Allocation and management of risk is central to all commercial contracts and is one of the key factors in determining a successful project. Effectiveness and value for money will only be achieved where risk allocation is equitable and where the party managing the risk is the one most reasonably able to do so. The objective of risk allocation is not to transfer as much risk as possible, but to distribute risk appropriately across the parties.
It is a common starting point for contractors to consider that if they are adversely impacted by forces over which they have no control, they are entitled to an increase in rates or price. The common cry is, "how can we be expected to carry costs over which we have no control?" The answer to that is if the contract does not provide otherwise, the contractor does carry the cost. It is all dependent upon the allocation of risk under the contract.
As with all contracts, risk in a construction contract broadly falls into three categories:
1. Risk within the control of the principal
2. Risk within the control of the contractor
3. Neutral or outside risk over which neither party has any real control
A good contract is one that allocates risk unequivocally, appropriately and commercially. Although it may be seen by some as good contracting practice to push as much risk as possible to the other side, it can often end up being counterproductive. A competent contractor will work into its price a contingency for the risks allocated to it. Accordingly, the price or the rate may needlessly be inflated for risks that may not eventuate or that would be more appropriately dealt with if and when they arise under appropriate contract mechanisms.
As well as allocating risk appropriately, a good contract does it comprehensively and unequivocally. The category of neutral risk must be dealt with specifically. It is a formula for disaster for the parties to address allocation of risk only once the risk manifests itself.
A principal may require tenderers to identify and price risks (rather than provide a global contingency for all risks), both those allocated to the contractor and to the principal. The principal is then able to choose which risks it is prepared to pay for and the likely cost of those risks.
However, the principal will only be able to assess whether it should retain that risk if it can reasonably assess both the probability of the risk occurring and the ultimate consequence or impact on the project if the risk does materialise.