The high risk nature of construction projects has led to the development and implementation of numerous risk management strategies, techniques and innovative solutions for dealing with risk. Considerable time and thought must be put into negotiating how the contract will allocate the inherent risks among project participants.

Contract Solutions Group can assist you to develop strategies for managing risk. CSG can assist with drafting and negotiating risk allocation contract provisions and identifying creative and balanced solutions using insurance or other risk transfer techniques.

Limitation of Liability and Risk Management are two concepts that frequently require additional review in our training sessions. We've provided general definitions below. A discussion of techniques to minimize and manage liability and risk follows these definitions.

Types of Damages

Construction risks generally involve two types of damages - property damage or bodily injury damage, which result from physical injury or loss to individuals or tangible property, and economic damages, such as cost overruns, delay damages and lost profits.

Also worth highlighting are consequential damages, which generally include those types of damages that would not be foreseeable as a direct and proximate result of the act or omission causing that damage. Many commercial contracts routinely exclude responsibility for consequential damages. Consequential damages are usually economic in nature.

Liability for damages can arise from breach of contract, extra-contractual obligations (tort), statutory violations and administrative violations. Tort damages arise from court-made law describing legal obligations of parties which are not based on a direct contractual relationship. Tort damages generally result from the failure of the person to meet established societal or business standards of behavior. Serious failures to meet standards of behavior may result in punitive damages.

Limitation of Liability

Limitations of liability and similar limitations of remedies and recoverable damages are well-accepted methods of allocating risk among contracting parties. These provisions are contractual in nature and are usually limited to parties that enter into a contract. Some provisions also limit the liability of intended third party beneficiaries of the provision.

A wide variety of possibilities exist for establishing limitations of liability, remedies and recoverable damages. Separate limits can be established for different types of damages. A contract can specify that certain remedies are the sole and exclusive remedies for recovering damages. Correcting deficient services and goods is a typical exclusive remedy. Recoverable damages may be limited to insurance proceeds, a percentage of profit or total contract price or other objective measures. There are dozens of variations that can be developed among contracting parties to allocate risk with respect to liability, remedies and recoverable damages.

Indemnity and Defense

The concept of indemnity involves a third party claim that is made against a contracting party, in which the contracting party has received a commitment from another contracting party that the second contracting party shall assume financial responsibility for the third party claim being made. Indemnity is often seen as a contractual agreement to step into the shoes of another contracting party in order to satisfy any third party claims being made. Indemnity generally is limited to payment of any amounts determined to be due to the third party making the claim. The scope of the indemnity obligation depends upon the specific contractual language used, and in some cases may include a general common law right established for parties who do not have a contact. Careful review of specific contract provisions is essential to understand the overall obligations.

The concept of defense is separate and distinct from the concept of indemnity. As the term suggests, the obligation to defend a claim is satisfied prior to the final determination of the claim or other resolution of the claim. As with indemnity provisions, the obligation to defend will depend upon the specific contractual provisions. Some provisions trigger the defense obligation by a mere allegation of deficient services or performance. Other defense provisions require a finding of deficient services or performance. Many accepted construction industry contract forms allocate responsibility for defense and payment of a claim to the party in control of the activity that generated the claim, or to the person in the best position to control the activity that led to the claim.

The term "hold harmless" generally includes obligations to defend and indemnify, but the term may vary with applicable law. Common insurance policies include both obligations to defend and indemnify.

Commercial Transfer of Risk

The insurance and surety industries have been established to provide financial security for parties that incurred legal obligations or contractual obligations. In addition, other forms of financial security and guaranty are available to transfer certain types of risk. For example, the risk of non-performance on a contract can be addressed by a financial guaranty.

Many commercial liability and professional liability insurance policies have significant exclusions and limitations on the types of contractual and legal obligations they will insure. Owners and their legal advisors need to consider the pros and cons of including broad form liability transfer obligations in a contract that cannot be fully insured. In some instances, inclusion of liability provisions that cannot be fully insured may cloud the overall availability of insurance for any portion of a claim. Well structured and coordinated contracts take into consideration the insurability of the contractual provisions, as uninsured obligations often are not in the best interest of any of the contracting parties.

