Unfair Risk Allocation on Design-Build Projects

Brian Perlberg | ConsensusDocs

The AGC annual convention included a session entitled “Who’s on the Hook for Design Defects in Design-Build Projects.” Fox Rothschild’s Dirk Haire, Les Synder of Infrastructure Construction Brightline West, and David Hecker of Kiewit presented. Attendees crowded into a standing-only room because more and more builders are facing design liability, especially design-builders on large infrastructure projects. The presentation highlighted how some owners abuse the submittal process on design-build jobs to make changes without compensating the builder with more time, money, or both. One project took a sample of owner comments and extrapolated that just one project generated over 15,000 submittals and generated over 110,000 comments of “concern” or “preference.”

Certain owner-representatives and attorneys for owners have oversold the risk allocation transfer aspect of design-build. The Spearin Doctrine protects a builder from design documents containing errors by entitling them to receive equitable compensation. The design-build project delivery method erodes potential Spearin protections. Ways that an owner may retain some design responsibility and bring Spearin protections back into play for a builder include the following:  

  • Accuracy of reports prepared by owner’s outside consultants
    • Owner’s design approval process
    • Viability of owner’s stated design and project criteria

The more an owner gives input and control on design, the more likely that Spearin compensation for design defects may apply to design-build projects. It is important to assess the RFP and contract language and determine if prescriptive or performance specifications are used. Prescriptive specifications set precise measurements, tolerances, materials, etc. Performance specifications leave the details to the design-builder. They set outcomes or “operational characteristics” that must be achieved but leave discretion on how to achieve such outcomes. Many design-build contracts combine both prescriptive and performance specifications. This further complicates liability for costs and delays caused by defective design.  Generally, an equitable adjustment will be determined by evaluating if the defective design element relates to the specification’s performance or prescriptive portion. 

Factors used to determine if the Spearin Doctrine applies may include:

  • Contract language and clauses
    • Discretion exercised by the design-builder
    • Circumstances surrounding the bidding (limitations on time and resources)
    • Discussions and negotiations
    • Owner reliance on design-builder’s representations and expertise
    • Prior course of dealings between parties and customs of the industry

When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

Mitigating Risks and Reducing Potential Legal Issues in the Construction Industry

Jennifer Grippa | Miles Mediation & Arbitration

Currently, the construction industry is in a period of growth due to several factors, including the pandemic-related housing boom, increases in government spending on infrastructure and a rise in demand for warehouses and other industrial spaces. However, some experts are expecting a downturn in the market due to rising interest rates, overvaluation of private assets, and higher government spending in the wake of COVID-19. As a result, it’s a good idea for businesses in the construction industry to take a careful approach to stay ahead of any potential risks, rather than jumping headlong into projects they might not be prepared to handle. Keep reading to discover ways construction companies can become more proactive and avoid mistakes, conflicts and litigation.

Beyond the housing market, the greatest areas of growth in the construction industry will be heavy civil and industrial construction.

There are several sectors within the overall construction industry that have seen or will see an increased demand. Whether companies might want to reconsider chasing the demand is another story. The following contributing factors are behind current building trends:

  1. Housing market boom – During the COVID-19 pandemic, people moved around due to layoffs, lockdowns, job movement or to be closer to family, causing an increase in demand for new homes. As lockdowns ended and people began to relocate and look for better jobs, the demand for rental and multi-family housing also increased. Furthermore, the demand for both rental property and new houses hasn’t decreased in spite of pandemic-related supply chain issues.
  2. Increased government spending – In November 2021, President Biden signed into law a $1 trillion bipartisan infrastructure bill that was passed by both houses of Congress. The bill authorizes federal spending over the next eight years, including billions of dollars in funding to states and local governments. It will have the most impact on heavy civil construction, including building and/or improving bridges, roads, dams, wastewater treatment plants, sewers and stormwater systems, etc.
  3. Rise in the need for industrial space – The demand for industrial space has also increased. Many consumer goods companies, including food and beverage sellers, electronics businesses, retail clothing, and more have experienced supply chain issues related to the pandemic and increases in consumer demand and consumer spending. Now, those same businesses are becoming proactive and acquiring more warehouse and/or industrial space, to try to defray the impact if those supply chain issues were to happen again in the future.

Construction industry firms shouldn’t let industry growth convince them to jump into unknown markets without understanding the risks involved.

While it might be tempting for contractors to bid on lucrative projects, especially civil infrastructure projects backed by government dollars or industrial development jobs, it would be wise for companies to weigh any potential returns against the risks involved.

But how do businesses in the construction industry avoid taking on unnecessary risks that often lead to costly legal issues?

1. CONSTRUCTION COMPANIES SHOULD LOOK AT FOCUSING ON PROJECTS FOR EXISTING CLIENTS IN MARKETS THEY KNOW INSIDE AND OUT AND AVOID PROJECTS THAT ARE OUTSIDE THEIR SCOPE AND LEVEL OF EXPERIENCE.

