Managing a construction project is a challenging proposition especially considering the potential risks which present themselves in almost every aspect of the work. Project delays, unplanned work stoppages, disruptions to the supply chain, and other unexpected events can cost contractors, owners, and developers a significant amount of money and lost time. Unfortunately, a single delay can easily affect another component of the job site downstream. When the COVID-19 pandemic arrived in Denver it brought new and unexpected issues which added another level of challenges to the formula. Not only did contractors struggle to maintain existing contracts but future work was immediately put in jeopardy due to project delays or outright cancellations. Since it is unlikely business will “return to normal” it is important for industry businesses to carefully assess risk management options to protect against future issues. To help clients, prospects and others, Hanson & Co has provided a summary of key insights below.
Managing Risk in the Construction Contract
From the contractor’s perspective, one of the key places to mitigate risk has traditionally been the force majeure clause. Force majeure protects the contractor from costly delays or damages due to the effects of unknown or unavoidable circumstances, like severe weather event or even terrorism. Practically every contractor, owner, and landlord spent the early weeks of the COVID-19 outbreak reviewing force majeure clauses and negotiating new terms.
What happened was that owners shouldered much of the financial risk when the contractor was unable to perform the job, but contractors ran into issues finding replacements for subcontractors, materials, and supplies.
At the time, contracts could be modified because it was a reasonable argument that COVID-19 met all the criteria for force majeure. Now, several months later, public health crises can be considered a known and preventable event in which insurers may seek to disqualify from coverage. Contractors need to be mindful of risk more than ever now. One of the primary ways to do this will be paying more attention to what is contained in the force majeure clause.
What is Force Majeure?
There are two general force majeure structures: “non-exclusive” and “exclusive.” General force majeure clauses do not specify certain events or triggers; rather, they set forth non-specific qualifying events such as “floods, hurricanes, earthquakes, wars” and so on. If triggering events meet one of these general categories, the contractor was protected against damages and penalties.
“Exclusive” force majeure clauses specifically name events and acts and are now likely to become more common. Expect to see language including “epidemics, pandemics, government orders,” and so on. Further, these clauses may include a stipulation that such triggering events could not have been prevented or avoided through normal due diligence.
In addition to language specifying pandemics and epidemics, also expect to see force majeure clauses address labor and workforce availability and the differences and risks pertaining to stick-built versus modular-built, tariffs. Contractors should also take care to avoid adding too much specificity in these clauses. For example, do not include stipulations for:
- Economic hardship
- Changes in market conditions
- Late delivery of equipment, materials, or supplies
- Equipment failure
- Labor strikes
- Unavailability of workers, including subcontractors
- Climate conditions, such as rain or snow (not including catastrophic weather conditions such as hurricanes or floods)
Also, note that most force majeure clauses do not address compensation for project delays. Even if force majeure is invoked and project delays are granted, the contractor is still out the money that was used to purchase materials, supplies, or to pay employees.
In any case, contractors should consider becoming more familiar and more involved with force majeure clauses. Seek clarification when needed, utilize designations for events and disasters from WHO and other governmental entities, and modify the definitions as needed to suit the risk profile.
When a project delay has happened or is likely to happen, communication goes a long way. This is more than good business; in many construction contracts, there are requirements to notify other parties in certain circumstances within a specified time. Missing a notice provision deadline can still result in unnecessary risk down the line. They are also easy to forget.
Ensure that notice clauses are precise, clear, and include what the notice should look like, how it should be communicated, what information should be communicated, who it goes to, and the time limit to send it after the triggering event.
Consequential damages, or special damages, arise when the delay of one party causes a breach of contract and results in damage to another part of the project. It sounds like a common scenario in COVID-19 and something that now must be given more weight and consideration. If not agreed upon in the contract, consequential damages can pose a substantial risk to contractors as they could be held liable for excessive financial burdens.
To mitigate this, contractors should try to negotiate a cap on these types of damages. Industry averages are between five and fifteen percent of the contract value or a percentage based on the contractor’s fee in cost-plus arrangements. Failure to do so can result in the contractor bearing 100 percent of the risk if they cannot meet project demands due to COVID-19 issues.
A comprehensive risk management program that covers all project phases is essential in a post-COVID-19 world. Taking a fresh look at potential sources for remuneration and protection can help Denver construction companies protect employees, physical assets, and cash flow. If you have questions about the information outlined above or need assistance with an accounting or tax issue, Hanson & Co can help. For additional information call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.