By Patrick Hogan, CEO, Handle.com

All construction projects carry a certain level of risk, and their success depends on how well participants manage these risks. The inherent risk in construction projects has multiplied over the years due to the rise of multiple factors. A construction project manager is expected to manage the risk of safety issues, weather conditions, and change orders, while also dealing with labor shortages and new government regulations.

Making sure that every risk is properly identified and mitigated is always a good practice in any construction project, and it requires considerable skill, careful planning, and swift decision-making. 

Types of Risks in Construction Projects

Risks in construction projects can be grouped into the following categories:

Particular risks

This type of risk is the result of the actions of individuals or groups of individuals, such as negligence, carelessness, errors in judgment, and disregard for the law. It includes fire, theft, machinery breakdown, and structural collapse.

Fundamental risks

This type of risk mainly comes from nature and other causes beyond the stakeholders’ control. It includes natural disasters such as flooding, hurricane damage, earthquakes, and famine. Wars, terrorism, riots, and other political activities are also included.

Speculative risks

This type of risk can either result in a profit or loss and usually includes pricing, forecasting, and credit sales. Fluctuations of market pricing, exchange rates, and interest rates are all speculative risks.

Aside from these main categories, there are other risks that emanate from delays, poor communication and supervision, the bankruptcy of business partners, delinquent clients, and delays in resolving disputes. 

Best Practices for Minimizing Risks

The construction contract is a contractor’s best weapon in dealing with the many risks in a construction project. Here are things you need to keep in mind to minimize risk when entering into a construction contract. 

1. Set clear guidelines on which party will handle risk.

During the initial stage of a project, the first thing that the property owner and the stakeholders need to do is to identify risks. They should then analyze each risk and determine the probability of occurrence and its level of impact on the project. Afterwards, the stakeholders need to agree on how to respond to the risks. Using the construction contract, stakeholders allocate each risk to the party that is best prepared to manage it. 

Consider a typical construction project with an owner entering into a contract with a general contractor. In this example, the owner of the project will have responsibility for errors in the building design as they work closely with the project designer and are better suited to handle the mitigation of this risk. On the other hand, the contractor will handle the responsibility for property damage or injuries arising from their operation since they are better suited to make the construction site a safe place. 

2. Include indemnity provisions in your construction contract.

Indemnity provisions are contractual clauses that shift the risk by holding one party accountable for the losses incurred by another party arising from claims made by a third party. Considering our previous example, the contractor needs to ensure that the contract has the provision that indemnifies them against damages that result from negligence on the part of the owner with respect to the project design.

The importance of indemnity clauses cannot be stressed enough. Construction contracts without these provisions are all too common in the industry, which, of course, produces unnecessary risks for the contracting parties. Without properly drafted contracts with indemnities, it may not be possible for one party to claim for the losses they incurred. 

3. Cover indemnity provisions with insurance

After setting a clear language that defines the extent of the losses covered by the indemnity provisions, parties of the contract should then obtain the appropriate insurance policies to support these indemnities.

In general, contractors should secure general liability insurance, automobile liability insurance, and workers’ compensation coverage. On the other hand, the owner should have a builder’s risk insurance to cover the damage to materials, fixtures, and equipment resulting from natural disasters and other unforeseen site conditions. Requiring insurance coverage for indemnities will ensure that all contracting parties will be able to satisfy their indemnity obligations.

As construction projects grow in scope and complexity, it is more important now more than ever for contractors to use every tool at their disposal to manage risks. The construction contract has a huge role in minimizing the risks assumed by a contracting party. It is crucial for construction firms to be proactive in setting clear guidelines on how to handle risk in the construction contract, adding indemnity provisions and supporting them with insurance to reduce their assumed risk to a manageable level.

About the Author: 

Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.