How to not bet the farm on this next project: different options for project structuring and risk man
Welcome to a new year and new challenges. In these more uncertain times with less work available for the same, or more, number of constructors, we often see people willing, and wanting, to aggressively pursue projects at the start of the new year to build up their pipeline and plan their cash flow. We thought it would be useful to send out a reminder of a few things that constructors and owners can do that could alleviate some of that “bet the farm” risk on their next project:
Price in a contingency – A relatively easy option that is simply a list and quantification of the potential events that can go wrong and cost the contractor its margins or create a loss. Using this as a main strategy alone in the current environment with substantial competition is not ideal;
Transfer the risk onto another party – The concept is that the person who is in the best position to manage the risk should be the one to take it. An example is when a general contractor engages an electrical subcontractor that is in control of and is familiar with the required work and applicable codes. A properly drafted subcontract would transfer the risk of the electrical work to the electrical subcontractor;
Negotiate the risk out of the project – this is basically another risk transfer from a different party’s perspective. For example, a steel erector would negotiate the supply of steel, and consequences/risk exposure of late delivery or deficient product, out of its scope of work and subcontract, transferring the risk back on to the general contractor or the owner;
Partnering with another entity – two or more contractors can form a joint venture (either incorporated or unincorporated) that has many benefits, such as sharing of resources and complimentary skills, as well as sharing in the losses in the event the contractor does not go well;
Project-specific entities – The “corporate veil” is a well-established legal principle that generally means a corporation that signs a project contract will protect the shareholders’ assets that are not in the corporation’s name. One or a number of parties can incorporate a company (a “Project Co”)and sign the project contract, limiting their liability for losses or claims on the project to the assets that were infused into the Project Co;
Manage the risk – A solid project team and tight contract administration can go a long way in managing and minimizing risk, both during the execution of the project and during any disputes over work performed, deficiencies, entitlement to compensation for change order/additional work, etc. Often times a lengthy contract can be summarized into a couple of pages of key dos and don’ts that can guide the project team on site;
Financial security – there are both bonds and letters of credit products available in the market that are increasing in flexibility. Letters of credit are effectively cash in the hands of the holder and a solid understanding of the situations set out in the contract where it can be cashed is important. They can also be a difficult request for smaller contractors performing and often have serious implications on a contractor’s balance sheet and total ability to finance its operations. Bonds are more traditional and do also provide excellent security in certain default situations, however the benefit to the receiver of the bond is less than a letter of credit, as the receiver is faced with the same objections to payout on the bond as the contractor would have raised if a claim was made against it directly;
Insurance – a suitable insurance policy for the company and for the project operations is always important and can cover many theoretical contractual risks that are often heavily negotiated when alternative options are available for risk mitigation. However, it is very important to understand the limits of insurance as well: insurance only covers very specific losses in very specific instances and it will not cover you for all of your operational risks;
Investigations into partners, subcontractors and owners – A great starting point for risk minimization, especially concerns over getting paid or to ensure performance will occur, is to find out from other market players and acquaintances whether that company you are about to get into business with (be it owner, general contractor or subcontractor) has a reputation for poor past performance, slow payment or not paying trades or employees;
Documenting the project – We often say, we don’t care what happened, we care what we can prove. This is not meant to be flippant, but reflects the fact that, on the ground with boots running to try and get a project completed on an often unrealistically tight schedule, promises can be made from one side to the other that they will be compensated or “taken care of” in some way if they only do what they can now to get the job done. Months later, when the change order request is submitted or a claim is advanced for the costs associated with getting the job done, the people who have to approve cutting the cheque are not the ones who made the promises. Unless a contractor or subcontractor can show why and how much they should receive, in black and white documentation, they will have a very difficult time receiving compensation.
Sandquist Law & Construction Project Consulting is well-versed in the entire project lifecycle, from early negotiations and project corporate structuring and project counsel through to dispute resolution, claims settlement, liens and litigation. We would be pleased to discuss your operations and where we might be able to assist.