many definitions of the word “risk” but the one which I like that has

always stuck in the back of my mind is “risk is a combination of the probability

of occurrence of the risks and their possible impact on the project should

they be realized.”

1.2 Risk management normally falls into two categories, the formal and the informal.

The informal is often a combination of the provisions of contingency sums,

attempts at benchmarking similar projects, and engaging “experts” to give advice.

Such procedures are often reactive rather than proactive. The formal approach

demands both a qualitative and quantitative approach. The issues to be assessed

should include:

• A brief description of all possible risks.

• The stages of the project when risk may occur.

• The elements of the project that could be affected.

• The factors that influence it to occur.

• The relationship with other risks.

• The likelihood of it occurring.

• How could it impact the project?

• Increased time – increased cost.

• Reduced quality and performance.

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 Managing these issues are central to proper risk management and all of these

issues, or the vast majority of them, are present in the risks set out in the next

section of this paper.

2. Where are the risks in the context of a construction project? There are many but

for this paper I have made a personal selection.

2.1 Project strategy. Design and build and turnkey procurement strategies have

become the norm worldwide and are fast becoming the procurement strategy of

choice in the UAE. The perceived rationale is that most of the risk in a

construction project is placed with the Contractor, allowing him to control and

manage it and thereby containing the often dysfunctional responsibility and

communication failures that have bedeviled traditional forms of procurement.

However, Contractors should take careful note of the propensity of Owners to

take advantage of the Contractor’s design development responsibilities as an

excuse for the Owner to change his objectives expecting the Contractor to pay for

it as part of the design development cost. This is colloquially known as “design

creep” and unless the Contractor clearly identifies the phenomenon as a change in

work scope he will find himself assuming an expensive and time consuming set of

risks for which he did not include a price in his tender.

2.2 Structure of the Owner. This can be another hazard which a Contractor should be

keenly aware of at the time of tender. One of the worst Owner structures is a

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 multi-departmental government body where competing departmental interests can

create uncertainty, changes and constant financial reviews. One such UK project

which suffered from such a structure was the New British Library in London

conceived in the 80’s and built in the 90’s. The out turn cost was far in excess of

the original contract sum and the project was delivered extremely late. In fact this

project was cited by the United Kingdom National Audit Office during its

investigation into different procurement strategies for public works which

eventually led to the Private Finance Initiative.

2.3 Complex projects. For those familiar with the way UK hospital projects used to

be procured, the lack of coordination and communication regarding design

responsibility was legion. Some of these projects manifested some of the worst

aspects of traditional procurement. Such projects, heavily dependent on

mechanical and electrical services, led to such services being the responsibility of

the design consultant, the coordination of this design the responsibility of the

Main Contractor and the detailed design of these services the responsibility of the

specialist Sub-Contractor. Meanwhile in total isolation the structural engineer

and the architect were designing the building frame although much of the

cladding system was the responsibility of a specialist Contractor. These

dysfunctional relationships were intended to be managed by team coordination

meeting which were unwieldy and riddled with self-interest. Faced with this type

of arrangement each entity must appoint a focused team leader with authority to

make decisions and the coordinators must meet as often as necessary. Not

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 surprisingly, research has shown that small groupings of decisive people manage

risk far better than complex organizations.

2.4 Project phases. Risk management is a continuous process. Risks identified at an

earlier stage will have changed at a later stage. In addition risks may also change

during a phase as does the nature of the risk. As the project progresses risks also

change from broad brush to narrow issues such as more realistic costs forecasts,

detailed design and the need for more detailed programs. This process of

developing change must be recognized and proactively managed at all stages.

2.5 Human aspects. How do you produce a risk aware manager remembering that

risk is also about taking opportunities as well as managing risk? It is essential

that in any organization that takes risk management seriously there must be the

right environment for openness and discussion, a requirement to focus on the

needs and priorities of the client, realistic baseline schedules, cost estimates and

contingency provisions that in more sophisticated projects can be fed into a risk

model with the aid of appropriate software and, perhaps most importantly,

ownership or responsibility for results from a model or whatever risk management

tools have been adopted.

2.6 Sensitivity of client’s business. The most sensitive is the client’s financial profile.

Checks on client financial soundness are sometimes difficult to do but

nevertheless a Contractor should make what enquiries it can. Conventional loan

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finance often requires the Owner to provide the lender with a charge on the land

and the buildings to be constructed. Many of these arrangements are inflexible

and if major cost or delay overruns occur the Owner may not be able to service

the loan and the Funder may foreclose on the land and buildings.

The Funder may have step-in rights that allow it to stand in the shoes of the

Owner and in such circumstances the construction contract will oblige the

Contractor to recognize the Funder’s rights but often with no obligation on the

Funder to pay the Contractor’s pre step-in payments that may be outstanding from

the Owner at the time of step-in.

Many Owners seek to contract through worthless special purpose vehicles.

Contractors should not be afraid to ask for host company or parent guarantees. If

these are not provided or are extremely limited the contract may not be worth the

risk. A Contractor should not be afraid to walk away.

These days many projects cannot be commercially successful without the removal

of toxic waste and other environmental steps which need to be taken.

Contractors’ responsibilities can be severe and insurance cover limited.