In a potentially tightening or volatile market, construction companies should focus on performing work for their existing client base before looking at new clients and new markets. When companies start working with new clients, dealing with new contract terms they’re not familiar with, and taking on projects they may not have the experience in, there’s an increase in potential for risks, conflicts, and litigation.

2. COMPANIES NEED TO ENSURE THEY ARE FAMILIAR WITH THE TERRAIN, INDUSTRIES, AND LAWS AT ANY LOCATIONS WHERE THEY’RE THINKING ABOUT TAKING ON NEW JOBS.

If a business is considering bidding on construction projects in cities where they haven’t worked before or in industries they are not familiar with, they should question whether they know and understand the local requirements, including federal and state laws around the types of projects they want to work on in the area.

Even companies with years of experience in the types of construction projects, might consider their expertise in building in a particular climate or terrain, and whether they have the staff who understands all the necessary requirements. For instance, a contractor who has built several high rises in an urban area might not have any expertise in building those same types of structures on the coast. There is temptation for industry firms to bid on high-demand coastal area construction, even when they have next to no experience in coastal environments. Taking on work in unfamiliar areas is a recipe for extra risk of errors and litigation. Contractors are better served to think about ways to eliminate risk, not expose themselves to more risk.

3. BUSINESSES MIGHT WANT TO RECONSIDER TAKING ON CONSTRUCTION WORK IF THEY DON’T HAVE THE RIGHT TEAM IN PLACE OR ENOUGH WORKERS TO DO THE JOB.

In the wake of the pandemic and increased construction spending, there’s been a significant skilled labor shortage across the construction industry. Because workers are stretched thin, many projects are not managed as well as they otherwise would be with sufficient staffing. Project managers may be overseeing projects on opposite coasts or across several regions, stressing their time and attention and impeding their ability to effectively oversee each project. There’s tremendous potential for risks in this situation. When projects aren’t supervised properly, mistakes are made and/or miscommunications occur.

4. ORGANIZATIONS SHOULD READ CONTRACTS CAREFULLY TO AVOID MAKING ASSUMPTIONS, EVEN ON JOBS FOR WHICH THEY HAVE DECADES OF EXPERIENCE.

Careful contract analysis is crucial right now, especially when a company is working with new clients and new types of projects that have an unfamiliar scope of work. Businesses should look closely at the default provisions, termination provisions, and liquidated damages provisions to understand what the risks are if they don’t meet the construction schedule.

Disputes arise when people think they know the specifications of a particular project because they’ve been doing this type of work for decades, but the specifications in the contract or scope of work may require something slightly different. When a project team makes assumptions or doesn’t read or understand the project specifications, it can lead to mistakes, delays, conflicts, and litigation.

When disputes arise, mobile mediation can help businesses get in front of them before they turn into lawsuits.

Nothing is worse than having a construction dispute arise in the middle of a construction project when it can adversely impact the job schedule. Disputes affect everyone because work typically stops, causing costly delays to the job. In the construction industry, where multiple subcontractors, suppliers, or designers are typically involved, conflict can have a domino effect. Any work stoppage could cause delays for other trades. Furthermore, project delays and work stoppages create the potential for liens and lawsuits. Unfortunately, it can be even more costly to resolve conflicts after all work has been performed.

Mediation, and specifically mobile mediation, is particularly suitable for the construction industry because it provides businesses with the opportunity to resolve construction disputes right on the jobsite. With this unique type of mediation, an experienced construction mediator comes to the site and meets with the people involved to try to negotiate the problem and come up with a potential solution in the field.

In many instances, a mediator can help resolve misunderstandings and disputes onsite before they escalate into costly, emotional lawsuits. Mobile mediation provides everyone the opportunity to inspect the issue, discuss it and negotiate a practical solution right then and there. And, as in other types of mediation, all parties in the disagreement are bound by the mediation agreement and confidentiality. Therefore, mobile mediation delivers efficiency, cost savings, and timely solutions to most types of construction disputes.

Final thoughts

In our experience, litigation and disputes in the construction industry occur because of mistakes, miscommunication, lack of manpower and/or inexperience. Construction industry disputes can be some of the most difficult cases to resolve in a cost-effective manner. There are already tight margins in the industry. To remain profitable, most construction companies need to focus on effective methods that reduce unexpected job delays, conflicts, and costs.

It’s crucial for developers, contractors, and industry professionals to be more proactive about risks and solving problems, including disagreements, with minimal to zero impact to a project. Furthermore, businesses in the construction industry can minimize risk and prevent many potential disputes by taking a more conservative approach to bidding on unfamiliar projects in new areas, by analyzing contracts, and by ensuring they have the right staff in place. However, even the most vigilant firms will run into problems from time to time. When disagreements arise, mobile mediation allows construction companies to resolve disputes before they turn ugly and move forward so they can get projects done on time and on budget.

