Navigating Contracts, Risk, and Litigation in the Construction Industry

In this episode of Construction Insiders, host Jessica Busch delves into the evolving landscape of contracts, risk, and litigation in the construction industry with experts Allison Hunt and Sonny Jester. The discussion focuses on today’s market environment, material cost escalation, and innovative approaches to contract structuring and risk management.

[00:00:00] Brad Ducey: Welcome to the Construction Insiders Podcast, where our host Jessica Busch talks with industry experts about new trends, best practices, and how to successfully deliver construction projects in today’s market. Whatever your role on a project, we think you’ll find these discussions interesting and worth your time.

[00:00:19] Jessica Busch: All right. Thank you. We’re here today to get an updated view and an updated perspective on all things contracts, risk, litigation, where we are today in this very unique environment that we are seeing ourselves in the middle of.

We are sitting down today with Alison Hunt, who in her previous life was the head of construction for a development company. And we have Sonny Jester, who we spoke with last time on this topic, but wanted to get a fresh perspective on what he’s seeing these days in terms of the risk management and litigation side of things with these large scale construction projects.

So thank you both and welcome.

[00:01:00] Sonny Jester: Thank you.

[00:01:00] Alison Hunt: Thank you. Super excited to be here, making my podcast debut and very interested to talk about this topic today, especially with Sonny. So we can give our very opposite opinions. Mine coming from my past as a developer and Sonny’s through his lens as an ex lawyer.

[00:01:19] Sonny Jester: I’m excited to be here as well and look forward to talking about ways to avoid litigation, actually.

[00:01:25] Jessica Busch: Which is the big thing, right?

[00:01:26] Sonny Jester: Absolutely. Through appropriate risk mitigation, risk management.

[00:01:30] Jessica Busch: Awesome.

I’m really excited about today as well, guys. The first topic I have for you, we just have to be realistic. We are living post covid, we are dealing with the fallout from those years on the construction side of things still. So in terms of risk, we have the cost implications, we have escalation going up, down, and sideways.

We have completely deviated from the traditional norms. What are you guys seeing in terms of risk as it relates to where things are now?

[00:02:00] Alison Hunt: Yeah, I think a lot has changed post covid all, feeling those impacts that you just listed out. And I think for today, we can really focus on the escalation factors and trends that we’ve seen over the past several years.

In 2021 and 2022, we really saw things take off and we saw an annual. increase of 15 to 25 percent just for material escalation alone. And that really jumped from normal ranges from three to five, even 6 percent sometimes in a pre COVID era. So even though now we’re seeing trends come back down to something that we’re used to seeing those years where those impacts were felt really changed.

A lot of our market changed the contract structure changed the relationship between the owner. And the contractor and sometimes the designer as well, and it changed how risk was allocated among all of the parties in a project.

[00:02:59] Sonny Jester: And even though some of the factors are coming back down, not quite back where they were, but into more of a normal range, the ripple effect of those impacts is still being felt.

So while we are post COVID and everybody’s tired of talking about COVID I think rather than talking about what is COVID doing to your project, what we’re talking about now a little bit is how have things changed? After all of that, and maybe it would be worthwhile to mention not just COVID, but the subsequent supply chain issues and cost increases, and not just materials, labor as well, which were impacted.

A lot of people didn’t come back to work or just now coming back to work or have taken other jobs or moved on to other careers. So labor as well as materials have been impacted.

[00:03:47] Jessica Busch: We’re talking about a lot of what I think is fair to say abnormal risk. And how are these typically being addressed in a contract?

[00:03:58] Sonny Jester: We can get into how they should be now, but how are they, how are these types of risks typically addressed in a contract?

One thing I would say, and then I’ll let Alison address this, because I think it’s more in her bailiwick, but I think it’s fair to call it abnormal risk. from the traditional side of things.

But these risks are now at the risk of becoming not abnormal. They are things that we’re now seeing frequently. There are escalation change orders of enormous magnitudes. There are time impacts of enormous magnitude that are not necessarily the exception anymore. They’re becoming, I won’t say the rule, but they’re becoming non abnormal, if you will.

[00:04:37] Alison Hunt: Yeah, I agree. I agree. And, a lot of what we’re seeing initially. is coming across in change orders from the contractor to the owner for escalation that wasn’t previously anticipated. And to go back to your original question, historically in contracts that risk is allocated depending on where you are in design phase and how you anticipate starting construction.

