CHAPTER ELEVEN

RISK ALLOCATION AND

LIABILITY SHARING

I
RISK MANAGEMENT
n recent years, a great deal of lip service has been paid to
the concept of risk allocation and liability sharing. It The first thing that must be recognized is that risks, especially
seems to be the inevitable result of the many losses suf- in construction, do exist but are not necessarily fairly dis-
fered by owners and engineers alike in connection with the tributed. Some kinds of risks must be recognized as being
projects they build, due to a new emphasis on the resolution inevitable in engineering and construction and therefore must
of construction disputes through litigation and arbitration. be accepted philosophically and realistically as a part of the
Many of the risks were there all the time, but in earlier years, situations to be dealt with. Managing risks means minimizing,
the contractors were always expected to bear the responsi- covering, and sharing of risks—not merely passing them off
bility for as many construction risks as the owners could onto another party.
pass off on them through indiscriminate use of exculpatory Although some risks can be avoided, risk management
clauses for everything from risks of unforseen underground deals primarily with the following concepts:
conditions to substandard designs and specifications. 1. Minimizing risks—regardless of whose risk it is
Far from trying to operate in a risk-free environment, a
2. Equitable sharing of risks among the various project
contractor understands that risk is part of the business. All
participants
that is wanted is a fair reimbursement for taking such risks.
However, the modern contractor is no longer content to sit The parties must be able to sit down together, prior to
idly by and take all of the risks while being locked into a the start of the work, to come to a better understanding of
guaranteed maximum price but now stands ready to fight the realities of the risk responsibility, assumption, and
back. Contractors have come to realize that they have the allocation. The parties must be prepared to discuss and to
means and often the right to recover the losses that are the decide on the following issues:
result of the imposition of unfair contract conditions or 1. What levels of risk are realistic to assume?
administration.
2. Who can best assume each risk?
Whereas part of the job of the Resident Project Repre-
sentative is to minimize exposure of the owner and the 3. What levels and kinds of risks are properly and most
architect/engineer to risk of claims losses, there are other economically passed on to insurance carriers?
risks that are rightfully within the responsibility area of Risk exists wherever the future is unknown. Because
the project manager to control. Some of the risks may be the adverse effects of risk have plagued humankind since
transferred to others by contract. However, it should be the beginning of time, individuals, groups, and societies
recognized that all risks are rightfully the owner’s unless have developed various ways for managing risk. Because no
transferred or assumed by another party for fair compensa- one knows the future exactly, everyone is a risk manager,
tion. The principal guideline in determining whether a risk not by choice but by sheer necessity.
should be transferred to another is whether the party assum-
ing the risk has both the competence to assess the risk and
the expertise necessary to control or minimize it. The choice
Definition of Risk
must be made before the allocation of risk takes place. One Risk has been defined in various ways. There is no single
such approach to the decision-making process is outlined in “correct” definition. In order to emphasize the major objec-
the flowchart in Figure 11.1. tive of risk management, we will choose to define risk as the
164
 Risk Allocation and Liability Sharing 165

FIGURE 11.1. Logic Flowchart for Risk Decisions.

variation in the possible outcomes that exist in nature in a this distinction. To the extent that a person’s estimates are
given situation. Another way to clarify this definition of risk incorrect, that person’s decisions are based on false premises.
is to distinguish between risk and probability. Risk is a prop- Consequently, risk managers must constantly strive to
erty of an entire probability distribution, whereas there is a improve their estimates. Even with perfect estimates, deci-
separate probability for each outcome. sion making about risk is a difficult task. Uncertainty is the
Both risk and probability have their objective and sub- doubt that a person has concerning his or her ability to pre-
jective interpretations. The true state of things is different dict which of the many possible outcomes will actually
from the way it appears. Because a person acts on the basis of occur. In other words, it is a person’s conscious awareness of
what is believed to be correct, it is important to recognize the risk in a given situation.
166 CHAPTER ELEVEN