When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

Identifying and Accessing Coverage in Complex Construction Claims

Jeffrey J. Vita and Michael V. Pepe | Saxe Doernberger & Vita

I. Introduction

First-party, third-party, builder’s risk, professional liability, commercial general liability, wrap-ups, and additional insured status are all potential sources of insurance coverage for a large construction loss. Therefore, it is critical for construction industry participants, from owners and developers to general contractors and their subcontractors, to have a functional knowledge of the different types of insurance coverage available to them and how those coverages intersect to respond to a loss. This paper presents a brief overview of the various types of coverage available to contractors, construction managers, and owners in a large construction loss and the risks each coverage is designed to insure.

In general, there are two forms of coverage: (1) First-party liability coverage, which protects an insured’s own losses on a project during construction; and (2) Third-party liability coverage, which insures the project participants for losses that become the subject of claims or suits brought against the project participants by third parties. When a loss occurs, such as property damage, both types of coverage can be implicated. For example, if a fire burns down a building under construction, the contractor likely would incur first-party losses such as cleanup costs. The contractor may also have third-party exposure if the owner alleges that the contractor was responsible for the fire. On the other hand, when a bodily injury occurs, all losses to the contractor will be third-party losses. A broad overview of each of these policies is provided below.

II. First-Party Insurance Coverage for Construction Projects

First-party coverage protects the insured or its property against a covered loss.

A. Builder’s Risk Builder’s risk is a form of commercial property policy that provides coverage for direct physical loss to the construction project while it is being built. Unlike liability policies, builder’s risk coverage does not require a claim or suit to be brought against the insured to trigger coverage. Rather, builder’s risk policies provide first-party coverage, i.e., coverage for the insured’s own property (the building that is being constructed), typically along with any materials and fixtures to be incorporated into the finished project.

Generally, builder’s risk policies are written on either an “all-risk” (often referred to as “special form” policies) or “named peril” basis. All-risk policies provide the broadest coverage. All-risk policies typically insure against all risks of loss except those specifically excluded. Most jurisdictions that have analyzed all-risk policies have held that all-risk policies cover all fortuitous losses, which cause some form of physical alteration to covered property.1 Some courts have gone a step further by not requiring any actual physical damage or alteration of property to trigger coverage.2 Courts agree that the initial burden of showing that coverage is triggered is on the insured. This is generally satisfied by proving that there was a fortuitous loss to covered property. Then the burden shifts to the insurer to prove that an exclusion unambiguously applies.3

In contrast, “named peril” policies insure against only those losses caused by a specifically listed peril or cause of loss. Named peril policies typically include coverage for fire, windstorms and hail, flood, earthquake, and other specific risks. The insured has the burden of proving that one of the listed perils caused its loss to obtain coverage.4 Generally speaking, policyholders prefer broad all-risk coverage for construction projects; however, all-risk coverage is more costly than named peril coverage and may not be feasible for every project.

Builder’s risk insurance policies vary widely. Insurance Services Office (“ISO”) has developed a standardized builder’s risk form (CP 00 20), but most carriers nonetheless choose to write builder’s risk policies on their own forms. Also, many policyholders look to the London markets for coverage. Because of the variation in terms, policyholders must carefully review their policies to ensure that they receive the coverage they expect.5

One area to pay particular attention to is who is insured under a builder’s risk policy. An owner may choose not to insure any contractors or only the prime contractor, when the owner purchases a builder’s risk policy. When an owner negotiates with the prime contractor for the prime contractor to purchase a builder’s risk policy, the prime contractor will often require that the owner, as well as upstream parties and lenders, be added as additional insureds. It is possible that a builder’s risk policy may insure only the party that purchased the policy or every party in the contractual chain from the landowner to the lowest tier subcontractor. In addition, most policies limit an insured’s status to the scope of their insurable interest in the project. Thus, a subcontractor may only have coverage for its own work or materials.

Perhaps one of the biggest impacts of who is an insured under a builder’s risk policy is related to subrogation. Parties must be very careful in drafting waivers of claims and waivers of subrogation with respect to first-party losses covered under a builder’s risk policy. Suppose a party that is an insured under a builder’s risk policy has not waived claims against a downstream party, and the downstream party is not an insured under the builder’s risk policy. In that case, the builder’s risk insurer may bring a subrogation claim against the downstream party if the downstream party caused the property damage for which a claim was paid.6 In this situation, the downstream party may be surprised to find out it has liability even though a builder’s risk policy was in place. This example illustrates the importance of carefully drafting risk transfer provisions and reviewing them in conjunction with the insurance that is purchased to ensure the risk transfer mechanisms work as intended.

