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A successful construction project depends on how well project participants manage project risks. Risks are managed through sound business and construction practices and through careful preparation and review of the project contract documents. A significant component of successful risk management begins with how well the project participants allocate risks at the contract formation stage. Ideally, the project documents will allocate responsibility for certain risks to the party best situated to bear them, thereby minimizing the likelihood and the cost of each risk. Following are six key risk allocation and management concepts that should be considered at the project contract formation stage.

1.      Allocate risk to the party best situated to control the risk. At the outset of each project, an owner and a contractor should anticipate and evaluate potential risks to project success and, where applicable, assign responsibility for those risks to the party or parties best situated to control them. For example, a contractor should assign the owner responsibility for design errors because the owner typically holds the design services contracts and is in a better position to work with the project designer to minimize the risk of those errors. From the owner’s perspective, the contractor should undertake primary responsibility for bodily injuries or property damage arising out of the contractor’s operations, since the contractor is in the better position to minimize those risks by maintaining a safe jobsite.

2.      Allocate risk through indemnity provisions. Contract indemnity provisions generally require one party to pay for losses incurred by the other party as a result of claims made by third parties. A construction contract indemnity provision typically requires the contractor to indemnify the owner against claims for bodily injury or property damage arising out of the negligent performance of work by the contractor or its subcontractors. Conversely, the owner typically is called on to indemnify the contractor against claims or losses arising from the existence of hazardous substances at the project site, at least to the extent that the contractor does not have any control over those substances.

3.      Use insurance to support indemnity provisions. Contract provisions requiring insurance coverage provide assurance that each party can satisfy its indemnity obligations. Drafting effective insurance coverage requirements in contracts first requires properly identifying the risk obligations assumed by each project participant, and then ensuring each party has the right insurance to cover those obligations.

For example, owners must require their contractors to secure commercial general liability, automobile liability and worker's compensation/employers liability coverages. These obligations should flow down to subcontractors. Commercial general liability insurance generally covers bodily injury and property damage resulting from contractor or subcontractor negligence. However, owners and contractors should bear in mind that liability policies typically do not cover the contractor for defective work, which is instead subject to the contractor’s warranty. Similarly, liability policies typically do not cover project improvements or construction materials for damage due to unknown site conditions, natural disasters and similar risks. Those damages are covered by a “builder’s risk” policy, which is usually required to be obtained by the owner.

Contracts with design professionals, such as architects, engineers, and contractors performing design-build functions, must also require professional liability insurance to cover errors and omissions in providing design or other professional services. Because professional liability policies typically cover claims made on all of a particular design professional’s projects during a given policy period, the aggregate limit of coverage must be sufficiently high to protect the owner with respect to the owner’s specific project. An owner can accomplish this by requiring project-specific coverage or excess limits applicable to professional liability. For larger projects, the owner may also consider obtaining owner’s protective professional liability coverage to indemnify the owner directly for losses arising from the design professional’s negligence.

4.      Require additional insured status and evidence of insurance. Owners and contractors should always require lower tier contractors or subcontractors to add the owner and contractor as additional insureds. A central reason for additional insured status is the insurer’s primary duty to defend claims made against the additional insureds. Additional insured status is obtained by endorsement; thus, the applicable endorsement should be broad enough to cover ongoing and completed operations on a primary and non-contributory basis.

Project participants must confirm that contractual insurance requirements, including proper coverages, policy limits, and additional insured status, have been obtained and properly documented. Project participants should never rely solely upon certificates of insurance to confirm insurance requirements. Most certificates of insurance are issued by the broker, rather than by the insurer, and are not contractually binding. Accordingly, the insurance provisions of a project contract should mandate delivery of copies of policy declarations pages and all applicable endorsements.

5.   Include waivers of subrogation. Where applicable, contracts should include waivers of subrogation to ensure that project risks are transferred in the manner intended by the project participants. Subrogation allows an insurer to stand in the position of its insured to recover amounts paid on behalf of the insured for damages for which another party may be liable. Project participants intentionally shift risk through a variety of contract provisions. Allowing an insurer to recover amounts paid on behalf of a contract participant to whom that risk was shifted through indemnification or other means may undermine the parties’ intentions. A waiver of subrogation precludes the insurer from seeking reimbursement for amounts paid on claims, and thus prevents an insurer from passing assigned risk back to the other project participants. In other words, a waiver of subrogation ensures that transferred project risk stays with the insurers as contemplated by the project participants.

6.      Review documents with appropriate consultants. Construction projects typically require multiple contracts, which need to be consistent and complementary. For example, project lender and owner requirements for payment timing and conditions should flow down through all project contracts. Dispute resolution provisions should be consistent throughout the project contracts to assure that all parties to a dispute are involved in the same proceeding at the same time and are subject to the same dispute resolution rules. In addition, many standard construction contracts utilize insurance terms that are inconsistent with current insurance industry offerings, usages and customs. To minimize issues arising out of conflicting, inconsistent or antiquated terms in the various project contracts, the project participants should rely on experienced counsel and trusted insurance consultants familiar with current industry forms and practices. In short, careful contract preparation and review are essential to proper risk management for a construction project, and the ultimate goal of project success.


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