Risk-shifting may even be counterproductive

August 11, 2010

The negotiation of a construction contract is a unique exercise in the shifting of risks. The allocation of risk should be based upon the ability to control the risk. The party who has the greatest ability to control a risk-factor should assume responsibility for that risk. All too often in today's market, the intent is to shift risk to somebody in the contract chain without regard to who controls the risk. As risks have increased and profits decreased, contracts have become more onerous.

Set the tone

Ideally, all parties to the construction process will work as a team to accomplish a common goal and purpose — namely to provide the owner with a building on time, within budget and without injury. Tailored clauses designed to shift risk, in certain circumstances, can be counter-productive to achieving the common goal. If the wrong tone is set at the inception of the process, by one party feeling that another party is trying to take undue advantage in the contract documents, the clause may actually lead to new problems and exacerbate old ones.

For example, what purpose is served by an owner's clause requiring a general contractor and a subcontractor to defend and indemnify the owner and architect for the negligence of those parties? Or why should a general contractor who is delayed by an owner not be able to recover its delay damages where the owner, and not the general contractor, was responsible for the delay?

When grossly unfair clauses like these become the industry standard, they cause the victims to become active in the legislative process, seeking relief from state legislatures. Over time with enough prodding from the industry, the legislatures often react by enacting remedial legislation directed at items such as broad form indemnity clauses, no damage for delay clauses and abusive retainage practices.

It bears repeating: The allocation of risk should be based upon the ability to control the risk. To use leverage to unduly shift risk downward is simply not good business. Can a party really expect to get its best bid and best productivity from those who are being asked to take risks which they are in no position to control?

Why assume the worst? In some cases, parties are required to accept the low bidder and thus have no choice but to deal with a party who is unknown or who may be known in an unfavorable light. In such cases, onerous contract clauses are easier to understand. But in the vast majority of negotiated contracts, parties can carefully screen their bidders and limit their bids to parties who have a known track record of performance. In these instances, there is no reason not to use a balanced and fair contract that will signal the desire to create a relationship based on mutual trust and respect.

Enlightened contractors

Signs are emerging that some sophisticated contractors are recognizing that it is good business practice to treat subcontractors fairly. For example, Alberici Constructors, St. Louis, Mo., has devised a unique and extraordinary proprietary subcontract form which rivals the A.I.A. A-401 Subcontract Agreement as being balanced and fair. In addition, Pepper Construction Co., Chicago, has adopted contract language which includes reasonable indemnification clauses and also gives subcontractors an option to provide Owners and Contractors Protective Liability Insurance in lieu of an "additional insured" endorsement. Likewise, Weitz Co., Des Moines, Iowa, allows subcontractors the option of using owner controlled policies and also includes favorable subcontract payment terms.

Lessons learned

Construction projects often take on a mood or character at the beginning which continues throughout the entire project. For their own benefit, owners and general contractors should experiment with form contracts which are fair and balanced. Such a practice will have the effect of inviting more bidders, better prices and result in improved productivity. There is no substitute for dealing with people whose track records are known and who can be treated fairly and equitably.


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