Finally, it is important to be mindful of the temporary nature of builder’s risk insurance. Builder’s risk coverage ceases once construction is completed. Thereafter, the owner must procure appropriate property insurance to cover operations at its new premises. Some policies call for a specific expiration date of coverage, while others automatically terminate upon occupancy of the project, whether in whole or in part. This may cause a coverage issue if the project contemplates a phased roll-out or if the owner otherwise decides to start its business operations in one area of the project before the entire project is complete. Therefore, builder’s risk policyholders must work with their insurers to ensure that there is no gap in coverage in these scenarios. If there is an overlap, there are appropriate “other insurance” provisions to establish priority clearly.

B. Subcontractor Default Insurance Subcontractor Default Insurance (“SDI”) is a first-party coverage that indemnifies an insured contractor for losses resulting from a subcontractor’s default. SDI insures the cost of completing the work, the cost of correcting defective/non-conforming work, legal and other professional expenses, costs incurred in the investigation, adjustment, litigation, and defense of disputes related to the default and other expenses as set forth in the policy. SDI is often considered an alternative product to performance bonds and differs from such bonds in several respects:

SDI is a two-party insurance agreement between Contractor and Insured as opposed to a three-party guarantee arrangement between bonding company, subcontractor, and contractor. The Contractor prequalifies the subcontractors as opposed to the bonding company. Coverage extends to the policy limit, unlike a bond which is limited to the value of the contract. The insurer responds quickly to the claim as opposed to the bonding company, which can take considerable time to investigate the claim.

III. Third-Party Liability Insurance for Construction Projects

Third-party coverage protects the insured against claims made against it. The person or entity making the claim is the third party that suffered some loss for which it seeks to hold the insured liable.

A. Commercial General Liability Insurance Commercial General Liability (“CGL”) insurance is the most common form of third-party liability insurance purchased by businesses, including those operating in the construction industry. CGL policies are meant to provide the policyholder “with the broadest possible spectrum of protection and to transfer to the insurer the risk of all liabilities for unintentional and unexpected personal injury or property damage arising out of the conduct of the insured’s business.”7

CGL policies are primarily a standardized product, written on a form drafted (and periodically revised) by the ISO (form number CG 00 01). The standard policy form provides coverage for “those sums that the insured becomes legally obligated to pay as damages” because of “bodily injury” or “property damage” caused by an “occurrence,” or because of “personal and advertising injury,” which takes place within the coverage territory during the policy period.8 Standard CGL coverage applies to the insured’s operations nationwide. It is common, however, for construction project participants to purchase a specific CGL policy to cover a single project, such as wrap-up insurance policies which are discussed in more detail below.

CGL insurers have two key duties to their insureds in the event of a covered loss. The first key duty is the insurer’s duty to defend. In practice, the insurer’s duty to defend means that it will retain an attorney on the insured’s behalf when the insured is made party to a lawsuit or claim. This duty to defend may convert to a duty to reimburse,9 or the insured may have the right to select their own counsel, which the insurer pays in cases of a conflict of interest.10 The duty to defend, which essentially functions as “litigation insurance,”11 is typically provided outside of the policy’s limits of liability, meaning that all costs the insurer expends in defense of its insured will not count towards reducing or exhausting the per-occurrence or aggregate limits of liability. Whether an insurer has a duty to defend a given claim is dependent on the policy terms and state law. Most jurisdictions recognize that the duty is broad and is triggered whenever a claim is alleged against the insured that has the potential to invoke coverage under the policy, including those claims which may appear groundless, fraudulent, or false.12

The second key duty is the insurer’s duty to indemnify their insureds from any covered legal liability. Whereas the duty to defend depends on filing a suit against the insured,13 the duty to indemnify is typically triggered by entry of a final judgment, settlement, or other means of final resolution.14 “In short, whereas the duty to defend is measured by the allegations of the underlying complaint, the duty to indemnify is measured by the facts as they unfold at trial or are inherent in the settlement agreement.”15

Parties to construction contracts also may shift their risk by requiring “additional insured” status on another party’s CGL insurance. More specifically, an “upstream” party (e.g., an owner or general contractor) will require in its subcontracts that all “downstream” parties (e.g., subcontractors and suppliers) provide the upstream party with additional insured status on the downstream parties’ CGL insurance. Parties may specify terms such as limits of liability, coverage triggers, and scope of additional insured status. There are several benefits to additional insured status. First, the additional insured is typically entitled to the same coverages under the CGL policy as the named insured, subject to the “triggering” language of the additional insured endorsement, which usually requires some causal connection between the named insured’s work and the additional insured’s liability.16 Second, the upstream party protects its own insurance program by shifting risk from the upstream party’s insurance to the downstream party’s insurance. The upstream party’s limits are not exhausted, and the loss does not count against its loss/claim history. This benefits the upstream party because it avoids the possible negative impact on insurability or increased premiums on future policies.