Watch the trends in the market. It is not unknown for Owners to block

completion as they know they cannot use or tenant the building. It is not

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 unknown for an Owner to contend that his building has not been completed even

though the contract administrator would gladly sign it off.

2.7 New technology. The use of untried and/or untested materials can be a huge risk.

This is so in conventional contracting but this inherent risk is magnified if a

Contractor has post construction completion risk through an operation and/or

maintenance contract. In such a situation the selection of certain materials or the

use of such materials which may not have a proven life cycle or which may be

difficult to maintain, present major financial risk.

2.8 Novel methods. Increasing pace of change, customer demands and market

globalization should prompt Contractors to apply risk management techniques to

construction in the same manner as they hopefully apply such techniques to the

management of other areas of their business such as financial, quality, health and

safety and corporate governance. The Turnbull Report [published by the UK

Institute of Chartered Accountants in September 1999] like the Sarbanes-Oxley

legislation in the USA supports sound financial management and corporate

governance regulation. In other words effective risk management. In the

construction industry other methods can be adopted to manage and reduce risk

such as Partnering and Framework Agreements. In 1995 the University of

Reading published “Trusting the Team” which commended partnering to the UK

construction industry. In its introductory section “Trusting the Team” defines

Partnering as “a managerial approach used by two or more organizations to

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 achieve specific business objectives by maximizing the effectiveness of each

participant’s resources. The approach is based on mutual objectives, an agreed

method of problem resolution, and an active search for continuous measurable

improvements.” London Heathrow’s Terminal 5 is being designed and

constructed using such methods.

A Framework Agreement is a long term commitment between the parties to

enable clients to place contracts on pre-agreed terms, specifications, rates, prices

and mark-up that are embedded in the framework to cover a certain type of work

over a period of time and/or in a certain location. Shared knowledge and learning

curves underpin these relationships.

I have seen little evidence of Partnering or Framework Agreements in the UAE

although some maintenance contracts may adopt framework structures.

2.9 Extreme time constraints. A failure to confront over ambitious and illogical

programs and the injudicious use of recovery programs represents one of the

major failures in controlling construction risk. It is perhaps trite to suggest that a

program should be checked to ensure that all the key activities have been

identified and that durations are realistic and the logic links and constraints are

correct. However, experience shows that frequently the project program fails to

identify all constraints and design/construction interfaces so use of risk logs and

regular status reports is essential. The benefits and recommended methodology of

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 sound program planning are of course extolled in the SCL Delay and Disruption

Protocol published in 2002. Details of this document are available on the SCL

website.

2.10 Experience of the parties. Many Owners and Contractors often have no concept

of how to undertake risk management. Many Contractors still believe that risk

management is all about spending vast amounts of money on consultants and on

correcting projects that have deviated from the “hope for the best” style of

management.

Software for planning and estimating is relatively sophisticated and in general

use. Packages for risk modeling and simulation (RMS) are less well known.

However, as projects have become more sophisticated and privately funded

concession projects have become globally popular, RMS evaluation focusing on

political, financial and technical risk is now more widely used. Very specialist

training is required to use RMS techniques and as stated previously in the paper,

acquiring responsibility in order to respond to the results produced can be the

most difficult task of all.

2.11 Regulatory change. Existing legal frameworks and changes in laws during

construction and/or concession periods, conflicting regional and national laws,

changes in regulations regarding importation of materials, changes in company

law, changes in standards of specification, land ownership and royal decrees are

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 all types of risk which are extremely difficult to plan for but the responsibility for

which is often enshrined in construction contracts. In concession projects the

time period for bearing such risk is of a course a good deal longer than the time

taken to construct the project. The allocation of risk and reward should be taken

by the parties willing to bear them. In a concession project risk ideally should be

shared between the promoter and the principal through the concession agreement.

Contractor and operator risks are covered by performance guarantees, warranties

and operating guarantees. Such risks and the ability to ameliorate them should of

course be covered in a raft of sophisticated and well drafted legal documents.

Financial guarantees are also important and it is prudent for Contractors to take

great care as to how they will be paid, particularly for contracts in the developing

world where many of the materials and supplies specific to the project will be

sourced overseas and do not need to be subject to currency fluctuation.

2.12 Bad contracts. Never sign the Owner’s contract without reviewing it. As

appropriate take professional advice and do not be afraid to seek changes to

reallocate risk if this is at all possible. If all else fails try and persuade the Owner

to use unamended internationally recognized standard forms. As a minimum,

standard clauses have been drafted by individuals that know that risk is best borne

by the party best able to control it. If a dispute arises and if you do end up in

arbitration, the arbitral tribunal should be familiar with the standard clauses and

understand how to interpret their true meaning and effect. In other words, where

the rights and obligations of the parties properly lie.

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Conclusion

Traditionally the construction industry has been poor at managing risk. There is a lot of

risk to manage. Construction projects suffer more than other projects from the impact of

adverse constraints. Consequently the management of risk ought to be more mature and

more effective than in other industries but often the opposite is true.

In the construction industry risk often has to be managed by adjustment of price.

Sometimes this will make a Contractor uncompetitive and unable to win work. There is

no easy answer. The construction industry can help itself by at least identifying the risks

a particular type of project will deliver up, remembering that risk profiles constantly

change and at all times confronting such risks and being able to find solutions to better

control the destiny and profitability of the company.

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