But we usually see an escalation factor applied to a project budget and then it’s really sussed out during buyout and procurement. And what we saw during 2021 and 2022 is that escalation that was carried in the project budget completely insufficient for what was necessary to move the project forward.

So that’s what created change orders. And most. Most recently we’ve seen a change order come across for one of our public higher education clients and it was in the range of 20 to 25 percent and that was just for materials for the project and to keep the project going. And I think that was the response that was felt in different impact levels from contractors to owners and, really threw us into a realm that we had never encountered before on how to handle that.

Where was that money going to come from? Who was truly responsible for it? And how could everybody around the table act in the best interest of the project? And, keeping everything moving forward was going to be really difficult. So, everyone sat down for a brainstorming session and came up with several ways.

To keep things going, and it wasn’t a one, size fits all kind of answer for this situation. But some of the things that we saw, just to throw out a few things, and we can dive into them separately, are expedited buyout processes phased notice to proceeds advanced payment options.

And then, there’s a few wildcards that I tried on the side as well that didn’t land as well. I’m happy to share those too.

[00:06:35] Jessica Busch: And sorry, Sonny, not to cut you off, but so when we’re talking about protecting ourselves and contracts for these projects, it sounds like the traditional language and safeguards, maybe they’re lacking, for lack of better words, for today’s environment.

So how do you see those to be addressed? How do they need to be addressed?

[00:06:54] Sonny Jester: So I think one of the things that people need to do, I think, is have some intentionality in the way they devise their contracts. Using forms is fine. There are lots of really good contractual forms out there that have been used and are tried and true, and those shouldn’t be just thrown in the rubbitch heap.

But I think people have to start thinking about if these are non traditional risks, non historical risks, if they’re at all, what would have been abnormal five years ago are now becoming normal, then maybe it’s time to start looking at abnormal ways to address them. As Alison said, maybe you put in some clauses that might be unpalatable or have been unpalatable five years ago.

We’ve had a recent project where ultimately the contractor was terminated. The contract, which was cost of the work with the GMP. I had a provision that the buyout had to be completed before the first pay app. That’s aggressive, historically. And it wasn’t because the contractor assumed that things were the way they’d always been and that he could play the gum, so to speak, and make some money at the back end by waiting on his buyout.

The opposite happened. The buyout became cost prohibitive. Materials were not available, switchgear, et cetera, that was hard, which started impacting time. You end up with change orders that were We’re saying one, I can’t finish for this much money, even though I have a GMP and two, there’s no way on earth I can finish in this amount of time.

So that while it was at the time the contract was negotiated an aggressive approach, I think to procurement to buy out that’s something that needs to be thought about. That’s, contractors need to be prepared to address and owners need to be prepared to insist on. I think it’s important to note that this can’t be a heavy burden.

negotiation technique. For this to work, you’ve got to have some fairly frank and fair and open handed discussions between the contractor and the owner about how this works, because ultimately, it can’t be fair to one side and not fair to the other if the project’s going to succeed. You’re just you build in a guaranteed failure.

But that’s one example of something that’s perhaps been used before, sure but perhaps a little bit non traditional or a little bit aggressive for the type of project that it was used for, which was a residential project.

[00:09:17] Alison Hunt: And speaking of, Frank conversations across the table, another approach is to do a phased NPT, and that really doesn’t work unless you’ve got a very strong relationship between your contractor and your owner, really in a setting like that.

The owner is providing an NTP for the partial procurement of the job and then is allowing itself to reevaluate the job at that point to determine. It’s a way to determine what to release next. It’s a way to get the job off the ground without committing to the full exposure of the entire cost of the work.

So that’s something, that’s another technique that, as you were saying, isn’t palatable in past experiences, but now is a structure that can help projects keep going forward because the theme of all of these things is keeping the project going, keeping the best interest of the project at heart, and moving in that direction together as a team.

And that’s when you really feel the compromise between the contractor and the owner to keep things going in the right direction.

[00:10:19] Sonny Jester: And I think when people are not prepared to have those kind of frank discussions and build those collaborative relationships, projects collapse. I’m personally seeing a bit of an uptick, I won’t say a massive climb, but a bit of an uptick in owners willing to terminate contractors.

That has always been, in my view, a last resort, the nuclear option. But it’s happening a lot. I won’t say a lot, but it’s happening more than I’m accustomed to seeing it. And it’s because there’s no relationship. We’re in a mess here, and if I let you go, is the mess going to get worse? Is replacing you a bigger mess or a lesser mess?