B. Excess Liability and Umbrella Coverage For many construction projects, the project participants’ risk of potential liability exceeds the amount of coverage available on a primary basis. Accordingly, policyholders often purchase excess and umbrella insurance policies, which provide coverage over and above the insured’s primary insurance. Excess and umbrella coverage responds only once the primary policy or policies have paid their limits of insurance.17 Excess and umbrella insurance, though both purchased to meet this need, differ in function.18

Excess insurance applies only after a set amount of primary insurance exhausts. There are many types of excess forms. Some excess policies strictly “follow form” to the designated underlying policy, except for items specific to the excess policy (e.g., limits and policy period). The policyholder enjoys the same or substantially similar coverage from the first dollar of primary coverage to the last dollar of excess coverage. Other excess policies may only follow form for specific items but not for others. For example, excess policies may contain their own terms that apply to the excess coverage, which may not match all terms of the primary policy.19 As a general rule, excess coverage will not be broader than the underlying primary coverage.

Umbrella insurance is a subset of excess insurance that provides potentially broader coverage than what is provided by the underlying policy. An umbrella policy performs two key functions: (1) it provides an additional layer of insurance for losses that are generally covered by primary insurance; and (2) it provides additional coverage for those less common liabilities that are not usually covered by primary CGL insurance (e.g., malpractice coverage). Thus, umbrella coverage is often considered a hybrid contract, which combines “aspects of both a primary contract and a following form excess insurance contract.”20

C. Wrap-Up Insurance Policies It has become increasingly common for contractors and owners to purchase some form of consolidated or “wrap-up” insurance policy covering the project and all or some of the project participants. Wrap-ups consolidate what would otherwise be multiple policies held by the owner, general contractor/construction managers, and subcontractors into a single, unified insurance program.21 Most often, a wrap-up includes CGL and excess/umbrella insurance; although, a wrap-up may also include workers’ compensation insurance. A wrap-up is usually procured by either the owner (an “Owner Controlled Insurance Program” or “OCIP”) or the general contractor (a “Contractor Controlled Insurance Program” or “CCIP”). All project participants performing on-site work, with a few notable exceptions,22 are typically included as insureds on the wrap-up policies and have equal rights to coverage thereunder. Wrap-up policies provide many advantages to both the entity procuring the coverage and the other project participants. Given the economies of scale involved, the procuring party typically has greater bargaining power with potential insurers. As a result, it can often secure better coverage terms than any one party could obtain on its own. This is particularly important in jurisdictions where subcontractors struggle to procure quality coverage (whether due to poor insurance markets or lack of sophistication). In a “traditional” (i.e., non-wrap) project, the upstream parties must rely on downstream parties to secure appropriate coverage that will protect them as an additional insured. Procuring a wrap-up alleviates this concern. The party sponsoring the wrap-up controls the coverage it procures.

D. Professional Liability Insurance Professional liability insurance is another type of third-party liability coverage that is particularly important to construction project participants performing some form of design or engineering services. Most CGL policies specifically exclude, by endorsement, coverage for bodily injury or property damage “arising out of the rendering of or failure to render professional services.”23 Professional liability insurance is intended to dovetail with this exclusion, providing broad coverage for any kind of act or service that arises out of specialized knowledge, skill, or labor that is predominantly intellectual.24 Although design professionals are not generally required by law to purchase and maintain professional liability insurance; most project owners require that they do to ensure there is an adequate means to respond to a loss caused by a breach of their professional services contract.25

Typically, professional liability insurance is supplied on a “claims-made” basis. This means that the policy will respond to claims first made against the insured during the period when the policy is in effect.26 When a claim is “made” for purposes of triggering coverage, it is often defined as when the insured receives a demand for money or services or is made party to a lawsuit.27 Professional liability policies frequently include a “retroactive date,” a date in the past that cuts off coverage for claims that result from wrongful acts or omissions which took place prior to that date, regardless of whether the claim is made during the policy period. It is critical that construction industry policyholders ensure the retroactive date pre-dates the start of their services or work on the project to avoid incurring a gap in coverage.

Finally, additional insured status is not available on professional liability insurance, so upstream parties should not expect that project consultants can supply the upstream parties with that coverage. There are, however, specialized products available for those project participants who may be concerned about incurring liability on a vicarious basis for the errors and omissions of their consultants. Those products are known as owner’s or contractor’s protective indemnity policies. These protective indemnity policies are a source of recovery for losses incurred by a contractor or owner because of a consultant’s professional negligence.

E. Other types of Coverage Other lines of insurance coverage that may be implicated in a large construction project include, but are not limited to:

Pollution Liability Protects against injury or damage caused by pollution, which is generally excluded under CGL policies. Pollution liability policies can provide coverage for both first-party and third-party losses. Pollution liability policies are often “claims-made” policies, meaning that coverage expires when the project is completed. However, insureds can often purchase a “tail” to provide continued coverage after project completion.

