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Risk requires close control

LAW - Risk is about taking responsibility, and the key to managing it is to keep a close eye on the contract, writes Catriona Dodsworth

IN COMMON parlance 'risk' is the exposure to danger. But in construction contracts 'risk' is the currency of the project.

It is not necessarily bad and many contractors welcome it when they think they can control it. There are famous stories of clients proposing to take on more risk themselves and contractors resisting strongly so as to protect their margin.

Fundamentally, risk requires a party to deliver on its promises or, more accurately, to assume responsibility in the event that it is unable to keep its promises. Contractors therefore attempt to assume risk in a conscious, planned and well organised way, even planning for unforeseen risks. But it is the risks that are not strictly 'unforeseen' or 'unclear' which can result in disputes.

In most cases risk is allocated in the written contract.

If there is a dispute, the courts will always construe the written terms strictly, giving the words used their ordinary meaning. If there is ambiguity, the courts will construe the words to the disadvantage of the person who prepared the written document.

Only if the words used do not disclose any clear intention will the courts will look outside the document to the 'factual matrix' surrounding the dispute to ascertain true intentions.

The courts also strongly support the principle that contracts must be performed. If a party made a promise to do something, no matter how difficult it proves to achieve, it must do it.

As long ago as 1886, the House of Lords cautioned (in Thorn v The Mayor and Commonality of London) that contracting parties should beware of, and properly investigate, the extent and circumstances of the promises they make. The responsibility for difficulties in performance lies with the party who made the promise.

The strict application of contractual promises is to some extent mitigated by the understanding that performance can be affected by a change in circumstances. If there is some event that affects the contract so obligations cannot be performed (not merely rendered more difficult to perform), the parties might be discharged from their obligations.

In construction contracts, this principle of taking into account changes in circumstance beyond the control of the parties is usually referred to as 'force majeure'.

As no exhaustive list of force majeure events exists, it has to be something pretty major: war, hostilities, rebellion, terrorism, strikes and natural catastrophes are typical examples.

As ever, there is always an exception to the rule, and it is by no means certain that a strict literal approach will always apply. Indeed, in the 2005 case of Full Metal Jacket v Gowlain Building Group which considered the interpretation of a building contract, Lady Justice Arden said: 'The courts must keep the principles applying to the interpretation of contract up to date like any other branch of law. It may be that in the future the law will develop so that evidence such as subsequent conduct is admissible in interpretation of certain types of contract, or that certain types of subsequent conduct are admissible in interpretation'.

Lady Arden remarked that, to date, the courts have not taken that step. But if they ever did, it might have the effect of reducing the rigours of strict interpretation.

The judge in the Gowlain case envisaged balancing the parties' intentions in the written agreement against subsequent performance. This approach acknowledges the reality of many projects in which the parties might produce a sophisticated, carefully crafted, all-embracing contract which is then put away in the drawer until a disagreement looms.

But any relaxation of the strict interpretation approach could lead to all sorts of unfortunate consequences.

The traditional arm's length method of procuring construction has in recent years given way to new models of 'strategic partnering' which change the parties' relationship or manage it in a different way. This model seeks to encourage cooperation by establishing mutual benefits or alignment of commercial interests.

There is plenty of scope for the risk to shift in partnering relationships because of this obligation to co-operate. What happens when the party not contractually responsible for an obligation finds itself in the best position to manage it and, for convenience, adopts the management role?

This is particularly significant where the partnering principles are simply grafted onto traditional procurement forms which might, for example, still require third party security such as performance bonds and parent company guarantees. So while the management of projects is altered, fundamentally the same structure, mechanisms and share of risk remains.

If the contract is no longer to be treated as the rule book or is subject to modification by the way the parties behave, you may find you have assumed a risk you had not bargained for. For example, an employee might vary a contract to the way he thinks it ought to be performed simply by adopting slightly different procedures. This might seem quite convenient to the project team but there is usually a very good reason why contract procedures have been drafted in a particular way.

However irksome it might appear, it is sometimes necessary to follow the prescribed procedures because that is what the funders require and to modify those procedures could have serious consequences.

The key is to ensure that everyone in the project team understands the scope - and the limit - of their contractual obligations and sticks to the bargain. The only way to do this is to keep the contract close to hand and use it like a manual.

This does not mean you need to be aggressive or unduly legalistic and it certainly doesn't mean parties should refuse to collaborate to find solutions to advance the project. It just means you need to do so with a mind to the bargain.

Key points

Contractual obligations are simply promises and risk is that the party who made the promise cannot - or does not - deliver on its promises.

Contracts are interpreted strictly in accordance with the written document - where there is one - but this may shift Parties should take care to ensure they stick to the contract otherwise they might take on more risk than they had bargained for Use the contract as a manual