Successfully managing contract risks depends on a full understanding of the contract, an accurate measurement of any potential risks, and a clear knowledge of your available options.
Whilst this might sound simple enough, we regularly meet with construction subcontractors who have put their business in jeopardy by failing to accurately identify, measure or manage critical risk factors. So, what can your business do to avoid failing into the same trap?
The first thing to recognise is that every contract you sign has some level of risk. Not all of these can be avoided but, when properly identified and measured, they can at least be managed.
The second point to make is that what people usually refer to as risk is not risk at all, it is a hazard (i.e. something that could go wrong). On the other hand, risk is the likelihood of something happening. And, whilst this could easily sound like semantics, it goes to the very heart of why so many construction subcontractors fail to successfully manage contractual risk.
By understanding that every contract contains a series of things that could go wrong, often with pre-prescribed penalties, it is clear that managing risk starts with identifying these issues, calculating the likelihood of them happening, and determining the potential adverse effects if they do. Only then can we decide whether the level of risk is acceptable or if it needs to be mitigated in some way.
Sadly, some contractors seem to have an almost fatalistic attitude to contract risk, taking the view that if they want the work then they have to sign the contract in the form it is presented. In other cases, they fail to identify potentially damaging contract clauses which could be fairly easily managed as long as the right systems and processes are put in place.
In reality, there are four main options to consider:
1. Accept the risk
You may decide that the commercial realities of the contract, or that of your business at this point in time, means that the level of risk is acceptable as it currently stands. This may of course be a perfectly reasonable decision, but it is important to base this view on an accurate measurement of potential impact versus reward.
2. Mitigate the risk
Mitigating risk can come in two forms. Firstly, this can be achieved by changing your regular systems and processes to specifically address the level of risk within a specific contract. Secondly, you may also be able to challenge the relevant contract clauses. Whilst it may not be possible to remove them completely, sharing the risk more evenly with the main contractor may be achievable.
3. Transfer the risk
This might not seem the most attractive option, as it will undoubtedly cost you money and therefore impact the profitability of the job. However, if the potential profits are high, but so are the risks, you could look at some form of insurance, or perhaps a retentions bond to reduce the level of risk to a more manageable level.
4. Avoid the risk
If risks cannot be mitigated, either through adjustments to the contract or working practices, it can sometimes be necessary to decline the job in its current form. And, whilst this might seem like an extreme step, there is no point accepting a contract that could put your employees or your business in danger.
Making the right decision
As already highlighted, the key to successfully managing contractual risk starts with an accurate assessment of where issues could occur, together with their likely impact and the options open to you. This can be challenging, especially as many construction contracts are unnecessarily complicated and weighted far too heavily in favour of the main contractor.
However, there is no greater risk to profitability than an incomplete understanding of the risks in a construction contract you are asked to sign. Without the facts, clearly identified and measured, it is impossible to take steps to manage the risks and protect job profitability.
PJE International offers a risk assessment service for new and existing construction contracts and can help you to identify, measure and manage these risks and thereby protect your business profitability. To find out more, just get in touch with a member of our team.