Then what you’re creating for me. So I think if you work at the front end to avoid those situations, to build in those opportunities, you maybe get back to the, to termination being an extraordinary remedy, which I think it needs to be. You mentioned phased buyout or whatever at the front end or NTPs.

I spent a year in the Caribbean working for the government of an island nation there on some projects and they use a different suite of contractors. generally in the U. S., the fitting contracts, which are European contracts, which have a lot of problems, but they also have some interesting aspects.

One of the things that was consistent across those projects was the use of advanced payments, where the owner would say, we will give you this percentage of the contract value with your notice to proceed. So that you can go out and do advanced purchase of big ticket items or long lead time items. We had a particular project, it was an athletic stadium, where an advanced payment of tens of millions of dollars against a, a hundred, two hundred million dollarcontract value were given as advanced payments for the purchase, the pre purchase of concrete and steel.

Ultimately the contractor sent in a change order request for increased prices for concrete and steel that needed to be bought. And the owner’s response was, wait a minute, we gave you tens of millions of dollars to buy that, where’s the money? And the contractor couldn’t produce the money or the records or an accounting of where the money was.

So while that mechanism was designed to avoid the problem that we’re talking about, escalations, it didn’t because there was no money. There were no owner safeguards in place to make sure it was being done. So I’m not recommending the use of advance payments necessarily in the U. S. But something like that, while it is an option for people to consider, because you can contract for whatever you want to do as long as it’s not against public policy.

If you want to consider that, you have to build in safeguards to make sure that they’re being used for the purposes intended. Just like the situation with the biotech. contracts before first payout. Okay. Make sure they’ve done it. They let the job get into 50, 60 percent progress before they found out, Oh, wait, you haven’t done that.

So you have to have safeguards.

[00:13:30] Alison Hunt: And I think what goes hand in hand with safeguards is understanding the realistic risk that’s around your specific project. So a lot of these concepts that we’re talking about are great ideas, but like I said earlier, they’re not a one size fits all. So taking the front end of your project and spending the time to outline the risks that are in your cost and in your schedule can help you mitigate against, and not only mitigate against, but allocate appropriately the risk.

And that’s how you really safeguard yourself as well in a contractual setting to move forward. It gives you the checks and balances that you need to make sure that your project’s going to move forward. In the right direction.

[00:14:10] Sonny Jester: Interesting that the time I was working in that Caribbean island, Alison was also working for the same client on different projects and her projects didn’t have the problems mine had.

[00:14:22] Alison Hunt: Shameless plug for me. Yeah.

[00:14:25] Jessica Busch: Way to go Alison. So these risks and these clauses and these safeguards I’m assuming you guys want to maybe dive in and provide some examples of how these can be addressed in today’s environment and what can be done to be thinking about.

[00:14:38] Alison Hunt: I think what we’ve created for ourselves over time is just an excellent pool of solutions. I think that projects today are coming together in untraditional ways that we haven’t seen in a long time, just because of the way that the market’s moving around us. And I think being able to supplement different project teams to keep a project moving and pivot and incorporate the safeguards that we need and the and mitigate the risks that we’re seeing, not only from escalation, funding in some capacity to pivot and move a contract in a way so that the projects are still successful for everybody involved is important.

And so what we’re creating is really a pipeline full of options. So no matter what combination we put together for a project, we’ve got a solution for it in our back pocket because we’ve tried it before. We’ve been working on this for over these past couple of years that have been trying, and we know what works in what setting,

[00:15:31] Sonny Jester: and I think that makes an interesting point, which is we’re talking about how to build the contracts to protect against these risks.

I think one of the things that I think Alison probably ought to talk about this more than me is, I think the best mechanism to build in the safeguards. is to prior to contract when you’ve identified who the parties to your project are going to be having a robust, realistic risk identification process.

So that you can sit down and say, here are the things that we think might happen on this job based on past experience. Here are, here’s the risk to that happening, the chances of it happening and what it’s going to cost you. So how do we want to address this? Do you want to address this? Is it worth And I think if you conduct a serious, realistic risk assessment, At the front, almost pre preconmaybe even pre precon, I’m not but early in the process, then you can build a contract that will address the things that are of concern to both sides of the project.

[00:16:40] Alison Hunt: I completely agree and it’s critical to a successful risk analysis to have the right parties in the room when you’re discussing risk. If you sit down as an owner and you identify risks to your project and then you have a contractor sit down and identify risks to that same project, you’re going to come up with two completely different, two completely different lists of risks.

And when you introduce a design team into that conversation as well, they’re going to point out additional. And so it’s important to collaborate together and use that as the vetting process for who’s going to be involved in your project and what that structure is going to look like. And

[00:17:22] Sonny Jester: it can be robust.

