The 6 Rules of Risk Mitigation in Construction Contracts

Consistently achieving acceptable profit margins is difficult during the best of times. The slightest challenge can derail a project for weeks or even longer, causing profit margins to erode while also increasing the risk of potentially costly claims or litigation. And that was before COVID-19 became a reality.

According to the midyear update of Deloitte’s 2020 Engineering and Construction Industry Outlook, “Apart from labor-related challenges, the engineer and construction industry is likely to face several other short-term challenges amid the pandemic, such as delays or projects being put on hold, difficulty obtaining permits for projects, a rise in project cancellations, an increase in claims and litigation … ”

As a result, achieving profit margins can be even harder during a crisis. This is especially true for the business owners and managers looking to stay competitive with the lowest bids. Success is achievable when all goes well. If not, errors, omissions and a slew of other problems can not only greatly reduce bottom lines, but also lead to financial hardship and even bankruptcy.

That’s why firms should adhere to a strict set of criteria when bidding on projects and entering into contractual agreements. This includes carefully calculating margins based on the client’s special demands, entering contracts with a close attention to detail, understanding owner objectives and validating every construction phase—from design through completion.
 

1. Bid Wisely on Projects That Make Sense

During slow times, the temptation is always present to bid on projects that do not match the contractor’s expertise. This error is often compounded with bids that fail to provide comfortable profit margins or enlist the aid of skilled professionals. Contractors should only take assignments with the support of adequate leadership and staff, while including margins of error into their bids. Unfortunately, doing too much for too little is a recipe for disastrous financial results, claims and possibly even years of litigation.
 

2. Evaluate the Cost of Materials in Your Bid

Proposals should address the potential increase in the cost of materials due to the pandemic. Production and manufacturing delays have affected the availability and cost of products. A prudent step to take prior to submitting a proposal would be to double-check both the availability and cost of most, if not all, of the materials that will be needed to fulfill the project’s contractual obligations.
 

3. Factor Site Safety into Your Bid

Jobsite safety is always an important concern on every project. However, additional steps may need to be taken to address pandemic-specific governmental requirements. The additional costs associated with these regulations in both time and materials needs to be factored into every proposal.
 

4. Choose Your Business Partners Wisely

How well do you know the project owners? Have their other projects been successful or plagued with problems, change orders and delays? These are important questions to consider before entering into agreements that can ultimately prove far too laborious to be profitable.

Construction firms should only work with owners that they know and trust or have excellent industry reputations for treating business partners fairly, keeping to schedules and delivering projects on budget. Do not let the need for business warp your judgment. Never work with anyone that has a questionable background or work history. Beware of owners or other partners who are more concerned with expedience and the bottom line than the project’s integrity.
 

5. Do Your Due Diligence

Never enter an agreement without a clear understanding of the project demands and the potential for unforeseen challenges and changes. This extends from the conceptual design and preconstruction phases to every project component and the owner’s objectives. It’s also important to seek the qualified, third-party validation of trusted partners on everything from the estimated project costs and construction time frame to soil and site condition analyses. Reference all of this in the final agreement before signing.
 

6. Avoid Bad Contracts

Every word matters. Never enter an agreement without documenting the scope of services and the role of every partner involved in the delivery process. This includes the associated risks and procedures for rectifying disagreements.

There is little room for negotiations—or more importantly—renegotiations once all the paperwork has been signed. In addition, it’s an imperative to make sure that the project’s insurance is both reasonable and proportionate. Indemnity provisions can be onerous. Insureds should always push back on policies that overstate the assumption of liability, while carefully documenting activities and amending contracts as services expand or decline during the course of the work.

Furthermore, every contract from the prime contractor and design professional through the subcontractors should be consistent not only in their language, but in the details that highlight the responsibilities of each party. Other considerations surround the processes for authoring, reviewing and approving each contract’s terms and conditions, including:

• Limitation of Liability—This clause can balance risk/reward considerations, particularly when the agreed-upon services are limited in scope.
• Waiver of Consequential Damages—This clause can help control the potential of liability.
• Waiver of Subrogation—This clause can help minimize lawsuits and the claims related to property loss.

Failure to plan for the unexpected can be problematic. This was apparent just a few months ago, when thousands of projects were either halted or shuttered due to the pandemic. The result was layoffs and a multitude of cash-flow challenges for many contractors.

Every project should include contingency plans that clearly map out next steps when crises occur. The cost of delays and the expenses involved with restarting the work should be factored into all contracts. At the end of the day, every project should turn a profit. But don’t forget that even minor mishaps, relatively small misunderstandings or errors and omissions can carve mightily into already tight profit margins.

That’s why it is so important to partner with specialists who can recognize challenges before they become problems, the pitfalls within low bids and even local ordinance and labor issues. There is no substitute for the forethought leading to successful, profitable projects completed on schedule, within budget and with few difficulties.