Construction project risk-management strategies in a challenging market

Disputes less likely with a customised approach 7 min read

Disputes will always be a key risk to be managed on major projects. Now, though, principals and contractors must also grapple with decades-high inflation rates and the ongoing impacts of the COVID-19 pandemic and the Russo-Ukraine War.

In our recent Insight, we set out three key ways to avoid construction project disputes:

• be realistic about costs, including both the contract price and, for the Principal, a project's likely 'ultimate cost';
• engage the delivery teams to ensure they are up to speed upon contract award; and
• address specific risks flexibly and creatively, with a view to better sharing of known high-risk areas of a project.

In this Insight, we re-examine these strategies through the lens of current issues being faced by market participants.

Be realistic about costs in a distressed market

The last two years have been marked by a surge in the number of construction company failures, and we continue to see a significant number of contractors in distress as they continue to face a number of headwinds, making it difficult to deliver projects profitably and on time.

The high-profile collapses of builders such as Probuild, Grocon, Condev and Clough dominate the headlines, but the problem is widespread—918 construction firms entered administration between January and July 2022, representing a 55% increase on the year before.¹ 

A perfect storm

Inflation is a material issue. Between 2021 and 2022, contractors have reported cost increases of 70% for structural steel, 30% for asphalt supply and placement, a 100% increase to the cost of cable supply and a 15% increase to the costs of skilled and general labour.² Further, the current infrastructure boom means there is a general shortage of labour, which is leading to a spike in labour costs and inefficiencies in the carrying out of project works. Finally, though there are signs of improvement, there remain significant delays (and unpredictability) in the procurement of materials. All these factors and more (such as inclement weather), continue to contribute to legitimate delay and disruption to contractors.

Contractors are therefore currently facing a 'perfect storm' of significant obstacles in terms of delivering projects on time and on budget. Worse, this comes as they are completing fixed-price projects commenced several years ago, where their tendered costs were well below the true cost of the project.

Unsurprisingly, many of these same contractors are submitting large claims towards the end of projects, or otherwise seeking additional time or money from principals, in order to be 'made whole' for their work. This is presenting difficulties for principals (private sector and government) who might, at first, baulk at such claims, but who are realistic about the fact that they need their project completed and want to avoid the time and costs of protracted disputes.

In these difficult circumstances, both principals and contractors must be prepared to be realistic about the costs of these projects, and work together to ensure the viability of the project and the contractor. In practical terms, this means contractors must be prepared to be nimble and work flexibly (both in terms of program and staging) to achieve the principal's reasonable project requirements. In return, principals ought not simply 'turn the tap off' on contractor claims, but instead be prepared to consider 'outside the contract' mechanisms such as variation payments or settlement deeds in recognition of the increased costs and disruption faced by contractors, and any unplanned work the contractor must carry out for the principal's benefit.

Finally, both parties must collaborate as early and often as possible on projects to confront difficult issues that might jeopardise the project or the contractor. We discuss this in greater detail in the next section.

Engage the delivery team

Having previously discussed the importance of good communication during contract negotiations, the handover phase and the administration of the contract, we elaborate here on the importance during project delivery of:

• clear and consistent lines of communication between the principal's technical, commercial and legal teams; and
• the principal's delivery team engaging proactively with the contractor to overcome any project hurdles or issues, to mitigate against the risk for potential disputes to escalate.

Operating in the current climate and faced with the 'perfect storm' described above, we are commonly seeing contractors approach claims in one of two ways. The first approach is to issue a series of claims during the delivery phase of the project to create a lot of 'noise', but failing to engage meaningfully with the dispute resolution mechanism to particularise or resolve those claims. Conversely, the second approach involves the contractor failing to raise any claims or disputes at all during the delivery phase of the project, but subsequently raising a significant claim following completion. We are seeing these approaches regardless of the project-delivery model, eg even in the context of a 'no sue' alliance and other forms of collaborative contracts.

Similar challenges are inherent in either approach, with ongoing uncertainty and the potential for significant costs exposure (both legal and management) for the principal. Good communication strategies, both internally and with the contractor, are often overlooked in their simplicity as some of the most effective ways to manage, mitigate or avoid those challenges. In knowledge of the wide-ranging difficulties presently faced by the construction industry, and the resulting potential for increased projects disputes, it is especially important that principals have strong communications policies in place across teams—and between the delivery team and the contractor—at the outset of the delivery phase and well before difficulties become apparent.

This can be achieved internally by the delivery team planning ahead to maintain good communication, including scheduling regular check-ins, meetings and updates. The objective should be to keep the commercial, legal and technical teams aligned on approach for when quick, on-the-ground decisions are needed. If the project runs into difficulty, the best approach is to seek input and guidance across the business before acting, but this is not always feasible.

Similarly, principals can work together with contractors to foster a culture of early engagement and constructive communications. Given the ongoing disruption faced in the industry, contractors will inevitably look to principals to absorb some of the burden they face. While it is, of course, open to the principal to take a black-letter contract approach and stick rigidly to the risk allocation agreed between the parties in more amenable times, the more collaborative, adaptive and flexible the principal's approach to contract management (including scope and program), the less likely the potential for lengthy and costly disputes to arise.

Address specific risks

In the current climate, 'tried and tested' approaches to contractual risk allocation may not be fit for purpose. To be realistic about project cost, it is necessary to account for current market factors (such as supply-chain disruption) and recent lived experience in the Australian market (including common issues that have led to cost blowouts on major projects).

Over recent years, for example, the market approach to sub-surface issues has evolved in ways such as:

• sharing of risk associated with contamination, particularly contamination that migrates onto the project site through no fault of the contractor;
• providing relief for the contractor in respect of unforeseen geotechnical risk (eg where geotechnical conditions differ from assumptions included in geotechnical baseline reports); and
• sharing utilities risk where utility locations are outside agreed tolerances.

It is now common, and we suggest constructive, for principals and contractors to be discussing these issues during the procurement process.

There is no reason why other difficult risk issues cannot be resolved in a manner that is flexible and creative. Input costs is one such current challenge. As we have written elsewhere, for example, the approach to input cost risk allocation in the Australian market has changed significantly in 2022. For a generation, major infrastructure projects in Australia have not typically contained 'rise and fall' mechanisms. Contractors have borne the risk that their price will make sufficient allowance for escalation of input costs (eg materials and labour) during delivery of the project. However, that traditional approach is changing.

For parties to successfully develop an escalation-risk-sharing mechanism, it is important:

• the contractor acknowledges that the corollary of escalation-risk sharing is a reduction in contract price and is transparent as to how it has calculated its price build-up for inputs proposed to be subject to the mechanism;
• the principal accounts for its assumption of escalation risk in the project's likely 'ultimate cost'; and
• the parties can identify and agree upon the matters that should be considered when negotiating a risk-sharing mechanism, particularly given many parties may be unfamiliar with the development of an escalation mechanism in relation to a major project.

In relation to the final bullet point, our October 2022 Insight sets out in detail the matters we suggest should be discussed when negotiating an escalation-risk-sharing mechanism.

Parties are less likely to encounter disputes where known, high-risk areas are addressed in a bespoke and considered way.

Please contact us below should you wish to discuss how these strategies can apply to your project.