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A LEGAL PERSPECTIVE:

Risk and  Rewards

WORDS BY Damian Abraham

1. What are the risks and rewards of a construction project?

At the most fundamental level, a construction project involves an investor who acquires property, improves it and seeks to realise a gain (usually but not exclusively financial) thereby. That gain is generally the investor’s reward. Other rewards, generally associated with the role of other participants, will be the fee charged by them in exchange for their contribution to the project.

The risks in any project are innumerable, including changes in the property market; in the cost of materials, labour and finance; and a party itself suffering, or becoming exposed to liability to another person on account of their suffering, loss or harm. In either case this could be by way of personal injury, property damage, or economic loss: the common thread is that the loss in some way results from the carrying out of the project.

Broadly speaking for any participant in a project these risks will fall into two categories: those which the participant may reasonably be able to manage and those which they cannot. In legal terms, this distinction is recognised and can be described as on the one hand loss for which the participant may be held liable, or at least has no entitlement to seek to recover from others; and on the other, loss for which they may not be held liable, or which they may be entitled to seek to recover from others. In each case this is based on rights and liabilities arising at law (eg for negligence, breach of contract or breach of statutory duty) and in the absence of contractual modification.

 

 
2. The evolution of project procurement models

Traditional procurement had a client engaging its architect and other professional consultants from ‘go to woe’ (or more optimistically, to success!) and, following assistance, consultation and advice from its architect, separately engaging the builder on a similar basis. Under this basic model each consultant and the builder would assume, under law, liability for any misconduct by them in the course of performing their role in the project and the client would retain the balance of risk. Essentially this dichotomy could be referred to as that between ‘professional risk’ and ‘project risk’. It is worth noting here that such ‘professional risk’ is that for which an architect is able to insure against.

As projects have grown larger and participants more sophisticated, and also with the greater influence of banks and other financiers in the process of project procurement, new models have evolved with a key driver and characteristic of allocating risk and reward between the participating parties (with the focus being very much on allocation between the owner, builder and where relevant occupant/operator) differently to the traditional model.

So a ‘Design and Construct’ process has the builder assuming all liability for not only its role in construction, but also for all design related risk. This serves the client’s interest by giving it a ‘one stop shop’ against the builder should something go wrong in the project. The builder then offsets this by engaging, and thus assuming contractual rights against, the design consultants (either from the start or more commonly by novation once design development has completed to the client’s satisfaction).

Build-Own-Operate-Transfer (BOOT), Public-Private Partnerships (PPP) and other forms of procurement have taken these contractual reallocation of risks even further, and can see project participants with whom the architect has no other direct relationship (and certainly not as ‘client’) such as financiers, sponsoring governments or others, seeking direct rights against an architect.

 

3. Having the cake and eating it too.

There is nothing intrinsically problematic for architects or other consultants about any of these forms of procurement. Sometimes there can be practical advantages. An architect might find for example that having a builder as a client can be a much more positive and productive experience as a result of having had a previous working relationship with that builder. Or even simply as a result of a builder having a better understanding of the design and other issues which the architect may be contending. It is possible also that a builder may have deeper pockets than a debt funded trustee ‘special purpose vehicle’ of a developer client.

A common theme which has emerged however as procurement forms have changed, and the extent of the scope of the architects services have changed, has been a trend toward the allocation of project (rather than professional) risk upon architects (and other professional consultants).

At least in some cases it has seemed to me that such ‘risk creep’ for consultants has not been the result of a considered strategy achieved by negotiation and consensus in the same manner as occurs between financiers, developers and builders, so much as an afterthought as being appropriate because this is vaguely analogous to what is occurring upstream. Whatever the case, certainly it is convenient and desirable for those who are offloading the risk.

However, the difficult and important distinction to be made is that for professional consultants, such risk is inherently uninsurable. Moreover, the risk is being transferred without any offer or expectation of a quid pro quo of project reward, which is a major distinction to how this transfer is handled at an upstream level. And the extent of the project risk being sought to be transferred only appears to be growing.

 

4. A few examples of such project risk transfer:

  Indemnities: where the client seeks to make the client liable for matters of a character or quantum which it would not otherwise be liable for. A good example would be a contractual indemnity overriding the statutory proportional liability provisions, making the architect (inequitably) responsible once again for loss even where caused or contributed to by others.

  Absolute obligations: where an architect’s obligation is couched in absolute language such that they effectively guarantee the outcome, rather than simply using their professional skill and ability.

  Releases: where the client seeks to avoid liability to the architect where this would otherwise arise – for example in regard to information provided by the client to the architect, or by putting time bars on claims by the architect against the client.

  Scope: where a client for example includes matters outside the architect’s field of expertise or competence.

  Third party obligations: where the client requires the architect to assume multiple exposure to different parties for the same subject matter, or to bind the architect to perform obligations and assume liability and risk of the client under other contracts to which the architect is not a party.

  Novation obligations: which interfere with the architect’s corporate autonomy including deciding with whom and in what circumstances it will contract. These require the architect to release the client from obligations it would otherwise have had but without the builder assuming corresponding obligations (particularly as regards pre novation occurrences), or require the architect to assume obligations in favour of the builder without the client releasing the architect from having those same obligations in favour of the client.

 

5. Don’t panic!

It may be that no such reward is desired on the basis that no such risk is deemed worth it. That is a legitimate commercial approach to take, although it may well be limiting in terms of practice growth.

An alternative is to regard and accept some level of project risk as part of doing business in today’s procurement environment. This is equally legitimate. But it would be foolish to do so without at least being aware when this is occurring and taking positive commercial steps to both minimise the project risk transfer to the greatest degree possible; and to the extent not possible, to secure some (appropriate) reward in exchange.

A due diligence process can be instigated to assist in this understanding and negotiation, which must be undertaken before agreeing to any contractual documents (terms and conditions, scope, brief, and other schedules, annexures or any other documents which may be incorporated by reference). This might include:

At the very least, a careful comprehensive reading of all draft documentation by both principals and directors but also project architects

Discussion with colleagues and peers and other consultants.

Having the documentation reviewed and commented on by your insurers and legal advisers.

Frequently one hears of builders pricing in risk. It is difficult for architects to do so – partly because they have not traditionally assumed such risk; partly because the market does not expect it; and partly because by its nature it is uninsurable and if actuaries can’t price it, how can an architect be expected to? Moreover developers and builders frequently structure their project participation through ‘special purpose vehicles’, trusts and the like which insulate them from major liability claims.

Architects however must put their regular, architecturally registered trading practises on the line, backed up by the provision of their substantial insurances. The impact of a major uninsured claim is likely to be far more prejudicial to the professional architect than it will to a builder or developer.

Be that as it may, in the current and foreseeable environment it is open to and arguably critical for architects to be vigilant for, and to take confident steps to remove or minimise, and otherwise to be appropriately compensated for, the transfer to them of project risk for which they cannot insure and will be penalised on project failure.

Such compensation might perhaps be simply by greater fees; or perhaps by some form of financial reward tied to project success. Whatever form the bargain might ultimately take, the requirement for a good faith and equitable negotiation and outcome around the extent of the allocation of and compensation for assumption of project risk should be a perfectly reasonable part of the commercial discussion and equation.

In my experience, once these issues are raised most clients are prepared to work with an architect to find some level of compromise around these issues which, if still far from ideal, nevertheless represent a significant improvement to what is initially presented. This may take some time, cost, effort and stress but usually the outcome is well worthwhile.