In the aftermath of the Global Financial Crisis (GFC), and with the risk of a ‘double dip’ into recession still lingering, principals are repositioning their exposure to contract risk to try and ensure that enterprise risk is strategically managed.
Risk has been defined as “the chance of an event occurring which would cause actual project circumstances to differ to those assumed when forecasting project benefit and costs”. Risk naturally sits at the centre of project viability, and therefore efficient management of risk is vital to the success or failure of any construction project. Which is why it has been said that “projects are about risks, their evaluation and their subsequent acceptance or avoidance”.
RISK MANAGEMENT PLANNING
Accordingly, it is always advisable that, prior to commencement of any project, the principal is able to quantify both actual and potential risks over the life of that project, as well as the potential losses those risks could impose. This is in order to identify which risks must be most carefully managed over the contract life cycle and to develop management strategies to assume control of, allocate, mitigate or eliminate those risks. Better management of contract risks inevitably means that an organisation can undertake more challenging projects with greater confidence and deliver those projects on time and on budget.
LIFE CYCLE PROFILE
It is important to note that the effect of an actual risk occurring is greatly minimised when its likelihood has been foreseen, and effective management strategies have been developed ahead of time to reduce its potential impact and assist both parties to a contract to implement recovery procedures. Certain periods in the life cycle of a contract present particular risks to projects, and these should have particular attention. They include the tendering process, which needs to be carefully managed to ensure that the relationship starts on a clear and certain footing at the calling of tenders; posttender negotiations, which should be carefully structured to ensure the tender documents and eventual contracts are not confused by random comments; formal board approval, which is a valuable ultimate check that all is in order and unusual risks identified (and justified if appropriate); cost time monitoring, which is a formal external process, often implemented by a project review of cost and time trends, to detect site difficulties and promote early resolutions rather than playing the blame game down the track.
Delivery risk occurs when the practical problems of managing a project’s delivery, present issues not capable of being resolved within the current resource budget. Managing these risks usually calls for the co-operation of both parties on an informed and involved basis to meet the challenges. Of course, it is important that a public authority does not exceed its agreed range of responsibilities or expenditure when responding to a risk which has been properly outsourced by the contractor. Like all contract risks, delivery risks must be met and resolved, but within the applicable probity and management guidelines. Early intervention is vital and the monitoring of progress, progress claims and the correspondence is essential to an early warning system. As such, contract risk plans and monitoring are becoming more and more popular as a feature of the contracting scene.
MACRO RISK ANALYSIS
For significant projects, risk analysis includes a consideration of the risk of a major strategic assumption changing. This macro risk analysis should always be updated as a project proceeds. Particularly when we experience such events as super profit taxes, which put a variety of projects in doubt, all parties are looking to their potential risks if the contract proceeds as well as their risks if the contract is postponed or cancelled. For a contractor, the risk associated with cancelling a project can often give rise to un-funded and un-managed exposures. Furthermore, the risk allocations achieved in warranties and indemnities in regards to the relevant contracts, need to be carefully monitored and reinforced so that the risk allocation in the contract is not obscured by practical day to day conduct in the field. As a result of all of this, the management of contract risks requires a range of expert assistance, because that assistance makes the difference between projects either being properly risk managed, or simply abandoned to their fate.