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Looking at some common risk allocation tools for construction contracts, P.1

Previously, we looked briefly at a contract cancellation dispute between the Greater Orlando Aviation Authority and a contractor who had agree to complete the first part of a multi-phase expansion project for the airport. As we noted, the airport claims that it cancelled the agreement because of the contractor’s attempt to shift risk to the airport.

Risk allocation is, of course, an important aspect of contract negotiation, and there are a variety of tools and strategies that can be employed to distribute risk between parties. The idea behind risk allocation is to minimize risk while maximizing reward, though there has to be a balance of risk and reward between parties for a contract to be sustainable. Different types of approaches to risk allocation can be used to achieve this. 

Representations and warranties are one set of tools that can be used to negotiate risk. In construction contracts, warranties and representations are commonly used, and there are various types of warranties that can be made. These include express warranties regarding the quality of the materials, that the contractor’s work will conform to the specifications of the agreement, and that the work is free of defects. Other express warranties may be made, and courts may in some cases recognize implied warranties as well, such as warranties of good workmanship. Contractors can assume risk by making various warranties and representations, but it is also important for them to consider the ways it may be desirable to limit the warranties they make.

Indemnification provisions can also be used to allocate risk in construction contracts. They can do this in a number of ways, including: shifting the costs of loss; limiting the potential scope of future liabilities; shifting the cost of defending third-party claims; and compensating a party for certain risk and/or expenses. In negotiating indemnification, each party will have the goal of limiting its indemnification obligations, but some sort of agreeable balance has to be struck. Working with an experienced attorney ensures a party’s interests are represented in the final contract.

In our next post, we’ll pick back up on this topic, and look at some other common strategies for allocating risks in contraction contracts.

Source: Thomson Reuters, “Using Contractual Risk Allocation Provisions to Minimize Risk and Maximize Reward,” Practical Law Commercial, July 10, 2013. 

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