Workers Compensation Worker’s compensation is a type of first-party insurance that protects an insured’s injured workers and limits the insured’s liability for claims.

Business Auto Policy The Business Auto Policy (“BAP”) is an ISO commercial auto policy that provides coverage for both auto liability and physical damage. Auto liability insurance covers third-party loss resulting from accidents caused by vehicles used in the policyholder’s business. Auto physical damage insurance covers first-party loss resulting from loss events, which include, but are not limited to, collisions, hail, theft, and vandalism.

Policyholders may expand coverage available under a BAP by endorsement.

Cyber Cyber risk insurance provides both first-party loss and third-party liability coverage for data breach events, privacy violations, and cyber-attacks. There are variations in the types of cyber insurance policies available; however, cyber insurance generally provides risk shifting for costs associated with having to respond, investigate, defend, and mitigate loss arising from a cyber-attack.

Inland Marine Originally covering ocean materials and vessels, inland marine insurance has expanded to cover various types of property, including tools and mobile equipment at or in transit to a project site.

“Rip and Tear” Third-party coverage insuring contractors from costs to remove and replace defective work.

Crisis Management First-party coverage that protects the contractor for professional responsibility and response costs in a publicized event.

IV. Conclusion In any given construction project, policyholders are faced with a multitude of potential risks. It is critical that policyholders carefully consider and evaluate potential risks in determining which types and amounts of insurance coverage will provide the best protection from those risks. Parties to a construction contract should first obtain some form of first-party insurance: generally, a builder’s risk policy, to protect the property of the insured during the project, and some form of third-party insurance, generally in the form of a CGL policy, to protect parties in the case of third-party claims In addition to those policies, policyholders should consider the advantages of obtaining additional insurance, such as (1) excess coverage to cover losses that exceed the limits of the primary policy; (2) professional liability coverage, to cover risks relating to the performance of a specialized or design-related nature; (3) pollution liability coverage, to cover any risks associated with the release of contaminants and/or mold; (4) a performance bond, to ensure completion of the project; and/or (5) SDI insurance to cover risks associated with subcontractor default.

Once policyholders have obtained coverage for their construction project, they should carefully maintain records evidencing that coverage. Because most third-party coverage is “occurrence” based, policies may still hold value years after the construction project is completed. If policyholders do not carefully maintain records, they may find themselves in a position, years after project completion, where they are forced to pay out-of-pocket because there is no record of the policy in place for that year. Thus, policyholders should carefully evaluate what coverage is necessary and maintain records of that coverage in case of future claims.

Mitigate Construction Risk Through Use of Contingency

Laurie A. Stanziale | Construction Executive

Mitigation of risk and costs in a construction project are always priorities for owners. In some contracts, in particular, Guaranteed Maximum Price contracts, some of those monetary risks are shifted to the contractor. Contingency is important because it allows for money to be in the budget for the unexpected and to keep the project moving, which benefits everyone.

WHAT IS CONTINGENCY?

Contingency is an amount of money built into the contractor’s price to complete the project to address unforeseen (although sometimes very common) costs that arise. This sum of money is generally referred to as the contractor’s contingency. The amount of the contingency is a balance struck between having money on hand to address the unexpected while also not unnecessarily tying up money that could otherwise be used for the project. Contingency is typically 5-10% of the hard costs. However, how the money is actually allocated during the project is not always well thought out, which can be the source of problems during the project. 

The contractor’s contingency is not to be confused with an owner’s contingency (or reserve) which is outside of the contractor’s budget and generally used for owner driven changes to the project, such as changes to scope, design and schedule. 

WHO OWNS (FUNDS) THE CONTINGENCY?

In a fixed-fee contract, the risk represented by the contractor contingency is the contractor’s. The owner typically is not involved in setting or accounting for contractor contingency in a fixed-fee contract. Unless the contingency is disclosed in the schedule of values, the owner may not even know that a contingency exists. Any money left unused in the fixed-fee contract contingency simply becomes profit for the contractor at the end of the project. In this scenario, the contractor controls the contingency and essentially owns and funds it from the contractor’s profit built into the contract price. This scenario, however, could lead to contractors cutting corners when problems arise in order to save money, which presents risks to the owner. 

Contractor contingency in cost-plus-fee contracts, with or without a GMP, are where many disputes arise. Contractor contingency is a disclosed budget line item. In such a scenario, the owner funds the contractor contingency, from which costs arising from the enumerated risks are drawn until the contractor contingency fund is exhausted, at which point costs that exceed the GMP that do not constitute a change order, are the contractor’s responsibility. Even in a contract without a GMP, the contractor may be responsible for costs that exceed the contingency.