It can be high flung, big ticket items, but it can also be mundane, and it probably should be. I know that I’ve overheard Alison conducting a risk assessment on a private higher ed capital program. One of the questions asked was, where are you going to put your lay down? That’s a risk on a constrained site.

It may not be one that anybody’s thinking about at the early stages of that job.

[00:17:48] Alison Hunt: Exactly. And as, as you start a project in the very beginning, the risks that you see are going to be very high level. Labor just labor location. Where is your workforce going to live? Are you building in a remote area?

Escalation as a whole. What do the team around the table feel the market is going to do during the time of this project? And how can you safeguard against it? And those are the kinds of conversations that lead to contracts that are well used and well understood by the team. The worst thing that you can do in a volatile market is introduce a contract to a team.

A team of people who haven’t read it and have never used it before, they’re, they don’t even know what safeguards are in there because they haven’t reviewed it. But when you have these early risk assessments and open the conversation to the team around the table, you can work together and allocate risk in a way that’s comfortable for everyone so that they understand how to move forward.

[00:18:46] Sonny Jester: And I can’t believe I’m about to say this given my position, but the contract shouldn’t be developed to help you build your claim. It should be developed to help you build your project. That’s what. Risk Mitigation is about avoiding the claims, avoiding litigation, avoiding stumbling blocks to finishing the project on time and on budget.

[00:19:05] Jessica Busch: So avoiding to need you.

[00:19:06] Sonny Jester: Yes, absolutely. Work me out of the job.

[00:19:10] Alison Hunt: If you use me, you shouldn’t need him.

[00:19:12] Jessica Busch: Need Sonny.

All right. If you use Alison, we don’t need Sonny. That’s it. Perfect. So in talking about, the risk assessments way up front I’m assuming when I also think of kicking up a project.

We’re talking bid packages and quals and all of that. Are there any kind of ways to address risks in, in, in those phases?

[00:19:37] Alison Hunt: I will tell you a few years ago, we were really getting desperate and decided to just introduce a material escalation allowance. And that was something that we just threw in the project budget because no one had any clue what was going on.

And we just wanted to start as a developer. Okay. I’m not saying that’s something I would. would ever recommend anybody to do. It turns into a pot of money that no one’s quite sure what to do with or how to manage

[00:20:02] Sonny Jester: and who owns

[00:20:03] Alison Hunt: it there. It opens a whole can of worms that no, no one should have to sort through, but those are the kinds of conversations that need to happen early on when you’re talking through bid packages and how you’re going to phase and let the project.

[00:20:18] Sonny Jester: And own contingencies.

I think there’s something else there that, If you build multiple categories of contingencies into your contracting process, you may have your hard construction contingency. You may have an operational contingency. You may have a design contingency. That’s fine, but you need to make sure that those are discrete and that if you rob from one to benefit another category, that everybody knows it and realizes that means you don’t have money for that particular component of the project.

[00:20:51] Jessica Busch: And I’m assuming you have some kind of what you’d like to call your war stories on these examples and is there anything that you guys have seen as of late that maybe people should stop and think about or a scenario that’s played out that’s worked out well or that maybe was more of a lesson learned for, a developer, a contractor, or what you’ve seen on the litigation side..

[00:21:21] Alison Hunt: I think the material escalation allowance one is a good one to probably set aside. Not necessarily use that one again. But I will say the one that I’ve found works. Most beneficial from an owner’s perspective is a phased notice to proceed and in this environment that we’re in right now, there are, expirations on funding requirements and things like that.

So projects have to get started and move forward or they lose a deal that they’ve secured. And when you’re looking at that and also looking at the difficulty in sourcing materials and things like that, it’s really the only way to have the two hold hands and move forward. And. Yes, that is something that’s tricky and should be well vetted and safeguarded against in a contract.

However, it is a lesson learned for me in moving forward that it can be successful and it can prove to keep a project on track and it is very unconventional but it works.

[00:22:17] Jessica Busch: When it’s done appropriately.

[00:22:18] Alison Hunt: Yes.

[00:22:19] Sonny Jester: I’m not going to advocate pre qualification is the right source for everyone, but I do like it for certain categories of project, particularly where there’s a high technical.

Mission critical healthcare, those kind of things. But I think something that’s closely akin to prequalification is having a relationship with, whether formally documented or not, a relationship between the owner and the contractor so that the owner understands the qualification of the preferred subcontract that are planned to be used by the contractor.

