Here are the takeaways on the subject of risk management from the IACCM Europe Conference 2019. It is based on the following sessions:
- “Risk allocation & acceptance as a source of value creation and leakage in contracts” by Walter Akers.
- A panel discussion about “risk allocation – when is it ‘good’ driving performance versus ‘bad’ undermining performance” with Natalia Ombach, Walter Akers and Tim Cummins
- “Contract management and dispute resolution strategies” by Nicolas Gould.
Contracts and Risk
Contracts are all about risk allocation and risk transfer. Risk is to be seen as the fruit of uncertainty, positive or negative. A party should be rewarded for its ability to manage uncertainty. Very often, risk transfer is an illusion, on the paper, until that risk actually manifests itself. Tim mentioned that much of the conversation on contracts was a complete waste of time, that it should be more focused on quality assurance. When looking at what can go wrong, we fail to see recurrent patterns. in the reality, most of the problems are about scope.
Economic view on Risk
Contracts should be economic instruments to realize or protect value. In an economic view, it makes sense to shift your uncertainties, against compensation, to the party that can solve a problem for a better value than you can. Natalia warned that some risks can however not be managed and should then be monitored and mitigated in other ways.
Walter reminded us of the general principle that “risk is best allocated to the party best placed to handle it”. This means that it shouldn’t be allocated to the weakest party in the negotiation or the one that is most desperate to get the contract… yet, that is what happens so often.
Project price, cost and risk
Signing contracts just on the basis of the price, Walter said, is like asking the butcher to do you a complicated surgery. Yes, he has the knives and knows how to cut … but …
Every clause in the contract has something to do with risk, directly or indirectly.
The project price is the cost of the project plus the risk. It makes therefore economic sense to allocate risk to the party best able to handle it.
Suggested approach on Risk Management
Walter’s suggested approach is as follows:
- Identify the risks;
- Allocate the risk to the party best placed to handle it;
- Never suffer from the illusion that risks can be transferred in totality. For example in an EPC Contract: shifting all the risk/uncertainty to the Contractor; it will come back, as a boomerang, to the Employer if the EPC Contractor goes bankrupt.
The whole contract management system should be designed around risk sharing.
Focus on EPC Contract Risks
Shift in Owner’s behavior
Nicolas Gould made a focus on EPC Contract’s Risks. Originally, Owners wanted control. But now, whenever a new risk is identified, it is passed on to the supply chain. And, as long as a Contractor doesn’t go into bankruptcy, he must fulfill the contract. According to the “fitness for purpose” principles, if things go wrong, even if the Contractor has been designed and built the project carefully, he will remain responsible.
Claims and their roots
Nicolas mentioned 3 causes for claims:
- project uncertainties (such as complexity beyond the expectations of the parties),
- process problems, and
- people issues.
The roots go back to unclear risk allocation. Claims under EPC are normally for:
- Employer’s instructed variations
- Constructive variations
- Delay in Employer approvals
- Access to the site
- Feed availability (for a power plant: supply of water, gas etc)
- Lacking utilities
- Unavailability on the off-taker side (power to the grid)
- Force Majeure
- Acts of prevention
5 steps towards a successful project
For Nicolas, the following 5 steps are needed for success:
- Properly setting-up the project: follow the specs + seek clarification + schedule the project + apply the contract + appoint the DAB + establish the role of the Engineer or the Employer’s representative;
- Running the project: this is about having a proper programme + progress meetings about the real subjects + applying the payment procedures + process & substantiation;
- Managing change: build-up of the contract price + standards for measuring change + being aware of time bars and notices;
- Avoiding disputes: honestly implement value changes with variation orders + understand the programme + identify facts and supporting evidence;
- Dispute management: only as a last resort.
The many examples provided during the event and the arguments extracted above show that, across businesses and over the past decades, people – Employers, Contractors and Engineers – continue to make the same mistakes: lacking proper risk management & allocation + not identifying, acknowledging and speaking about the real problems when there is still time to mitigate. Usually, the parties are technically knowledgeable, are not so good at communicating and really bad at using the contract.
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