Scope and Applicability to Construction CONTRACTUAL ALLOCATION

Risk, as such, is present in all situations and businesses. As OF RISK
applied to construction, we will use the categories detailed In the absence of contractual provisions to the contrary, our
by the American Society of Civil Engineers at the Specialty legal system already allocates most construction risks between
Conference on Construction Risks and Liability Sharing in the designer, owner, and contractor. Therefore, when we speak
Scottsdale, Arizona, in January 1979, where the principal of risk allocation, we really mean risk reallocation, risk spread-
categories listed included: ing, or reaffirmation of the existing allocation of risk so that
1. Construction-related risks the risk stays where it otherwise would be.
There are two basic precepts or guidelines that should
2. Physical risks (subsurface conditions)
be recognized as the criteria for the sharing of risks inherent
3. Contractual and legal risks in a construction project.
4. Performance risks
1. All risks are rightfully those of the owner unless and until
5. Economic risks contractually transferred to or assumed by the contractor
6. Political and public risks or insurance underwriter for a fair compensation.
As it may well be imagined, not all of these items are 2. The principal guideline in determining whether a risk
considered in the same order of priority by owners, architect/ should be so transferred is whether the receiving party
engineers, and contractors, and there are also considerable has both the competence to assess the risk fairly and the
differences of viewpoint as to the percentage of each item that expertise necessary to control or minimize it. An addi-
should be shared by the various parties. tional guideline is the determination of whether the
As a means of defining the range or spectrum of risk shift of the risk from the owner to another party will
and liability sharing in construction, consider that at one result in a savings to the owner and the public.
end of the spectrum, the contractor is assigned the entire The principal means available for contractual allocation
risk or liability with no risk to the owner. This usually results or reallocation of risk are the construction specifications for
in high cost; in effect, the contractor is acting as the insurer the construction contract and the owner/architect/engineer
of the owner. agreement for the design of the project. Under the format
At the other end of the spectrum, the contractor is endorsed by the EJCDC,1 which has been approved and
released from all risks or liability, and the burden is assumed endorsed by the Associated General Contractors of America,
by the owner. This usually results in a lower cost; in effect, such provisions would logically be spelled out in the General
the owner assumes a self-insured role. Conditions or the Supplementary General Conditions. In the
Either end of the spectrum has both advantages and case of a public works contract, the contractor does not have
disadvantages. Owners must thoroughly assess their own the opportunity to participate in the wording of the agree-
situations to determine what allocation or distribution of ment between the parties. However, in private contracts risk
risks would serve them best. For instance, the viewpoint of allocation could become a valid bargaining consideration.
a large city, with an excellent engineering force of its own, The wording should in any case be prepared by competent
might be that it is to its advantage to minimize contractor legal counsel—avoiding the attitude adopted by some attor-
risk and assume more of the risk itself. An owner with a neys that their client is best served by exculpatory clauses that
large amount of engineering resources and a thorough would seem to relieve their client of any responsibility for
and expert design staff could afford to assume a larger por- anything, including the negligence of their own personnel.
tion of the risk to obtain the overall benefit of lower costs. The weakness of this attitude may become more evident dur-
Other factors that should influence the owner’s assessment ing the settlement of some of the large claims that frequently
are the type of construction (does it include high-risk follow such issues.
construction such as underground work?), the degree of
detail, accuracy and/or completeness of the plans and spec-
ifications, in some cases the urgency of the project, and
Exculpatory Clauses
similar considerations. An exculpatory clause is one that attempts, by specific lan-
guage, to shift a risk or burden of risk from one party to
another. As the impacts of such clauses can be very great, a
IDENTIFICATION AND NATURE contractor must be very careful to review the contract for such
OF CONSTRUCTION RISKS exculpatory clauses to determine what risks are being shifted
to it and how the bid should be adjusted to reflect that risk.
Although construction risks can be categorized in many
ways, only four groupings are presented here: physical,
capability, economic, and political and societal. In the 1Standard Forms of Agreement, Engineer, Owner, and Construction-
process of identifying risks, only those that are created by Related Documents prepared by Engineers Joint Contract Documents
Committee (American Council of Engineering Companies, American
the parties themselves in their attempts to transfer risks are Society of Civil Engineers, Construction Specifications Institute, and
included. National Society of Professional Engineers).
 Risk Allocation and Liability Sharing 167

