Risky business

24 April 2008

Construction Law is all about risk. At the planning and procurement stage, the key issue is the identifying and allocating the risks. But during the construction phase the contractual allocation of risk is administered as events unfold.

Risk allocation is made by the contractual documents that are entered into by the various parties involved in the project. These documents include the construction contract, consultants' appointments, sub-contracts, performance bonds, warranties and insurance policies.

Once the project moves onto site, the risk allocation is made through contractual procedures for valuation, variations, extensions of time, loss and/or expense and delay damages. If claims or disputes arise over the administration of those risks, then construction law comes further into play, to determine how any issues of disputed allocation of risk are to be resolved.

Promise To Perform

In common usage risk is the exposure to danger, or the ‘stake' which is vulnerable to such danger. It is a negative term but in construction contracts ‘risk' is not necessarily bad. Many parties welcome it when they think they can control it, because the basic law of economics is that the reward for risk can be profit. In this sense risk conveys a meaning which is no different to obligation. Fundamentally, risk requires a party to perform promises or, more appropriate, to assume the risk of not being able to perform its promises.

Most construction projects allocate the main risks in a written agreement between the contractor and the owner. In the majority of cases, when determining risk, a tribunal interprets the terms in the agreements by giving the words used their ordinary meaning.

In the UK, if there is ambiguity, the form of words can be used against the person who prepared the written document, by the legal principle ‘contra proferentum'. It is only if the words used do not reveal any clear intention, that UK law allows evidence outside the contract documents to be used to ascertain the parties' true intentions.

Tribunals also uphold the principle of pacta sunt servanda - under which contracts must be performed- and if a party made a promise to do something, no matter how difficult it proves to achieve, it must do it. Under English law, once a party has agreed a contract for the impossible, it has to deliver or will be liable in damages. This is not the case if there is a ‘get out' clause for, say, legal or commercial impossibility.

Force Majeure

The strict application of contractual promises is mitigated by the principle rebus sic stantibus, which is an understanding that performance is subject to circumstances remaining the same. If there is some intervening event which impacts upon the contract so that obligations cannot be performed, the parties may be discharged from their obligations.

This principle is labelled ‘force majeure' in many construction contracts around the world. There is no exhaustive list of force majeure events but war, hostilities, rebellion, terrorism, strikes and natural catastrophes are common examples.

Contracts with express force majeure provisions often embrace the principles of frustration and common mistake in England and the US (together with impossibility and impracticability in the US), imprévision in France and Wegfall der Geschäftsgrundlege and Unmoőglichkeit in Germany.

Mission Impossible?

Common mistake ‘force majeure' is a more difficult subject. This principle should be contrasted with situations that merely make performance more difficult than initially envisaged.

In the case of Bottoms v City of York (1892), Bottoms agreed to construct sewers based on Bottoms' assumption of the ground conditions. The ground conditions were not as he expected, and needed a more costly technique to complete the works. Bottoms claimed an additional payment, stating that the additions were a variation but the engineer rejected this, so Bottoms abandoned the work and made a claim in court. The court held that there was no common mistake resulting in a variation.

By contrast, in the US case of Miller v City of Broken Arrow, Miller won a contract to lay sewers according to detailed specifications prepared by the City, following a ground investigation. But Miller encountered unstable ground and found it impossible to comply with the specification.

The City accepted this and issued a variation but this also failed. Miller's contract was terminated by the City due to insufficient progress and the works were awarded to others with a modified design. Miller successfully claimed for his costs because the court found that it was impossible (not just difficult) for him to build the sewer in accordance with the detailed designs he had been given.

Risks & Rights

UK courts are reluctant to move away from the contractual agreement, except in the clearest of cases. In that way commercial parties have more certainty as to the extent of their risks, rights and obligations, because the answer as to who owns any particular risk is found in the contract itself.

The key tool for risk management in any construction project is the construction contract itself, which is why great care and expert advice must be taken in drafting its terms.

The next article in this series will focus on how one of the most important risks in a construction contract can best be managed - the risk of delay and disruption.

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