Description
Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase
8-3.003 October 2009
Strategies for managing risk of construction suspension or termination
Introduction
The construction industry invests considerable time and effort in developing and improving practices for planning, commencing and executing construction projects. Significantly less time is devoted to understanding what happens when a project is suspended or terminated. In today's economic climate, it is no secret that many projects have been suspended or terminated or are at risk of a similar fate in the near future. So, what happens when a project is suspended? Can the parties involved just pack up their offices or jobsite trailers and move on to the next project? Unfortunately, the reality is not quite so simple. Although the project may be on hold or terminated, there are still project-related risks that must be managed. Many of the ongoing risks relate to liabilities retained by the parties. However, there are also broader business risks to be addressed.
Circumstances leading to project suspensions or terminations
Numerous factors can contribute to the suspension or termination of a construction project. Common factors are: • Owner issues – The most common reason for a project suspension or termination is due to owner financial issues. The owner may have difficulty obtaining financing for all or part of the project, they may experience cash flow problems or they may go bankrupt. A change in ownership could also lead to a project suspension or termination. In other instances, the owner may elect to put a project on hold to complete a major redesign. Economic – A difficult economic environment can lead to financial issues for project owners, as previously noted. However, there are other economic factors that can also lead to project suspensions or terminations. For example, an owner may elect to suspend a project until market conditions improve, as we have seen recently with residential construction and speculative office space. Other economic factors are labor availability and supply chain issues for key components or materials. Political/Public – Nearly all projects require some form of government approval. These projects have the potential to be suspended due to changes in governmental factors such as regulations, priorities and funding issues. Projects can also be suspended based on public opposition, serious safety or health issues and acts of violence or war. A serious safety issue such as an accident or a fatality may initiate a governmental investigation that may require a shutdown.
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•
•
Environmental – Common environmental factors include unknown site conditions (i.e., discovery of archaeological findings, endangered species or pollution) and natural catastrophes.
Risks associated with project suspension or termination
Risks associated with suspended or terminated projects can be classified into two categories: 1) liability and property risks, and 2) project execution risks. While many of the liability and property risks are traditionally addressed through various insurance coverage, effective risk management will require implementation of appropriate risk mitigation. Project execution risks are likely to be more intangible and may be difficult to assess. Managing project execution risks will require substantial efforts for identification, assessment and mitigation. These strategies can reduce or help mitigate the potential adverse impacts to profitability, reputation, long-term relationships, and other key measures of success. Liability and property risks • Liability associated with a partially completed project - Attractive nuisance - Unlawful occupancy - Environmental damage, including groundwater contamination, erosion, storm water management Property risks associated with a partially completed project - Increased potential for weather-related damage including: o Wind o Rain o Freezing o Mold o Ultraviolet exposure o Rust /oxidation - Increased potential for illegal entry to the site by unauthorized persons intent upon causing damage through activities including: o Theft o Vandalism o Arson
•
Project execution risks • • • • • • • • • • • • • Degradation of partially completed structures, equipment and materials necessitating the need to remove and/or rework the effected structure, equipment or materials Delays caused by re-inspection and/or testing of critical building systems Unresolved claims and change orders Cost escalation Equipment obsolescence Increased mobilization and demobilization costs Extended overhead Potential loss of key individuals and project knowledge Potential loss of labor resources Expiration of permits and/or the need to obtain new approvals (potentially under new codes) Extensive coordination required for restart; increased potential for conflicts between parties Potential need for partial acceptance/partial occupancy Identification or allegations or poor workmanship at project restart by new owner or new contractor via a Property Conditions Report (PCR) upon restart
Risk mitigation strategies
Prior to project suspension or termination The best way to mitigate risks associated with suspended projects is to avoid them altogether. While this is not always possible, there are steps that can be taken to reduce this risk. As a start, do some research regarding the project's funding. Is the source of funding secure and adequate to meet the project's cash flow requirements? Does the project owner have a good reputation and a proven payment history on past projects? Do you have an owner/project pre-qualification process to access the owner's reputation and payment history? Are there any contingency plans in the event that project funding is disrupted? Any concerns regarding project funding should be discussed during negotiation of the contract terms, particularly as they relate to damages for delays. Review contract requirements for suspension and termination clauses, such as "Termination for Convenience" and "force majeure". Consider possibility and financial impact of subcontractor and supplier liens and "pay-when-paid" or "pay-if-paid" clauses in subcontracts. As previously noted, several