WHAT COSTS CAN BE PAID FROM THE CONTINGENCY?

Failure to clearly set forth in the contract the permitted uses of the contingency can lead to disputes, which can lead to delays. Some common contingency uses in contracts include the following:

  • abnormal weather caused delays; 
  • cost overruns where the actual cost of an item exceeds the amount allocated to such item in the GMP;
  • incomplete designs or design errors;
  • minor changes in the work;
  • concealed conditions;
  • regulatory change;
  • unanticipated price of materials or interest rate increases;
  • overtime and premium time or multiple shift or weekend time not due to unexcused delays of contractor or its subcontractors;
  • scope gaps between trade subcontractors;
  • costs of completing the work of a bankrupt or insolvent subcontractor or supplier in excess of the subcontract price where such subcontractor or supplier has not provided surety bonds; 
  • costs incurred due to force majeure delays to the extent that such costs are not reimbursed by Change Order;
    warranty costs prior to final completion; 
  • costs to address safety items;
  • cost overruns of general conditions;
  • contractor coordination issues and errors; and
  • costs incurred to repair defective, damaged or non-conforming work executed by the contractor or any of its subcontractors which are not otherwise reimbursable.

There are certain of the foregoing which can lead to debate during contract negotiations. For instance, design errors could be argued by the contractor to be an owner cost to come from owner’s reserve. Whereas, defective work of the subcontractors could be argued by the owner to be squarely the responsibility of the contractor and not a use for contingency. 

Further, items on the list are sometimes qualified by whether they arise due to the negligence of the contractor or its subcontractors and sometimes the frequency of the cost or amount is qualified. For example, if the same trade commits safety violations repeatedly, which result in regulatory violations causing additional safety procedures and fines, the owner could provide a “free pass” on the first or second occurrence (i.e. contingency can be used) but thereafter it is a not reimbursable and comes out of the contractor’s pocket or they have to figure out a way to charge it back to the subcontractor.

Contractors may argue that no project or contractor is perfect and there will be errors that should be paid from contingency while owners may argue their money should not pay for the contractor’s or its subcontractor’s negligence. The list of uses, any qualifications to such uses and, at times, express provisions of items for which contingency cannot be used can be contentious, but flushing them out in the contract, as best as possible, will benefit all.

WHAT NOTICE AND APPROVAL ARE NECESSARY?

The contract should also be clear as to how a contingency request is made, the owner’s timing for review, approval or rejection and the method for dispute resolution. It is not uncommon that the architect acts as the initial decision maker of a dispute (as is standard in an AIA document) but whomever the arbiter of disputes, it should be clear what the process is for submitting a dispute and whether that decision will be binding. Like all disputes, it is always preferable to keep the project moving, so some potential options (similar to disputes over change orders) are that: 

  • the contractor continues to work, provided the owner pay the undisputed sums; 
  • the owner escrows the disputed amount so the contractor has comfort that the money will be available should they be found to be correct about the use of the contingency; or 
  • the owner pays the full contingency request to the contractor and if the funds are found not to be due, the amounts can be withheld from a future payment. 

Even with the delineation of the uses in the contract, in most instances, use of the contingency still requires the owner’s approval, which is often qualified by not being unreasonably withheld. In some instances, a certain amount that the contractor can use before requesting approval is set in the contract, requiring the contractor only to advise owner of the use, but not seek approval. 

WHAT HAPPENS IF ALL OF THE CONTINGENCY IS NOT USED? 

Any unspent contractor contingency funds at the end of the project either: 

  • revert to the owner; 
  • there is a sharing of savings between the owner and the contractor; or 
  • as an incentive to the contractor, all savings go to the contractor. 

Whether there are savings is dependent on the proper uses along the way but also whether the contractor can move savings from one line item to another during the project or if those savings go into the contingency, where the owner may get the money back. Owners at times attempt to restrict the contractor’s ability to move money among the line items in the schedule of values, but ordinarily the contractor can use those cost underruns to fund cost overruns in other line items without the owner’s prior approval. 

At least one court has acknowledged that the GMP equals all line items listed in the schedule of values as a whole, not that each line item is a separate GMP, effectively allowing the contractor to shift savings to an overrun item to maintain the aggregate GMP (and avoid saving pour over into the contingency). In the case of Nason Construction Co. v. Bear Trap Comm., LLC, 2008 WL 4216149, (not reported in A.2d)(Del. Super 2008), the developer was withholding payments due and owing to a contractor, arguing that each line item in a GMP is its own GMP and money could not be shifted. The court disagreed with the owner and held that the GMP is viewed as a whole, which enables a contractor to shifts savings from one line item in the schedule of values to another. This ability to shift savings and avoid pour over into the contingency can help the contractor to stay within the GMP.

