Western Canada’s booming construction market has presented a number of risks for owners and contractors. Last week, we discussed the challenges posed by the workforce shortage. This week, we’ll look at other issues impacting the construction space and discuss how you can mitigate your risks.
SUPPLY CHAIN DISRUPTION
Disruptions to the supply chain can cause major issues for contractors. These disruptions impact a contractor’s ability to order and receive the materials and equipment they need to complete a project in a timely and reliable manner.
Contractors can seek opportunities early in the design development phase to mitigate supply chain risk. This may include pre-ordering key equipment, materials, commodity-based inputs and long-lead items to lock in pricing. Contractors may wish to create contingency plans that include alternative materials when possible.
INCREASING INSOLVENCY RISK FOR CONTRACTORS
Contractor insolvency is a risk for owners. As we are currently seeing in today’s hot construction market, many profitable jobs can put stress on contractor cash flows and credit lines. During hot markets and opportunistic times, more start-ups will form and new companies might not survive due to their inexperience.
There are various mitigation strategies owners can employ to mitigate the risk of contactors becoming insolvent, such as creating pre-qualification requirements that address companies’ financials and work capacity. Owners can develop a comprehensive contract security program prior to an RFP being released and verify that the RFP is strictly adhered to. Owners should be aware of signs of credit risk, including signs that the contractors and / or subcontractors are struggling financially.
Owners should ensure projects do not get into unfavorable overbilled situations. It is imperative that owners ensure subcontractors are forthcoming when they are not paid as intended by the CM / GC. Owners should also maintain strict compliance with the Builders’ Lien Act holdback and trust provisions as increased insolvency risk translates to increased claims risk.
Contractors can also employ various strategies to address risks of insolvency. As credit line and project financing is limited, contractors should be strategic about which opportunities they pursue. They should work to negotiate all banking, surety and insurance facilities with the most favorable terms possible. Moreover, they should keep a detailed record of cash flow operations to avoid issues with liquidity. They should also ensure transparency as to how much and what for owners who have paid GC / CM.
REDUCED APPETITE FOR STIPULATED PRICING
A risk for owners during hot market conditions is a reduced appetite for stipulated pricing.
Owners can market-test the viability of their projects under their proposed project delivery model to mitigate the risk of a reduced appetite for stipulated pricing. These market insights should be taken seriously.
REDUCED BIDDERS ON PROJECTS GENERALLY
Fewer bidders on projects generally means less competition, resulting in increased project costs and reduced leverage for owners to negotiate contractual terms and risk transfer. This may result in canceled project procurements or pivoting project delivery methods. Contractors may also take on projects and bear all of the same risks as subcontractors in such circumstances.
To mitigate the risk of reduced bidders on projects, owners should pay attention to the timing of projects. If specific projects can be delayed to a more favorable time, it may be beneficial to delay the RFP release. Owners can also market-test the project delivery model and conduct early project investigation, scheduling and budgeting.
Owners should ensure their main project parameters are attuned to new market conditions. They should consider project incentives such as travel allowances, best-in-class accommodations, best-in-class food / catering, internet and providing site offices and other site equipment for contractors. If the project is located outside of a major urban center, consider other perks to make your project more attractive.
Owners can also consider alternative project offering methods. For example, by bundling projects, owners can mix attractive opportunities with others that may carry a higher risk for diminished bidders. Owners can also break out projects into smaller packages to diminish risk, commitment and exposure for large, long-term projects.
REDUCED PERIOD OF PRICE CERTAINTY AND IRREVOCABILITY
In a hot market, a reduced period of price certainty and irrevocability is a key risk.
One of the strategies owners can take to mitigate this risk is to develop an evaluating period and contract award process quickly. Owners should do as much work / negotiation before the price submittals as possible. This could include the early submission of technical information and early negotiation of commercial terms. Owners can also consider pivoting their project delivery to a hybrid model. This allows for some pre-award fixed pricing and some post-award fixed pricing elements if owners cannot align the irrevocability period with their internal process.
To mitigate the risk of a reduced period of price certainty and irrevocability, contractors can be upfront and reliable with contract negotiations, flagging issues and negotiating resolutions early in the process. Contractors can identify which areas can and cannot be fixed pre-award and communicate these to the owner. They should also deploy material and commodity hedging practices.
DEPARTURE FROM TYPICAL CASH FLOW ON PROJECTS
Periods of high activity can trigger a departure from typical cash flow on projects for contractors and owners.
When owners are providing pre-payment for early-ordered project inputs, they should implement a high level of security in case of default or insolvency.
Contractors can undertake various strategies to mitigate the departure from typical cash flows on projects. They can seek opportunities to pre-order key equipment, materials, commodity-based inputs and long-lead items to lock in pricing. They can seek commercial reasonable opportunities to assign early supply contracts into the contractor agreement when appropriate. Cash flow can be managed so that more cash is available earlier in the project. Contractors can ensure that a level of security is implemented in case of default or insolvency if providing pre-payment for early-ordered project inputs. They can develop reliable and secure storage and housing of pre-ordered inputs to prevent damage or loss. Contractors can also engage with the CM / GC early on to identify the budget and schedule risk items.
To mitigate the risks associated with Western Canada’s hot construction market, sound drafting and project claims management will become significantly more important for owners and contractors alike to succeed.
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.