factors can lead to increased costs resulting from a long-term delay (i.e., cost-escalation, remobilization, extended overhead, repair or replacement of degraded or obsolete equipment and materials, etc.). Develop a strategy for recovering these potential additional costs and ensure the contract provisions support this strategy. This strategy may include the need for separate/additional contractual provisions regarding suspension and termination agreements which specifically addresses the risk associated with a long-term delay or suspension. It is critical to understand how prime contract and subcontract agreements will operate in the event of a project suspension or termination. However, it is also important to understand how the relevant insurance policies will be impacted in these situations, i.e., can the Builders Risk policy be extended to maintain coverage during a longterm delay? (Dependant on the jurisdiction, Builders Risk Coverage may be cancelled due project suspension or termination as it may represent a significant change in exposure.) When a project suspension or termination occurs When a project is suspended or terminated, it is important to act quickly and mitigate the risks previously described. Key considerations include: • Insurance coverage – Consult with your insurance broker and carrier and review all relevant insurance coverage (i.e., Builders Risk, General Liability, Environmental, etc.) and take any actions required to ensure appropriate coverage and limits are maintained. Pay particular attention to various endorsements and exclusions, including granting of "Additional Insured" status to other parties. Site security – Review contracts and establish responsibility for site security. Review insurance coverage to ensure security measures are in line with policy requirements. Protection of completed work – Identify any installed equipment or materials that might be at risk for damage from exposures to weather or intruders. Relocate or remove "at risk" materials if possible, but ensure that the storage of these materials does not present a fire risk. Consider protection methods for equipment that cannot be removed. Considerations and precautions should be taken to enclose the building or structure from unlawful entry and exposure to the elements. Environmental hazards – Confirm that hazardous materials are properly stored or removed. Whether temporary or permanent, ensure site drainage is in place and adequate for any weather that might occur during an extended delay. Ensure that the project and materials are sealed "tight" from weather exposures which may cause damage. Document completed work –Use photographs and video to provide extensive documentation of the work status at the time of suspension. Ensure that photographs and video are carefully dated, labeled and archived. Document project status – In addition to documenting physical completed work, it is also important to maintain all documentation of project status from a contractual perspective. Ensure an updated schedule showing the status of all activities at the time of the suspension is produced and archived. Maintain cost reports showing the project financial status (costs incurred, payments requested, payments received, etc.) at the time of the suspension. Accurate and credible cost and schedule information will be critical when negotiating any cost and schedule adjustments when the project is re-started.
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•
Partial occupancy – If any portions of the project are to be used during the suspension, obtain a partial certificate of occupancy.
Conclusion
With all the activity and excitement that typically occurs at the start of a construction project, people can be reluctant to consider and plan for what would happen if the project is stopped. Careful consideration and planning are critical as project suspensions are a continuous possibility, and even more likely to occur in difficult economic times. Careful planning when negotiating construction contracts and insurance coverage can help to mitigate the impacts of project suspension or termination. Additional steps must be taken, in terms of both addressing property and liability exposures as well as mitigating project execution risk. By addressing these issues, the negative consequences associated with the delay can be minimized and project re-start can be much smoother.
Resources
1. Construction Litigation Reporter. Parkman, Henry W. 'Projects on the Brink: Part I - When the Money Stops Flowing', Volume 30 Number 5, May 2009. 2. Construction Litigation Reporter. Marshall, J. Dean Jr. 'Projects on the Brink: Part II - Subcontractor Due Diligence is Essential in a Depressed Economy', Volume 30 Number 6, June 2009. 3. Construction Delays: Understanding Them Correctly - Analyzing Them Correctly. Trauner, Theodore J. 2nd edition. Subject Matter Team contributing to the development of this paper includes: • • • • • • Steve Reinoehl Deron Cowan Ashutosh Riswadkar Curtis Childress James Boileau Jeff Nolan
doc_697438682.pdf
Certain aspects of many of the risk management standards have come under criticism for having no measurable improvement on risk, whether the confidence in estimates and decisions seem to increase
8-3.003 October 2009
Strategies for managing risk of construction suspension or termination
Introduction
The construction industry invests considerable time and effort in developing and improving practices for planning, commencing and executing construction projects. Significantly less time is devoted to understanding what happens when a project is suspended or terminated. In today's economic climate, it is no secret that many projects have been suspended or terminated or are at risk of a similar fate in the near future. So, what happens when a project is suspended? Can the parties involved just pack up their offices or jobsite trailers and move on to the next project? Unfortunately, the reality is not quite so simple. Although the project may be on hold or terminated, there are still project-related risks that must be managed. Many of the ongoing risks relate to liabilities retained by the parties. However, there are also broader business risks to be addressed.