A contract, for example, may contain an exculpatory WHO SHOULD ACCEPT

clause that is intended to shift the responsibility for the WHAT RISKS?
engineer’s errors and omissions to the contractor, such as the
clause illustrated in the following example: There is no fixed rule to help answer this question, but
Figure 11.2 suggests a starting position for determining who
If the Contractor, in the course of the work, becomes aware should bear what risks. It should be recognized, however,
of any claimed errors or omissions in the Contract Docu-
that in some cases more than one party to the contract may
ments, it shall immediately inform the Engineer. The Engi-
neer will then promptly review the matter and if an error or
share a common risk. In such cases, though, the risk may be
omission is found, the Engineer will advise the Contractor shared in name only, as the specific risk carried by each party
accordingly. After discovery of an error or omission by the may differ materially in terms of the specific details of the
Contractor, any related work performed by the Contractor risk they carry.
shall be done at its own risk unless otherwise authorized in
writing by the Engineer.
TYPES OF RISKS AND
Under such a provision, the owner may claim that work
done by the contractor in accordance with incorrect plans or ALLOCATION OF THOSE
specifications will not be paid for. While it is the intent of RISKS2
the clause to prevent the contractor from knowingly exploit- Site access is obviously an early risk and one that the owner
ing any errors or omissions the contractor may have become should retain. The contractor lacks the capacity to influence
aware of to the detriment of the owner, one can see how those in control of the site to render it available. However,
such a clause could also be easily used against the unwary permit requirements that relate to a contractor’s capacity or
contractor. safety control program can be rightfully assumed by the
In the following example of an exculpatory clause, a contractor.
similar situation is created: Subsurface conditions of soils, geology, or groundwater
The Contractor shall give all notices required by law and can be transferred to the contractor, who is in a better posi-
shall comply with all laws, ordinances, rules, and regulations tion to assess the impact of these conditions on the project
pertaining to the conduct of the work. The Contractor shall cost and time. However, as an essential party of the transfer
be liable for all violations of the law in connection with work process, the owner has the responsibility to undertake
provided by the Contractor. precontract exploration measures, and the designer has the
Under the terms of the foregoing provision, the contractor responsibility to design for the conditions expected. The
can be held liable for violations of the law, even though those extent that this is not feasible should determine the degree to
violations were the result of building the project in accordance which the owner retains a portion of the risk under an
with the plans and specifications that violated the law. It is clearly “unforeseen conditions” clause.
the responsibility of the design professional to prepare plans Weather, except for extremely abnormal conditions, is a
and specifications that comply with all applicable laws; this risk for the contractor to assume, as its impact on construction
clause unfairly shifts the responsibility for such compliance methods can be better assessed by the contractor.
over to the contractor. Acts of God, such as flood or earthquake, are exposures
Although most exculpatory clauses are viewed by both that have no purpose in being transferred beyond the owner,
state and federal courts on the basis of what is equitable to except that the architect/engineer can assume the responsi-
the parties as well as the specific language of the clause, some bility for designing to minimize their impact. However, to the
courts on occasion disregard the equitable considerations extent that it can be occasioned by the contractor’s operations,
and apply only the harsh terms of the clause. In a New York fire may be one shared with the owner.
court decision, Kalisch-Jarcho, Inc., was a successful bidder Quantity variations are another form of risk frequently
on an $8-million heating and air-conditioning contract for encountered. Within reasonable tolerances, quantities of
the construction of a new police headquarters in New York work can be reasonably estimated and any variances assumed
City. The contract included a provision in which Kalisch by the contractor for all quantities in excess of, for example,
agreed to make no claim for damages for delay in the perfor- 15–25 percent. Where quantities are dependent upon sub-
mance of the contract occasioned by an act or omission of surface or other lesser-known conditions, significant varia-
the City, and any such claim would be compensated by an tions should be shared only to the extent that exploratory
extension of time. Kalisch sued the city for breach of con- information is available. Quantity changes triggered by late
tract, claiming damages for 28 months of delay. The trial changes in the owner’s requirements, however, should be at
court awarded Kalisch approximately $1 million, but the
decision was reversed upon appeal. The court found that
the exculpatory clause protected the City from a claim of 2This section follows J. Joseph Casey (President, Gordon H. Ball, Inc.,

damage as there was no evidence that the delay had been Danville, CA), Identification and Nature of Risks in Construction Projects:
A Contractor’s Perspective, presented at the ASCE Specialty Conference on
intentional [Kalisch-Jarcho, Inc. v. City of New York, Ct. App. “Construction Risks and Liability Sharing,” Scottsdale, AZ, January 24–26,
N.Y. (March 29, 1983)]. 1979.
168 CHAPTER ELEVEN

FIGURE 11.2. Construction Risk Allocation to Participants.