Dealing With and Mitigating the Risk

The first step in any effective risk mitigation program is effective contract negotiations and discussion of risk allocation with all contracting parties. In those instances when risk cannot be fairly and equitably allocated, a number of effective risk mitigation techniques are available to a contracting party after the contract has been negotiated and signed.

Many parties to a contract only consider the commercial terms when discussing and mitigating liability and risk. However, other portions of a contract have application to mitigating liability and risk. For example, the scope of work, project performance schedule and contract pricing can be utilized to mitigate or address some risk and liability exposure. A number of tools and model provisions are available for use in implementing liability and risk management techniques (see Tools).

Insurable risks are generally allocated by contract to the party best able to control, manage and insure the risk. Under contractor's general liability, builder's risk, automobile liability and environmental impairment, this usually is allocated to the contractor performing the work. To promote efficiency, reduce costs and avoid duplication of coverage, the owner, design professional and others are usually insured as additional insureds under the contractor's insurance policies.

Risks are assessed and evaluated in terms of frequency and severity. Many industry contract forms use general risk management principles and contract provisions that provide general allocation of risk among the various parties on a construction project. However, any attempt to allocate risk in a manner inconsistent with common industry practices or on a project with special risks should be carefully evaluated by an insurance professional, contracts specialist, legal counsel or knowledgeable design professional to assess specific or unique risks and exposures.

Standard or off-the-shelf industry contract documents require careful coordination among contracts, risk assessment and insurance coverages, often with input from contract specialists, legal counsel or design professionals. Risk allocation will often involve scope of work, pricing and commercial terms of a series of related contracts that will also require careful coordination to assess specific or unique risks and exposures. Risk assessment, evaluation, allocation and management is often provided by insurance professionals. Insurance advisory services are generally excluded under design professional insurance.

Risk Allocation

Project owners or their advisors often dictate the risk allocation philosophy used on a project. Many owners will accept certain levels of risk based on the expectation that their construction costs will be lower. Other owners seek to minimize their risk by contract, allocating the majority of the risk to others. Other project participants are increasingly developing strategies to minimize their own financial risk and are seeking reimbursement for insurance costs associated with excessive or owner-imposed risks.

A number of general risk management principles and techniques are incorporated into most consensus construction contract documents, such as AIA, AGC or EJCDC forms. Changes in risk allocation requires careful coordination among several contracts and related insurance coverages. In addition, risk allocation will often involve scope of work, pricing and commercial terms of a series of related contracts.

Risk is frequently allocated without the benefit of any risk management analysis or attempt to evaluate availability and cost of insurance, surety bond or other financial security to fund the contract obligation. Review by knowledgeable insurance professionals and legal counsel should be sought on any risk allocation in a manner inconsistent with industry practices to ensure that the appropriate protections are in place and allocations are lawful and enforceable.

Reasonable assignment of risk means reasonable allocation to the project participant in control, or in the best position to control the at-risk activity. Courts have understood the business necessity of allocation of risk and have upheld numerous risk management and risk allocation provisions.

Not all owner risk allocation clauses are enforceable or insurable, so care is required in drafting risk allocation provisions.

Limitations on Enforcement of Contract Provisions

Not all contract provisions are enforceable as written. Many states have statutes that limit the enforceability of construction contract indemnity provisions. Some states limit the enforcement of clauses which seek to limit delay damage recovery by construction contractors. Finally, a number of judicial principles and public policy considerations exist when determining whether a limitation of liability or limitation of remedy will be enforceable pursuant to its terms. These limitations on enforcement of contract provisions are uniquely specific to each factual situation and to each jurisdiction. Advice of knowledgeable legal counsel should be sought to interpret and construe the legal affect of any such provisions.