The advance the aggressive buyout provision makes you do that. If you’re going to, maybe you put it in your bid package, we need to know who your preferred critical subcontractors are. If it’s a mission critical project, who is your electrical sub? Who is your mechanical sub? If it’s, a problem with subsurface conditions, who’s your civil and grounds people?

Who are your geotechs? And address that at the front end so that you’re confident as an owner, not just in your contractor, but in your contractor’s team. Because a subcontractor. A significant amount of the problems that arise on time and money may not originate with the contractor. They may originate with the contractor’s contractor.

And yes, the contractor is responsible for those people to the owner but it’s a flow up. So I think there’s, that’s a reasonable approach to having a good relationship with the people that you work with, owner and contractor that as a contractor, you understand that the owner understands the constraints you have.

If you’re building a brewery, for example, you’re going to have to not just have welders, you’re going to have sanitary welders. You’re going to have people who are qualified to assemble those food grade piping components to the project. You better make sure you have them.

And if you don’t have them, you need to find out if the union hall has them or whatever the situation is. So you need to make sure, I think at the front end, that you understand the team you’re buying as an owner.

[00:24:20] Alison Hunt: And this goes right back to going back to the risk assessment that we were talking about a few minutes ago, if you’re doing a risk assessment appropriately, these questions will come up during that process.

Your areas of exposure will be addressed and discussed and it lends itself to protecting the owner and the project and the contractor and the prime subs as you move forward because you’re talking about it on the front end and you’re discussing the appropriate contract setting.

[00:24:48] Sonny Jester: I worked on a brewery as you might imagine from that last example.

Example years ago, and there were labor issues and the contractor’s response was there are no sanitary welders in the area of the brewery, but we can go to Philadelphia and get them. Okay, that’s five hours away. How is that gonna help us? Is it gonna help us? Is that gonna increase your cost? Yes.

[00:25:10] Jessica Busch: And if you had those discussions at the beginning and put in the appropriate safeguards, the risks would’ve been mitigated.

[00:25:16] Sonny Jester: Yes.

[00:25:16] Alison Hunt: Exactly. Exactly.

[00:25:17] Jessica Busch: Interesting. Okay. If you have one major or three major takeaways that you would like people to really have top of mind, if they’re starting projects or they’re even starting to brainstorm about what their next big assignment would be what they should have top of mind in today’s environment.

[00:25:36] Alison Hunt: I think one. The main one is understanding the realistic risk that’s around your project and starting those conversations early on. It will drive who you need around the table. It will drive the appropriate allocation of risk. It will drive an appropriate schedule, an appropriate budget, and an appropriate contract. And with those things, you can proceed in a way that is beneficial to the project..

[00:26:11] Sonny Jester: And I hate to use a buzz word, but I think you need to have intentionality around that process. I don’t think you need to make your risk assessment a box ticker.

[00:26:22] Jessica Busch: I was going to say, get a cell list of class, box to mark….

[00:26:26] Alison Hunt: It doesn’t work that way.

[00:26:27] Jessica Busch: Okay.

[00:26:27] Sonny Jester: We’ve done that, move on. I think you need to be realistic about what are the real risks we’re going to encounter here not the ones that are just on every construction project. Yeah, address those too. But I think you have to focus in on this is real.

This is what really might happen. This is how likely it is to happen and this is the likely impact if it does. How do we avoid that? And then build your contract around that with intentionality. As I said, there are so many good forms out there that you can use. I love bespoke contracts. I think there’s so many good contract writers available in the legal profession now that can write a really good contract. So I’m in favor of those, but I’m also in favor of taking a form contract and making it your own.

[00:27:17] Jessica Busch: Making it unique to that project.

[00:27:18] Sonny Jester: Unique, exactly.

[00:27:19] Jessica Busch: In the circumstances that you find yourself in.

[00:27:20] Sonny Jester: Very well said.

[00:27:21] Jessica Busch: Or could find yourself in.

[00:27:22] Sonny Jester: Yes, unique to that project.

[00:27:24] Jessica Busch: Thank you both. It’s been wonderful and I hope everyone has learned a little bit. So thank you.

[00:27:31] Sonny Jester: Enjoyed it.

[00:27:32] Brad Ducey: If you enjoyed this episode of Construction Insiders, we encourage you to check out our website at cumming-group.com, that’s cumming-group.com where you can find our full knowledge library under the Insights tab. It’s all great stuff. We’re really passionate about it. We hope you’ll check it out. Thanks for listening..