the owner’s risk. Some types of variation, such as tunneling performance standards in the face of this is quite difficult, and
overbreak, are contractor controlled and should be borne by occasionally, design or specification defects occur that create
the contractor. construction problems. Unfortunately, it is usually the owner
Capability-related risks are the result of the different and the contractor who suffer the consequences of such failures
capacity and expertise that each of the parties brings to the instead of the architect/engineer who created the problem in
construction project. The consequences of failure of any the first place. Design failures or constructability errors are
party to measure up to these standards should be borne by becoming more and more apparent, and the architect/engineer
the failing party. Unfortunately, this is not always the case. should bear the true cost of such failures. Often, ill-advised use
Too often the contractor who has the practical task of of performance specifications are provided as an escape from
building the project carries the burden of the owner’s or the responsibilities of design.
architect/engineer’s failure. This, in turn, renders the con- Subcontractor failure is a risk that is properly assumed by
tractor’s performance task either unfeasible or feasible only the contractor except where it arises from one of the other
at considerable extra cost. listed risks attributable to the owner or architect/engineer. The
Defective design is a risk usually associated with the archi- prime or general contractors are in the best position to assess
tect or engineer. The tremendous expansion of construction has the capacity of their subcontractors, and therefore it is they
placed great burdens upon the design professions. Maintaining who should bear the risk of not assessing the risk properly.
 Risk Allocation and Liability Sharing 169

Defective work of construction, to the extent that the capability may be able to fund these delays, with great outlay
problem is not caused by a design defect, should be the of interest, but all too often, the smaller contractor cannot
contractor’s risk. even survive.
Accident exposures are inherent to the nature of the work Labor, materials, and equipment involve considerable
and are best assessed by the contractors and their insur- risks. The availability and productivity of the resources nec-
ance and safety advisors. Furthermore, the contractors have essary to construct the project are risks that it is proper for
the most control over site conditions that can increase or the contractor to assume. The expertise of the contractor
decrease accident exposure. should follow the assessment of cost and time required to
In the viewpoint of some, the recent trend toward “wrap- obtain and apply these resources. This is the basic service
up” insurance coverage is a mistake. The safety record on a that the owner is paying for.
construction project is so heavily affected by the contractor’s Acceleration or suspension of the work is a risk properly
methods, site conditions, worker attitudes, and supervisor retained by the owner but is all too often pushed onto the
awareness that the owner will quite possibly obtain the oppo- contractor in the form of “constructive acceleration” or
site of what is sought for. Ultimately, the cost of insurance “constructive suspension.” An objective appraisal of the facts
is the cost of the losses plus the cost of administering the underlying the situation and acceptance of responsibility
compensation for these losses. where it belongs are necessary. It is important to realize that
Managerial competence is a risk that must be shared by this applies to legitimate acceleration, however, and not to
each party, as they each have their own set of managers. It is an false claims of acceleration as described in Chapter 14 under
ongoing challenge for each organization to assign personnel the heading “Who Owns Float?”
according to their respective competence levels. Political and societal risk is an area of growing importance
Financial failure is a risk not frequently mentioned and to any effort at risk allocation. It is an area in which political
can happen to any of the parties to a contract. Although and social pressures from parties having little interest in a
infrequent, the order of magnitude of such failure should be project but having a great impact on such a project greatly
considered. It is a shared risk, as the parties need to look at influence its outcome. This is an unclear area and deserves
the financial resources of themselves, their partners in joint much careful thought as to how the risk should be allocated—
undertakings, and the other parties to the contract. in some cases it is clear, in others vague.
Inflation is one of the world’s realities. Every owner is Environmental risks rightfully belong to the owner alone
conscious of its impact on the viability of any project. It is and should be retained by the owner except to the extent that
important that the owner retain the true cost of a project. they are influenced by construction methods determined
Government experts in finance have so far been unable to by the contractor or created by suppliers controlled by the
predict where the country will be a few years from now, so it is contractor.
unfair to expect the contractor to do better than so-called gov- Regulations by government in the social area, such as
ernment experts. The contractor’s apprehensions will result in safety and economic opportunity, are the rules under which
higher cost to the owner, or unwarranted optimism will result the contractor rightfully must operate. Although there is
in the contractor’s own financial harm. A default resulting additional risk in this less known and interpretive area, it is
from such a failure will result in even greater costs to the similar to the work rules established by union contract or
owner. The sharing of the escalation risk should therefore be agreements.
limited to a short span of time, approximately 12–18 months, Public disorder and war are political catastrophes of
when union agreements usually expire and beyond which is such impact that their risk is best retained by the owner, lest
pure speculation. it becomes necessary to pay an unusually high price for
Economic disasters, as referred to herein, are periodic eco- transferring the risk to another party.
nomic disasters of such magnitude that a contractor could not Union strife and all that it entails are risks that are prop-
properly assess either their probability or their cost impact. An erly taken by the contractor. Unjustified work rules and
example might be Organization of the Petroleum Exporting similar problems are all risks that the contractor must assess
Countries (OPEC) decisions, nationwide strikes, devaluation, and provide for.
tax rate changes, and similar large-scale incidents. The owner
should retain the risk of such disasters.
Funding is obviously a risk beyond the capacity of the
Risk Distribution
contractor to control. Improper sources of these funds may To many contractors, risk management is the nature of their
occasion delays or create interest costs that are not antici- business. That is what they are paid to do. Management of
pated and financing problems that to many contractors are risk first involves a “go/no-go” decision on risk assumption.
unbearable. There is no moral justification for a competent To the extent that this process is complicated by unwarranted
contractor being driven out of business by delayed compen- “risk dumping,” the costs in time and money eventually find
sation for services rendered. This is especially true in the their way to the owner in the form of higher prices.
protracted negotiation of changes. All too often the owner There have been some construction contracts where
plays the cash-flow game to lever dispute negotiations to the total physical risk was assigned to the contractor, including
owner’s advantage. Some large contractors with financial the risk of unforeseen (changed) conditions and of variations
170 CHAPTER ELEVEN

