19 November 2018

Impact of inappropriate risk allocations on mega project failure



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This structure, of the owner pushing risks down to the contractor and subcontractors is not sustainable on mega projects.
Australia Real Estate and Construction
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Scott Langdon and Ben Mahler recently presented at the Society of Construction Law Australia (SoCLA) 2018 national conference in the Hunter Valley. Their summary looks at key discussion points from their presentation including the impact of risk allocations in the delivery of mega projects.

The currently accepted norm of contracting is driving the compounding delays and cost overruns in mega infrastructure projects, with the contracted risk allocation in EPC contracts being the root cause of mega projects going from bad to diabolical.

We come to this conclusion based on our unique perspectives. We often get involved when there are issues, when there are delays, cost overruns, financial stress or in the dispute resolution process. The fact that we are employed by stakeholders on mega projects, is evidence itself that the status quo is not achieving the desired outcome.

We have experience acting for financiers, owners, contactors and various subcontractors and consultants on mega projects. From mines, to power stations, to tunnels and prisons. Each engagement has its distinctive characteristics, but the commonality is stunning. The common themes are that the client never expected to be in this position when signing the agreement; their key personnel are focused on the dispute and not the project delivery; that the size of the project compounds a problem into a business destroying cancer.

Current EPC contracting is completed on the assumption that there will be no issues in mega projects; no material design issues, no material unforeseen construction issues, no material performance issues. But evidence and experience suggest almost all mega projects face significant operational construction challenges. Therefore contracting arrangements are not structured for purpose, but rather built for a non-existent reality. When executing a contract on mega projects, based on historical evidence, no party should have confidence that the contact will facilitate the most timely and cost effective construction completion.

Despite this, EPC contracts on mega projects have risks being borne by the parties who have the least capacity to hold it and the least knowledge to execute. Without doubt, the owner of the mega project should have the greatest knowledge of the project and the land, and therefore the owner should retain at least some latent construction risks. Plus, the owner has the strongest financial position and therefore has the capacity to take on risk.

And this responsibility is specific to mega projects; not property construction and smaller projects. Mega projects. The key differentiator is the size context. Foreseeing and avoiding errors on mega projects is exponentially harder than on smaller projects, but the consequences are dire. Head contractors who 'error' by 25% on a smaller project, say $100 million, are more likely to be able to wear the $25 million additional cost. But there are not many contractors around the world who can 'error' by 25% on a $5 billion project and wear a $1.25 billion additional cost. Yet it is likely that the same head contractors will tender for the $100 million project and the $5 billion project.

The structuring of the owner pushing 100% of the risk down from the owner, to the contractor and subcontractors is not sustainable on mega projects. Because when things go wrong, and evidence suggests it does, there is a risk-reversal with the owner assuming up to 100% of the risk for the project – the polar opposite result which the EPC contract was aiming to achieve.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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