Contract Contingencies: Mitigate The Risk
Mitigation of risk and costs in a construction project are always priorities for owners. In some contracts, in particular, Guaranteed Maximum Price contracts, some of those monetary risks are shifted to the contractor. Contingency is important because it allows for money to be in the budget for the unexpected and to keep the project moving, which benefits everyone.
What is and is not a contractor’s contingency?
Contingency is an amount of money built into the contractor’s price to complete the project to address unforeseen (although sometimes very common) costs that arise. This sum of money is generally referred to as the contractor’s contingency. The amount of the contingency is a balance struck between having money on hand to address the unexpected while also not unnecessarily tying up money that could otherwise be used for the project. Contingency is typically 5-10% of the hard costs. However, how the money is actually allocated during the project is not always well thought out, which can be the source of problems during the project.
The contractor’s contingency is not to be confused with an owner’s contingency (or reserve) which is outside of the contractor’s budget and generally used for owner driven changes to the project, such as changes to scope, design and schedule.
What costs can be paid from the contingency?
Failure to clearly set forth in the contract the permitted uses of the contingency can lead to disputes, which can lead to delays. Some common contingency uses in contracts include the following:
- abnormal weather caused delays;
- cost overruns where the actual cost of an item exceeds the amount allocated to such item in the GMP;
- incomplete designs or design errors;
- minor changes in the work;
- concealed conditions;
Contingency items are sometimes qualified by whether they arise due to the negligence of the contractor or its subcontractors and sometimes the frequency of the cost or amount is qualified.
Contractors may argue that no project or contractor is perfect and there will be errors that should be paid from contingency while owners may argue their money should not pay for the contractor’s or its subcontractor’s negligence. The list of uses, any qualifications to such uses and, at times, express provisions of items for which contingency cannot be used can be contentious, but flushing them out in the contract, as best as possible, will benefit all.
What happens if all of the contingency is not used?
Any unspent contractor contingency funds at the end of the project either:
- revert to the owner;
- there is a sharing of savings between the owner and the contractor; or
- as an incentive to the contractor, all savings go to the contractor.
Proper drafting of the contingency clause is critical and should not be overlooked. Best practices are to clearly delineate:
- the permitted or prohibited uses of contingency;
- whether owner approval is required and how obtained;
- how to resolve disputes; and
- what becomes of contingency savings.