Circumstances leading to project suspensions or terminations
Numerous factors can contribute to the suspension or termination of a construction project. Common factors are: • Owner issues – The most common reason for a project suspension or termination is due to owner financial issues. The owner may have difficulty obtaining financing for all or part of the project, they may experience cash flow problems or they may go bankrupt. A change in ownership could also lead to a project suspension or termination. In other instances, the owner may elect to put a project on hold to complete a major redesign. Economic – A difficult economic environment can lead to financial issues for project owners, as previously noted. However, there are other economic factors that can also lead to project suspensions or terminations. For example, an owner may elect to suspend a project until market conditions improve, as we have seen recently with residential construction and speculative office space. Other economic factors are labor availability and supply chain issues for key components or materials. Political/Public – Nearly all projects require some form of government approval. These projects have the potential to be suspended due to changes in governmental factors such as regulations, priorities and funding issues. Projects can also be suspended based on public opposition, serious safety or health issues and acts of violence or war. A serious safety issue such as an accident or a fatality may initiate a governmental investigation that may require a shutdown.
•
•
•
Environmental – Common environmental factors include unknown site conditions (i.e., discovery of archaeological findings, endangered species or pollution) and natural catastrophes.
Risks associated with project suspension or termination
Risks associated with suspended or terminated projects can be classified into two categories: 1) liability and property risks, and 2) project execution risks. While many of the liability and property risks are traditionally addressed through various insurance coverage, effective risk management will require implementation of appropriate risk mitigation. Project execution risks are likely to be more intangible and may be difficult to assess. Managing project execution risks will require substantial efforts for identification, assessment and mitigation. These strategies can reduce or help mitigate the potential adverse impacts to profitability, reputation, long-term relationships, and other key measures of success. Liability and property risks • Liability associated with a partially completed project - Attractive nuisance - Unlawful occupancy - Environmental damage, including groundwater contamination, erosion, storm water management Property risks associated with a partially completed project - Increased potential for weather-related damage including: o Wind o Rain o Freezing o Mold o Ultraviolet exposure o Rust /oxidation - Increased potential for illegal entry to the site by unauthorized persons intent upon causing damage through activities including: o Theft o Vandalism o Arson
•
Project execution risks • • • • • • • • • • • • • Degradation of partially completed structures, equipment and materials necessitating the need to remove and/or rework the effected structure, equipment or materials Delays caused by re-inspection and/or testing of critical building systems Unresolved claims and change orders Cost escalation Equipment obsolescence Increased mobilization and demobilization costs Extended overhead Potential loss of key individuals and project knowledge Potential loss of labor resources Expiration of permits and/or the need to obtain new approvals (potentially under new codes) Extensive coordination required for restart; increased potential for conflicts between parties Potential need for partial acceptance/partial occupancy Identification or allegations or poor workmanship at project restart by new owner or new contractor via a Property Conditions Report (PCR) upon restart
Risk mitigation strategies
Prior to project suspension or termination The best way to mitigate risks associated with suspended projects is to avoid them altogether. While this is not always possible, there are steps that can be taken to reduce this risk. As a start, do some research regarding the project's funding. Is the source of funding secure and adequate to meet the project's cash flow requirements? Does the project owner have a good reputation and a proven payment history on past projects? Do you have an owner/project pre-qualification process to access the owner's reputation and payment history? Are there any contingency plans in the event that project funding is disrupted? Any concerns regarding project funding should be discussed during negotiation of the contract terms, particularly as they relate to damages for delays. Review contract requirements for suspension and termination clauses, such as "Termination for Convenience" and "force majeure". Consider possibility and financial impact of subcontractor and supplier liens and "pay-when-paid" or "pay-if-paid" clauses in subcontracts. As previously noted, several factors can lead to increased costs resulting from a long-term delay (i.e., cost-escalation, remobilization, extended overhead, repair or replacement of degraded or obsolete equipment and materials, etc.). Develop a strategy for recovering these potential additional costs and ensure the contract provisions support this strategy. This strategy may include the need for separate/additional contractual provisions regarding suspension and termination agreements which specifically addresses the risk associated with a long-term delay or suspension. It is critical to understand how prime contract and subcontract agreements will operate in the event of a project suspension or termination. However, it is also important to understand how the relevant insurance policies will be impacted in these situations, i.e., can the Builders Risk policy be extended to maintain coverage during a longterm delay? (Dependant on the jurisdiction, Builders Risk Coverage may be cancelled due project suspension or termination as it may represent a significant change in exposure.) When a project suspension or termination occurs When a project is suspended or terminated, it is important to act quickly and mitigate the risks previously described. Key considerations include: • Insurance coverage – Consult with your insurance broker and carrier and review all relevant insurance coverage (i.e., Builders Risk, General Liability, Environmental, etc.) and take any actions required to ensure appropriate coverage and limits are maintained. Pay particular attention to various endorsements and exclusions, including granting of "Additional Insured" status to other parties. Site security – Review contracts and establish responsibility for site security. Review insurance coverage to ensure security measures are in line with policy requirements. Protection of completed work – Identify any installed equipment or materials that might be at risk for damage from exposures to weather or intruders. Relocate or remove "at risk" materials if possible, but ensure that the storage of these materials does not present a fire risk. Consider protection methods for equipment that cannot be removed. Considerations and precautions should be taken to enclose the building or structure from unlawful entry and exposure to the elements. Environmental hazards – Confirm that hazardous materials are properly stored or removed. Whether temporary or permanent, ensure site drainage is in place and adequate for any weather that might occur during an extended delay. Ensure that the project and materials are sealed "tight" from weather exposures which may cause damage. Document completed work –Use photographs and video to provide extensive documentation of the work status at the time of suspension. Ensure that photographs and video are carefully dated, labeled and archived. Document project status – In addition to documenting physical completed work, it is also important to maintain all documentation of project status from a contractual perspective. Ensure an updated schedule showing the status of all activities at the time of the suspension is produced and archived. Maintain cost reports showing the project financial status (costs incurred, payments requested, payments received, etc.) at the time of the suspension. Accurate and credible cost and schedule information will be critical when negotiating any cost and schedule adjustments when the project is re-started.
• •
•
• •
•
Partial occupancy – If any portions of the project are to be used during the suspension, obtain a partial certificate of occupancy.
Conclusion
With all the activity and excitement that typically occurs at the start of a construction project, people can be reluctant to consider and plan for what would happen if the project is stopped. Careful consideration and planning are critical as project suspensions are a continuous possibility, and even more likely to occur in difficult economic times. Careful planning when negotiating construction contracts and insurance coverage can help to mitigate the impacts of project suspension or termination. Additional steps must be taken, in terms of both addressing property and liability exposures as well as mitigating project execution risk. By addressing these issues, the negative consequences associated with the delay can be minimized and project re-start can be much smoother.
Resources
1. Construction Litigation Reporter. Parkman, Henry W. 'Projects on the Brink: Part I - When the Money Stops Flowing', Volume 30 Number 5, May 2009. 2. Construction Litigation Reporter. Marshall, J. Dean Jr. 'Projects on the Brink: Part II - Subcontractor Due Diligence is Essential in a Depressed Economy', Volume 30 Number 6, June 2009. 3. Construction Delays: Understanding Them Correctly - Analyzing Them Correctly. Trauner, Theodore J. 2nd edition. Subject Matter Team contributing to the development of this paper includes: • • • • • • Steve Reinoehl Deron Cowan Ashutosh Riswadkar Curtis Childress James Boileau Jeff Nolan
doc_697438682.pdf