of quantities required to complete the work. Even under such In the specifications for a recent subway construction
extreme allocation of risk, the owner still retains a very contract that involved underground rock tunneling, there
substantial risk that the contractor may not comply with the was a “changed condition” clause included. The borings
terms of the contract and properly complete the work within generally indicated reasonably sound rock with ample cover
the allotted time. Even if a claim is made under a perfor- over the roof of the tunnel. Despite this, the specifications
mance bond, substantial damage may certainly have already writer saw fit to include the following paragraph:
occurred. Under the best of circumstances, from the owner’s
viewpoint, the owner will retain material risk. It is therefore The contractor’s procedures for tunnel excavation shall provide
important that the owner recognize the existence of this risk for such construction techniques, including but not limited to,
and not be lulled into the false sense of security that it has reduced heading advance, multiple narrow drift excavation,
somehow been passed on to the contractor or the contrac- forepoling, pumping of cement or grout to reduce water inflow,
tor’s surety. Unreasonably burdening the contractor does not and any other techniques applicable to rock tunneling, that may
be required due to the nature of the rock encountered.
necessarily rid the owner of the risk. Default on the part of
the contractor in whole or in part is also a very real risk that
the owner can be left with. Here, any benefit thought to be obtained from the use of
Inclusion in a contract of the frequently used (or the changed conditions clause by the owner was clearly lost
“misused”) disclaimer provision relating to geological infor- when that paragraph was added.
mation furnished to the bidders for underground construc- Contractors sometimes find themselves at the mercy of
tion may not be as effective in passing risk to the contractor contract administrators who lack the courage to imple-
as some might think, because such clauses are of questionable ment the contract in accordance with its terms. For exam-
enforceability. Despite this, such exculpatory clauses continue ple, a contractor was engaged in the construction of a rock
to be used, and such use actually places the risk upon all of tunnel for a subway in which the borings indicated sound
the parties to the contract, without at the same time provid- rock with substantial cover over the tunnel roof. In actu-
ing any relief to anyone. Under such circumstances, a dispute ality, the rock cover disappeared and approximately 30 m
will frequently arise if the geological formation does not (100 ft) of the tunnel had to be excavated utilizing
coincide with what is found in the field. Such a dispute may soft-ground techniques. Before encountering the area of
not be resolved until many years have passed, and then only reduced cover, the rate of progress was such that the exca-
at great expense to all of the parties to the contract, with the vation for the stretch of tunnel in question would have
resulting effect of creating a substantial increase in the cost taken approximately eight days. Actually, more than six
of the project. The final result is that the owner may have to months were required to redesign the support system, to
bear certain risks anyway, despite any contract clauses to the secure the necessary materials, and to excavate the tunnel
contrary. In view of this, it may be wiser for the owner to rec- utilizing a much slower and costlier procedure. Despite
ognize these facts at the beginning and provide contractually these facts, the contract administrator refused to find that a
for the owner’s assumption of such risks. changed condition existed. Instead, it was determined that
The fact that the contractor carries a substantial burden “extra work” was being performed for which, under the
of risk is beyond dispute. Unfortunately, it seems that the terms of the contract, the contractor could be paid only for
viewpoint of many who design and administer construction certain direct costs.
contracts is that the contractor should carry virtually all of The contractor had been denied payment for the very
the risk, whether provided in the contract or not, and it is great costs that resulted from the delay of the work. Under
precisely this attitude that has contributed to the inevitable the provisions of the changed conditions clause of the
litigation that will follow. contract, the contractor was very clearly entitled to payment
for the costs of the delay. The contractor was left with no
alternative but to seek relief in court, a process that is going
The Contractor’s Viewpoint 3 to be very expensive and time consuming to both the
It is not sufficient to establish policy on how risk is to be contractor and the engineering firm and owner.
allocated among the parties. Follow-up is required to ensure As an intelligent application of the risk allocation proce-
that these policies are actually being implemented. The dures, it would seem that the application of the following
owner may determine that it is in its own interest to under- guidelines could be helpful to produce construction at the
take extensive geological investigation for an underground lowest possible cost:
project. However, this effort may be wasted if the frequently
used disclaimer provision regarding geological informa- 1. If a risk is imposed upon a party, an opportunity for
tion furnished to the bidders is included in the contract reward to that party should exist for properly dealing
documents. with the risk.
2. Allocation of the risk to the party who is in the best
3Adapted from Norman A. Nadel (President, MacLean Grove & Company, position to control it.
Inc., New York, NY), Allocation of Risk—A Contractor’s View, presented at the
ASCE Specialty Conference on “Construction Risks and Liability Sharing,” 3. Allocation of the risk to the party in whose hands the
Scottsdale, AZ, January 24–26, 1979. efficiency of the system is best promoted.
 Risk Allocation and Liability Sharing 171

