MDA Attorneys Warns Contractors of Hidden Risks in Bankable Construction Contracts With Investors

Enter private financiers, who are a necessary catalyst for development and increasingly funding projects across the globe. While bankable projects are a boon in the construction sector, the characteristics that make them bankable for financiers usually translate into greater risk for contractors. But securing a bankable project contract can quickly turn into despair if contractors have not properly understood and priced for this risk.

As construction law specialists, at MDA Attorneys we’re seeing many contractors electing to ‘go it alone’ and enter into complex legal negotiations with seasoned lawyers. They often misunderstand the extent of draconian contract terms and do not adequately recognise and price for risk.

The issue isn't private investment per se, but rather the risk allocation that accompanies it, and a misunderstanding of such risks. The mechanisms for transferring risk to contractors have become increasingly sophisticated.

Time and budget issues

Construction projects often encounter time and budget problems. A recent Oxford University database of over 16,000 major projects worldwide reveals that only 8.5% are delivered on time and on budget, with just 0.5% also delivering the expected benefits. In addition, construction inherently involves uncertainty. The 1994 Latham Report acknowledged that no construction project is risk-free: “risk can be managed, minimised, shared, transferred or accepted. It cannot be ignored."

A further complication is the automatic adoption of engineering, procurement and construction (EPC) contracts by funders and developers for all projects, without questioning whether this procurement strategy is suitable.

When employers have already conducted initial design work, when projects are divided into packages with complex interfaces, or when subcontractors lack EPC capabilities, forcing an EPC structure introduces additional risk and inefficiency, often overlooked by funders and developers.

Disproportionate risk

Economic development requires private investment, and financiers seek to minimise risk, but contractors are entering dangerous territory if they are carrying disproportionate risk which they cannot control or adequately carry.

The problem is serious if not appropriately recognised. Contractors faced with unmanageable risk must either decline projects, artificially inflate prices to cover contingencies, or accept terms that may lead to financial distress or project failure. None of these outcomes serves South Africa's infrastructure needs.

The solution isn't to abandon private financing but rather to revisit the principle of risk allocation throughout the contract chain. Risks should rest with the parties best positioned to manage them. The principles in standard form contracts should be respected. Warranties and indemnities should be reasonable and proportionate to the risk.

As private financing of infrastructure becomes the new norm, contractors must approach these agreements with extreme caution. Engage expert advice and conduct thorough upfront investigations to ensure that you have correctly priced risk in financed projects.