Risk Management - A Refresher

13 April 2019

Risk Manager Felicity Dixon takes us through the fundamentals of risk management, advising on how best to identify, manage and allocate risk.

1 - Risk Management2

Risk, its identification, management and allocation, have become increasingly vital in our current commercial environment, perhaps most particularly so within the construction industry whereby the failure to sufficiently and accurately identify, evaluate and manage those risks assumed under complex contractual and commercial arrangements can have serious consequences. So, what exactly is risk? Who should be responsible for those risks? How can they be managed?

What is Risk?

The Oxford Dictionary defines ‘risk’ as “a situation involving exposure or danger”. Taking this concept of what risk and risk management is within the construction industry one step further, the Australian Standard ISO 31000 on Risk Management is a good place to start. Here, the definition of ‘risk’ relates to the “effect of uncertainty on objectives”. This definition seems to encompass both the positive and negative effects of uncertainty as well as an element of the likelihood of that uncertain event occurring in the circumstances (which considers risk attitude and risk appetite within each party) and any consequences.

So, what does this mean for parties engaging in the performance of professional services on a project? In effect, the parties would need to consider what are those risks that are likely to happen, and then ask themselves, “Have I covered that risk?”.

An example of a risk a consultant might encounter within the course of a construction project might be where a third party claims against the consultant for inaccuracy within their design documents, arising out of their own use of information supplied by the client under the contract.

How can Risk be Allocated and Managed?

Once the risks, and likelihood of them eventuating, have been evaluated, we need to consider how these risks are both allocated and managed. Risks within the construction industry are usually treated in a number of different ways whereby the risk is:

  1. reduced
  2. removed
  3. transferred
  4. shared
  5. retained

From our experience in reviewing over 1000 consultancy agreements each year, it appears that clients and consultants treat risk in very different ways, which can often lead to conflict or disagreement as to those identified risks within those agreements for each party.

It appears commonplace that the starting point for considering the allocation of risk in major constructions projects be “the Abrahamson principles”, established by international construction lawyer Max Abrahamson. Those principles assert that a party to a construction contract should bear a risk where:

  • the risk is within the party’s control;
  • the party can transfer the risk (for example, through obtaining various insurances such as professional indemnity insurance where it is commercially and financially beneficial to do so)
  • the greater economic benefit of controlling the risks lies with the party in question;
  • the placing of the risk upon a party is in the interests of efficiency; and
  • if the risk eventuates, the risk falls on that party in the first instance and it is not practical to transfer the risk.

In short, the Abrahamson principles appear to suggest that the risk should be taken by the party who has the best ability to manage that risk. Unfortunately, this is often not done in practice where we see increasingly more complex and onerous client/consultant agreements where the risk is mostly transferred to the consultant, regardless of who has the best ability to manage the risk.

Risk, Liability and Insurance

Whether or not an item is a risk can at times depend on the amount of liability the party is assuming or waiving within a particular contract. Often the more liability you are assuming or waiving, the more risk you are also incurring.

Liability is a legal obligation for one party to pay or compensate another. Importantly, a party’s loss does not necessarily equate to liability. For a consultant to be liable for loss, they would need to be liable for a breach of duty of care owed by them which caused loss or damage, with an obligation on the client to mitigate that loss.

Indemnity clauses attempt to short-cut this liability element. That is, indemnities are a contractual promise by one party to cover the loss or damage of another party often regardless of liability. In contracts, indemnities are generally given by the consultant to their client (and sometimes other parties too) and legally oblige the consultant to compensate the client (and others) for loss under the criteria of the indemnity clause in the contract.

At common law, however, for the consultant to be held liable there must be foreseeability, remoteness, causation and mitigation of loss (with many of these elements not provided within indemnity clauses).

Insurance is one way to mitigate or transfer risk where the consultant is unable to meet the liabilities they have agreed to.  For example, generally professional indemnity insurance will cover a consultant for civil liability for claims made against them by third parties arising out of breach of professional duty up to a maximum amount. Therefore, in the context of indemnity clauses, to remove the risk, you would obviously want to delete the indemnity. However, to reduce the risk, you would be aiming to draft and negotiate a liability-based indemnity encompassing the elements of common law and ideally transferring that risk (and liability) onto your professional indemnity insurer to cover.

What can be Done to Manage Risks?

It is almost impossible to be in a commercial situation where you are not taking on at least some risks within a project. The key is to know how best to manage it. Some helpful management tools to consider are set out below:

1. Set up a Risk Management Process:

  • Establish the context, then identify the risks associated with the project. Consider categorising those risks within groups such as performance risks (those affecting the performance of your services), safety risks (those risks that might injure or harm others) and cost risks (those risks that could result in actual contract costs exceeding those approved costs).
  • Analyse and evaluate those risks by categorising them, giving consideration to both the likelihood that the risk event might occur and the consequences in the circumstances where it eventuates, comparing them and setting priorities.
  • Treat each risk by reducing it, removing it, transferring it or retaining it, as appropriate through negotiation of consultant agreement terms, insurance, price or in some situations the decision to withdraw from the project entirely.

2. Consult with technical specialists, legal and insurance advisers as well as peers with respect to those identified risks which are harder to remove or shift and which would not ordinarily be a risk assumed by a consultant.

3. Conduct scenario planning and benchmarking from previous projects and risks.

4. Seek to remove, transfer or reduce those most likely and major/severe risks where possible through communication, negotiation and consultation.

5. Consider sharing or retaining those risks that are more certain with only minor consequences by monitoring and reviewing them regularly.

6. Where possible, choose your clients with good reputations for fairness and risk allocation.

Ultimately, no matter how risk averse you try to be, there is no guarantee that issues with serious financial, commercial and other consequences will not arise during the course of the evolving project. We cannot see into a crystal ball and cement the future of any dynamic, growing project. However, identifying, evaluating and managing risks as well as seeking external and expert advice and carefully drafting dispute resolution clauses can only serve to assist in this unique and complex industry.

Categorisation, Evaluation and Risk Treatment Options

Risk

Grouping

Rating
(likelihood)

Rating
(consequence)

Risk Treatment

Liability for errors by sub-consultants

Performance risk

Medium

High

REMOVE

  • Do not engage subconsultants

REDUCE

  • Obtain certificate of currency confirming adequate PI insurance of your practice and of subconsultant
  • Engage subconsultant on ‘back-to-back’ terms of own agreement
  • Select reputable, solvent sub-contractors

Uninsured losses

Commercial risk

Low

High

REMOVE

  • Negotiate to delete or amend uninsured liabilities in consultancy agreement

TRANSFER

  • Consider increasing PI insurance cover

REDUCE

  • Insert contract clause limiting liability to amount of PI insurance cover

Budget over-run

Performance risk

Medium

High

REDUCE

  • Advise client if starting budget is unrealistic
  • Advise client to engage a QS to take liability and responsibility for the budget
  • Establish procedures to keep client advised in writing if budget increases
  • Check any clauses in consultancy agreement regarding budget compliance

Felicity Dixon is a Risk Manager with informed by Planned Cover.

informed is the education and risk management arm of specialist insurance broker Planned Cover, one of ACA’s sponsors. Felicity and the team of legally qualified risk managers at informed provide online and live CPD, industry updates and guidance material, and deliver Planned Cover’s contract review service.