4. Allocation of the risk to the party who is best able to equipment, and prosecution of the work except as this
undertake it financially. control is affected by the action of third parties.
5. Steps should be taken to assure that risks are actually 2. In the area of third-party effects, risks should be allo-
allocated as intended. cated to those best able to deal with the third party. This
principle would assign to the owner the risks related to
Occasionally, it may not be apparent how a given risk
government agency regulations and to agreements with
should be allocated. In such a case, careful consideration of
adjacent property owners. Risks associated with labor
what may be the motivation of the parties involved may be
and subcontractor agreements and disputes should be
productive.
assigned to the contractor.
3. Construction safety should be the responsibility of the
How Are Risks Allocated?4 contractor, although financial risk with regard to third
How are risks allocated, and how should they be allocated? The parties is properly allocated to insurers (either the
allocation is initially made by the owner’s legal department or contractor’s or the owner’s).
its specifications department, which prepares the contract Construction is a highly complex business. Guidelines,
forms that are offered to the bidders on a take-it-or-leave-it recommendations, regulations, contracts, and even legal
basis. To the extent that such persons or departments are sensi- rulings can only provide direction for judging a particular
tive to practical construction and contract administration situation. Among the most difficult and important to define
problems, possibly some contractor organizations or engineers factors in evaluating and allocating risk are the reputations of
may be capable of exerting some influence upon them in the the parties to the contract. Some owners and some architect/
preparation of these documents and the resultant reallocation engineers have earned reputations such that reputable
of risks. More coercive and effective (and more expensive) contractors will not bid on their projects. Others have reputa-
allocations are the kinds made through the courts. tions that even attract bidders who would pass up similar
In the traditional construction contracting practice, the work in other jurisdictions. Conversely, some contractors
owner would allocate almost all of the risks to the contrac- have earned reputations that invite contract administration
tor, saying in effect: “You deal with all of the construction “by the book,” whereas others enjoy the ability to secure
problems and all the third parties, and don’t bother me.” In many contract modifications by negotiation. The risk of an
this same tradition, the architect/engineer would design a unfavorable reputation (or the benefit of a favorable one) is
structure in its finished condition, and if any thought was earned by all parties over a long period. It is not allocable, and
given to the construction problems that might be involved in it is not rapidly changed.
building it, considerable care was taken not to express any
opinions on these matters in the contract documents.
This one-sided attitude fostered two results: MINIMIZING RISKS AND
1. Contractors added high contingencies to their bids to MITIGATING LOSSES5
cover the costs of the risks. The provisions and methods used in allocating risks should
2. Litigation of construction contract claims followed. be clear and straightforward enough so that all of the parties
Broadly speaking, the owners lost; the courts reallocated know in advance what risks they have assumed, how they
many risks that the owners thought they had laid on the con- will be compensated, and that they can monitor the process.
tractor, and, as a result, the owners paid for their risks twice— Otherwise, the owner may lose the benefit of the allocation
once in bidding contingencies and a second time in court. and may even end up paying for the risk twice.
Meanwhile, the contractors were not profiting either. They In the allocation of risks, it is important not to discour-
were losing money on delays and disputes and often just break- age designer innovation or production of ultraconservative,
ing even (if they were lucky) in court. Construction law, as a defensive designs. Designers cannot innovate if placed in a
result, is rapidly becoming a very profitable field—for lawyers. position where the amount of their fee does not cover their
risks, unless the owner will protect them as a means of
Risks Reserved to the Contractor encouraging new concepts.
The concept of minimizing risks and mitigating losses
In addition to the types of risks referred to under “Types of can be implemented initially by the adoption of a set of man-
Risks and Allocation of Those Risks,” the following are typical agement policy positions that are vital to the success of the
of the risks reserved to the contractor: program. Whereas any one policy item may in itself appear
1. The contractor should bear all risks over which the con- to be somewhat insignificant, collectively they can save a
tractor can exercise reasonable control. These include all company a considerable amount of trouble.
matters relating to selection of construction methods,
5Adapted from Henry J. Jacoby (Chairman, Grow Tunneling Corporation,
4Following Thomas R. Kuesel (Senior Vice President, Parsons, Brinckerhoff, New York, NY), Summary Session, and David G. Hammond, Minimizing
Quade, & Douglas, Inc., New York, NY), Allocation of Risks, presented at the Risks and Mitigating Losses, presented at the ASCE Specialty Conference on
ASCE Specialty Conference on “Construction Risks and Liability Sharing,” “Construction Risks and Liability Sharing,” Scottsdale, AZ, January 24–26,
Scottsdale, AZ, January 24–26, 1979. 1979.
172 CHAPTER ELEVEN