Proper drafting of the contingency clause is critical and should not be overlooked. Best practices are to clearly delineate: 

  • the permitted or prohibited uses of contingency; 
  • whether owner approval is required and how obtained; 
  • how to resolve disputes; and 
  • what becomes of contingency savings.

The Power of Planning: Four Key Themes for Mitigating Risk in Construction

Zac Hays | Construction Executive

Construction is, and always has been, known as a relatively risky business. Whether it is dealing with factors that can be controlled or beyond control, proactively managing risk has proven to be of the most critical factors in delivering quality projects faster, more efficiently and with wider margins. 

Many people assume on-site activities introduce the greatest amount of uncertainty and potential risk. But many mistakes in construction originate in the planning phase – meaning preconstruction is ripe with opportunity to be the most effective place for mitigating risk, saving money and ultimately broadening margins. There are many ways to mitigate risk before projects even start, but four key themes emerge to be clear, repeatable opportunities for success.   

DIGITIZE THE PLANNING PHASE  

Preconstruction is where ideas are brought to life by translating architectural designs into a real, constructible plan. Decisions made at this stage can determine the project’s success and profitability – but it’s far from straightforward. Estimating, scheduling and planning are highly complex activities that depend on constantly changing details and are all areas where missed information or miscommunication can lead to costly rework down the line. 

Digitizing the planning phase of construction has quickly become a massive preconstruction opportunity, taking processes off paper and spreadsheets and putting automation, machine learning and digital collaboration to work. Firms can use digital project management and analytical tools to support and automate many challenging and overtly manual processes that are prone to cause collisions and result in information being lost. For example, firms can use Building Information Modelling data to automatically compare and dissect specifications, gather quantities and build budgets – saving an exponential amount of time. Workforce planning tools that integrate with construction project management solutions can help teams align resource planning throughout project phases. Bringing machine learning and digital collaboration into the equation can also reduce tedious manual entry and the risks of missed information that can lead to rework, cost overruns and delays.  

HARNESS DATA TO LEARN FROM THE PAST 

“Those who don’t know history are doomed to repeat it” is a classic adage, but it’s particularly applicable in construction. Being able to draw on data from previous projects is critical in avoiding the same mistakes and make better decisions on future projects. But once a project enters the build phase, preconstruction teams often lose access to that data. Information that is siloed in separate systems can make it difficult to draw data-driven insights. For example, is there a particular design feature that often creates confusion during site construction and consistently impact schedule? 

Connecting data throughout the building lifecycle in a common data environment is crucial for minimizing risk and delivering better project outcomes. As well as supporting ongoing projects, a common data environment enables construction businesses to analyze data and identify common pitfalls and patterns. Machine learning can also be applied in these instances to highlight and predict project outcomes based on data from previous projects. Armed with these insights, teams can easily learn from mistakes and make better decisions for their projects at hand. 

FIND THE RIGHT TEAM FOR THE JOB 

Construction is highly collaborative; no one completes a project by themselves. Choosing the right specialty contractors for the job can make or break a project. Preconstruction teams need to clear assessments of specialty contractors’ risk profiles and understanding the experience, safety record and even the financial solvency that factors into those risk profiles can be a tall order.  

Bid management networks designed for the construction industry can help preconstruction teams find the right subcontractors for the project. Using digital platforms can help quickly parse information on large number of companies, reduce administrative work and support the qualification process. Today, qualification tools can also tap artificial intelligence and machine learning to quickly assess specialty contractors’ experience, structure and financial status to build risk profiles. Consequently, preconstruction teams can quickly and more accurately assess risk – and focus on creating a strong team that will deliver. 

BUILD IN SAFETY FROM THE START 

Physical safety during site construction is also, of course, an incredibly important risk to manage. Being on-site can present a number of risks for workers, especially now given the pandemic. Progress has been made with technology in recent years with the digitalization of mobile safety checklists in the field – but if a company is just beginning to review safety protocols on site, that’s already too late. Building onsite safety planning into the preconstruction phase can pay dividends across the board. 

BIM is a powerful tool for reducing costly rework. Using clash detection and integrated building techniques with close designer, general contractor and specialty contractor collaboration from the start can help identify and course-correct for elements that will present risks to builders on-site. BIM models can also be used to hold virtual job walks before contractors even arrive on site. Using virtual reality to conduct immersive design reviews can provide more context than traditional design reviews. Since COVID-19, contractors have more heavily relied on virtual design reviews drive to projects forward while remaining compliant and ensuring a safe environment for everyone involved.  

As time goes on, there will be broader adoption of tools and approaches like these to reduce the number of accidents occurring on job sites.  

THE POWER OF PLANNING 

At the end of the day, preconstruction is where contractors set their projects up for success. With access to the right tools such as data digitizing and automating challenging processes, preconstruction teams can make the best decisions for the project before a single shovel has hit the ground. Mitigating risks during preconstruction can help create a more predictable, safer and more successful construction industry.