Monday, March 23, 2015

Developing and Implementing Risk Mitigation Strategies

In this penultimate installment of our managing contract risk series we explore how best to develop and implement risk mitigation strategies when entering into and performing procurement contracts.

As mentioned throughout this series, all contracts carry a degree of financial risk.

The terms and condition of the contract to be entered into will legally bind (unless contrary under law) the parties to it. Therefore, the risks arising from such legally binding obligations are required to be assessed and ranked (as covered in last month’s installment) and, once done so, a mitigation strategy developed in order to know how best to respond to those risks considered to be of most concern.

Risk mitigation involves the identification of methods to prevent or reduce them from happening and provides methods to be adopted in order to lessen their impact on the project and, importantly, the organisation.

In practice it is rare that risks will be completely avoided but their negative impact can be substantially reduced. In situations where a party is required to enter into standard forms of contracts and agree terms and conditions which are non-negotiable, it is of vital importance that such risk strategies are adopted by the organisation. In such circumstances the risks identified cannot be removed so a mitigation strategy is required for when those risks occur (and which are likely to happen).

Developing a risk mitigation strategy will involve:

  1. identify the possible responses to the risk;
  2. evaluate the effectiveness of the response;
  3. develop an action plan for the implementation of the appropriate response;
  4. maintain a continual review system of the response in order to asses its effectiveness.

Examples of risk mitigation responses in the form of contractual terms include performance guarantees, bank guarantees, milestone payments, insurance cover, liquidated damages and limitation on liability (the latter two of which were covered in an earlier installment of this series).

In addition, specific responses exist which can be adopted in relation to commonly encountered situations. Taking the construction industry as an example, from the contractor’s position the following situations and effective responses are considered appropriate and effective.

Ideal Response
Fixed Price Contract
Price inaccuracies
Bid for or undertake project if considered to be relatively straightforward or short time period and in line with the contractors skills and experience
Additional Scope
No price increase
Provide an accurate programme and BOQs (pricing); adopt own Statement of Works (where possible); involve all stakeholders in negotiations; inform client that your organisation will not accept non profit projects; do not commence works until contract signed (avoid limited notices to proceed)
Unauthorised Changes to Scope
No price increase
Include change order management process in contractual terms; inform client of the change order process and effect of not following it (i.e. no change); include contractual term that additional cost changes will require amendment to the contract; advise client to consider a contingency fee for required changes
Main contractor exposure
Undertake a risk assessment of subcontractor’s suitability  (qualifications to complete the works and financial standing); require subcontractor to follow your procurement process; where possible adopt standard form agreements for subcontractors; obligations of main contractor (incl. scope of work) are “tracked-through” to and reflected in the  subcontract; review subcontractor’s programme and staffing levels
Client fails to adhere to obligations
Client dependency for completion of project
Assess clients ability through checking management commitment, internal client funding for resources; skill level and experience of client
Intellectual Property Rights (IPR)
Exposure to copyright infringement claims
Assess pre and post existing IPR and ability to protect IPR; incl. IPR terms in contract; consider confidentiality agreement; IPR protection granted in subcontract;

Although risk responses are likely to be different from organisation to organisation, their management should, nevertheless, always make sure that the ability to undertake the project and adhere to their contractual obligations exist.

The questions that must be asked are, therefore, does the organisation have the capability and capacity to undertake the project? As such, the project deliverables required to be completed by the organisation must be clear. If not then no such determination can be made. If so, then the organisation will be in a position where it can decide to bid for the project or not.

When making such a determination, the legal risk exposure of undertaking the project is also required to be assessed. Matters such as jurisdiction of the contract will be important. As mentioned above, so too will be the number of parties involved (i.e. subcontractors).

Key issues for management to assess when considering legal risk exposure include whether or what
  1. the proposed contract contains standard clauses relating to public or product liability or professional indemnity insurance, warranties, dispute resolution, force majeure and termination. If non-standard clauses are included, appropriate legal input should be obtained (from in-house or external counsel) in order to be satisfied that the impact of legal risk exposure is tolerable.

  2. the activities involved in the contract are covered by the company's standard insurance policies;

  3. the company is being asked to warrant the quality of its deliverables at a higher level than the normal quality provided by the company for this type of work;

  4. the client’s expectations; and

  5. the conflicts with government policy, such as “Omanisation” for example.

Consideration of the above factors will allow the organisation to decide the legal risk of pursuing the project.

Finally on all contracts, an assessment should be undertaken as to what the likely benefits to the organisation will be were it to undertake the project. Even if the legal risks and ability to undertake the work are considered acceptable and appropriate, thought is required as to whether or not an opportunity cost exists in undertaking the work. Other, alternative, projects may be more beneficial to the organisation.

Next month in the final installment on managing contract risk in procurement contracts we will cover how to mitigate and plan for when things go wrong on the project and between the parties.