The following principles are essential to an effective risk Long-Lead Procurement

management program:
Before making a final decision about prepurchase of materials
1. Thorough engineering, with competent advance planning or equipment by the owner, the impact should be considered
to minimize the delays of the added risks that are thus assumed by the owner, such as
2. Adequate subsurface exploration and interpretation of latent defects, damage in transit, storage costs, compatibility
the data as it affects both design and construction problems, maintenance, and others. There can be several valid
3. Full disclosure of all information available to the owner reasons for owner prepurchase but saving money on the
and the designer to the contractor purchase price is not generally one of them. The contractor
4. Permits and rights-of-way obtained in advance by the must still add a percentage for handling and installation, and,
owner after the project is ready for testing and operation, if the
5. Strong, competent management by all parties prepurchased equipment does not work properly and substi-
tutions or replacements must be ordered, the owner will
6. On-site decision-making ability to minimize delays
become liable for the added cost of project slowdown and
7. Adequate procedures for handling disputes promptly, as delays. Thus, instead of liability reduction, liability has only
the work progresses increased.
8. Adequate financial security of all parties There are certain cases, of course, where it may be neces-
9. Contractor participation during design phase, or for sary to prepurchase equipment, such as in the case of long-
public agency contracts, contractor value engineering lead, factory-fabricated items. Here again, the owner must
clauses in the contract with shared savings provision consider the risks and costs and the ability to furnish the
10. Good labor contracts and conditions to improve equipment to the contractor when it is needed, what handling
productivity and erection costs will be, and whether there is warehousing
and maintenance capability available. As an alternative, on
No attempt was made in the foregoing list to assess the
long-lead purchases the owner may include an assignment of
effect of regulatory agencies and the interagency disputes
contract provision in the construction contract. In this man-
that delay and increase the cost of projects. These are recog-
ner, the cost of the prepurchase can be included in the project
nized as major risks and are considered beyond the ability of
cost as an allowance, and the successful contractor contractu-
the owner, architect/engineer, or contractor to control or
ally agrees to accept assignment of the prepurchase contract as
minimize except through the legislative or political process.
soon as the construction contract has been executed. In this
manner, the contractor makes payment directly to the manu-
Contractor Participation in Value Engineering facturer or fabricator of the item at the prescribed time; expe-
Value engineering by the contractor is a subject that is viewed dites delivery; and arranges for delivery, unloading, storage,
as controversial by some, but the concept has potential benefits maintenance, and installation just as would have been done
as a means of minimizing risks and cost overruns. Value engi- had the contractor personally initiated the order in the first
neering by the contractor (see Chapter 16) involves contractor place. This reduces the owner’s risk and places it in the hands
proposals for changing construction methods or designs as a of the contractor who generally has more experience and
means of reducing project construction costs. Generally, such ability in the handling of such transactions. The cost will be
concepts involve a cost-sharing provision on any savings real- reflected in the contractor’s bid just as if the purchase had been
ized. Many designers resist such potential intrusions of the a sole source procurement in the construction contract.
contractor onto their hallowed ground. They often feel that
their design approach was the proper one in the first place, and Permits and Rights-of-Way
it is a reflection upon their design ability if the contractor dares
to question it. Nevertheless, it should be recognized that for Another way to minimize losses is for the owner to obtain
most projects, the identity of the contractor will not be known permits and rights-of-way in advance of construction. Some
at the time of design. Obviously, what an architect/engineer permits can often be better obtained by the owner than by
might call for or permit to be done by a contractor whose qual- the contractor. In addition, there will be some savings to the
ifications were known and trusted might be quite different owner by not having the contractor’s markup added to the
from that which could be allowed for a contractor who is task of obtaining them and paying the fees. Some permits
known to the designer only as the “low bidder” with bonding can be better handled by the contractor, and some judgment
capability, but otherwise possesses unknown virtues. must be exercised in the allocation of these responsibilities.
Permits for things such as haul routes, disposal sites, and
similar items are better handled by the contractor, who has a
Management Structures better understanding of the plan of work.
Of major importance in the minimizing of risks and mitigat- It is generally agreed by all that whenever possible, it is
ing of losses is the management structure used for prosecution better to have the owner obtain rights-of-way in advance of
of the project. This includes all management, supervisory, and construction and make them available to the contractor
working levels of the owner, architect/engineer, construction upon notice to proceed. Although this is the ideal arrange-
manager, and the contractor. ment, often the complete rights-of-way are not available at
 Risk Allocation and Liability Sharing 173

the time that the construction should start. Here the owner information.” Only recently has this been recognized as not
must weigh the somewhat known risk of delaying the con- in the best interest of the owner or the architect/engineer.
tractor while the contract is in force until the rights-of-way On the Baltimore Subway Project, for example, complete
become available for the contractor to start, knowing full disclosure was made to the contractor in the bidding docu-
well that there may be some negative effect on the contrac- ments not only of factual data, such as boring logs and
tor’s efficiency of operation and therefore on the project cost cores, but also of the designer’s interpretation of how the
to both the owner and the contractor. ground or rock was expected to act during construction.
A complete geotechnical report including both factual data
Disputes and design analysis was made available to the bidders in the
form of a geotechnical report. It is considered probable that
Even in the area of disputes there is still some leeway for
the furnishing of such complete information enabled and
cost-saving measures. After a difference of opinion has been
forced the owner and engineer to do a more complete sub-
expressed, adequate machinery must be put into action for
surface exploration and thus avoided some surprises. The
the resolution of such problems. The second worst way to
evidence to date appears to support the premise that lower
handle claims is to ignore them; the worst way is to allow
bids may be anticipated from bidders when this approach is
them to go to litigation. If handled promptly and vigorously,
taken. Low bids on this project averaged 10 percent below
most disputes can be resolved without their being permitted
the engineer’s estimate.
to degenerate into large problems affecting not only the cost
In contrast, on the Chicago TARP Project, where the
to the project but also the progress of the work. It is impor-
initial philosophy was that all risks were to be assumed by
tant to both the efficient progress of the work and the lowest
the contractor, the contract did not provide any provisions
cost to both the owner and the contractor in the perfor-
such as those for changed conditions and the geotechnical
mance of “changed conditions” work that such changes be
information provided to the contractor was factual only, for
negotiated and settled as soon as possible.
which the owner further disclaimed any responsibility. Ini-
tial bids taken on early contracts resulted in few bids being
Disclosure of Information submitted, and those that were submitted were in amounts
It has been common until recent times for owners to keep more than double the engineer’s estimates. Subsequent
design or site information in their possession to them- modifications in the philosophy in the contract documents
selves, providing the contractor only with so-called “factual resulted in an improvement in that situation.

Review Questions
1. True or false? All risk belongs to the owner unless trans- 7. Name one alternative to long-lead purchase and
ferred by contract. issuance to the contractor of products as “owner-
2. Describe the two primary concepts involved in risk furnished equipment.”
management. 8. Name four types of construction risks that are properly
3. What are the principal issues that should be considered allocated solely to the contractor.
in the allocation and assumption of risk responsibility? 9. Name four types of risks that are properly retained
4. Name the six categories of risk. solely by the owner.
5. In a construction contract, which is the best party to 10. Name four types of risks that are properly allocated
bear the various risks? solely to the engineer or architect.
6. What are the four guidelines for allocation of risk in
construction contracts?