PERCEPTIONS OF RISK DISTRIBUTION IN CONSTRUCTION CONTRACTS
Anita M.M. Liu,
City Polytechnic of Hong Kong
S.O. Cheung,
University of New South Wales, Australia
KEYWORDS
Risk distribution, perception, standard forms of contract
Summarv
Risk has different meanings to different individuals. Since the construction industry has always been described
as having a high risk nature, how risks can be shared and thus properly managed among the parties is a major
concern. Standard forms of building contracts are therefore drafted in response to the needs and practices of the
industry. They then form the basis for identifying and allocating risks and uncertainties associated with the
construction works. By widespread use of the standard forms, the distributions of risks are well-known to the
parties, yet the frequent occurrence of amendments has often altered this distribution pattern.
This paper will study the risk distribution in the Australian Standard General Conditions of Contract AS2 1241992, and compare it with the standard form (HKIA/RICS 1976) used in Hong Kong. A survey will be carried
out in Australia to examine the project participants' identification of major risk items and their views on the
distribution of these risks. Their perceptions will be compared with a similar study of their counterparts in Hong
Kong.
Contract Systems
Traditional discrete economic transaction favours 'sharp in by clear agreement, sharp out by clear performance'
(Macneil 1974), but many contractual relations are not of this well-defined kind, hence, planning contractual
transactions and relations becomes essential. According to Macneil (1975), two processes are essential to
contract planning, namely, defining goals (along with related costs of their attainment) and communications.
The perfect contract is, quite often referred to, one that anticipates and disposes of all possible hture problems
and questions. Perfection, however, is rare if not at all impossible to attain and, since like any other human
activity, engaging in contractual behaviour involves risks of loss, risk planning in contracts is therefore an
important issue.
The concept of risk is a recognition that human beings are in a constant state of partial ignorance about the
future, including future losses. Risk is reduced whenever man acquires more certain knowledge about the
occurrence or non-occurrence of future losses. Risk planning in connection with contracts is actually one facet
of risk management in the economic world. However, no contract can ever be fully planned and this is
particularly hue of the risk aspects of the contract.
Risk and uncertainty are different. Risk is where the outcome of an event, or each of a set of possible outcomes,
can be predicted on the basis of statistical probability. Other events have outcomes which are uncertain, they
cannot be predicted via statistical probability and the probability of their occurrence is random. It is common
for risk (and uncertainty ) to be considered as only negative, i.e. the risk of making a loss or of not realising the
forecast profit. The degree of riskiness varies with the complexity, size, and duration of the contract.
Contractual provisions distribute risks between the parties who, in turn, seek compensation, usually financial,
for the risks which they assume. The application of risk management provides explicit recognition of the risks
which parties to a building project are required to take in terms of what the risks are and their sizes. The pattern
of risk distribution is a major influence on project price, and in extreme cases, the distribution of risks can result
in a party withdrawing from the proposed scheme. Hence, a study of project participants' perceived risk
distribution patterns will be useful.
Classifications of risk are plenty (Greene and Serbein 1983, Grose 1987, Moore 1983, Doherty 1985) and
include pure, speculative, static, dynamic, and inherent risks. These risks may not all be handled in terms of
explicit allocation to the parties through contract planning, nevertheless, the standard forms of contract do
address most of these risks. Under the neo-classical contracting system (Williamson 1986 classified contracting
systems into three categories, neo-classical contracting system is the one that provides 'gaps' and 'flexibility' for
the contracting parties such as provision of arbitration clauses rather than straight litigation; the other two
contracting systems being the classical system and the relational system). Risk planning plays the role of
handling 'gaps' and offering 'flexibility' in the contract . Indemnity clauses and variation clauses are examples of
the provision of this 'flexibility'.
The 'gaps' and 'flexibility' (Williamson 1986) allowed in contract planning include:
1. Third-party assistance - arbitrator I mediator I adjudicator
This is used in resolving disputes and one important purposive difference in arbitration and litigation that
contributes to the procedural differences is that, whereas continuity (at least completion of the contract) is
presumed under the arbitration machinery, this presumption is much weaker when litigation is employed.
2. Third-party assistance - architect I engineer I quantity surveyor
A third party consultant is employed to evaluate performance and acts as a relatively independent expert to
determine the content of construction contracts.
3. One party control of terms
The contract may provide that one of the parties to the contract will define, directly or indirectly, parts of
the relation. (This may go so far as to allow one party the free will to terminate the contract relation). One
important point to note is that whenever a party is not clearly paying for the privilege of retaining a free
will not to perform his own contractual 'obligations', the danger is that the consideration doctrine may
make the party's 'rights' unenforceable.
4. Use of standards
An example is the fluctuation clauses in standard forms of building contract where a certain published
price index is referred to.
Risk Distribution
Various practitioners and researchers alike have written extensively on the allocation principles of risk sharing.
Some suggested guidelines as the criteria for sharing the project risks are as follows:
1. All risks are rightfully the owners unless transferred to or assumed by another party for a fair
compensation, when the risk is so transferred, consider whether the receiving party has both the
competence to fairly assess the risk and the expertise necessary to control or minimise it (Casey 1979),
2. if a risk is imposed upon a party, an opportunity for reward to the party should exist for properly dealing
with the risk (Nadel 1979),
3. a risk should be allocated to the party which is in the best position to control it and to undertake it
financially (Nadel 1979),
4. steps should be taken to assure that risks are actually allocated as intended (Nadel 1979)
Risk distribution reasoning of this kind was implicitly approved by the House of Lords in Photo
Production v. Securicor Transport 1980 (Furmston 1986) in Lord Diplock's statement, "it is generally more
economical for the person by whom the loss will be directly sustained to do so rather than it should be covered
by the other party by liability insurance".
The framework for studying the risk distribution pattern in the standard forms of contract, Australian
~ ~ 2 1 2 4and
' Hong Kong HKIAIRICS~, is as follows:
Australian Standard 8 General conditions of contract (AS 2124-1992) with General conditions of tendering
andform of tender AS 2125-1992, and Form offormal instrument of agreement AS 2127-1992, Standards
Australia, 1992.
Agreement and Schedule of Conditions of Building Contract (Standard Form of Building Contract) for use in
Hong Kong, Private Edition with Quantities, Second Edition 1976 (May 1979 Revision), Hong Kong Institute
of Architects, Royal Institution of Chartered Surveyors (Hong Kong Branch), 1979
PHYSICAL RISK
AS2124
clause nos.
27
12
35.5
NSP
40
NSP
Site access
Latent conditions
Weather
Acts of God
Quantity variations
FINANCIAL RISK
Rise and Fail
Funding
-
PERFORMANCE RISK
Nominated Sub-contractors' failure
Defective work
1
Accidents
Managerial competence
Labour, materials, equipment
Acceleration and Suspension
Time for completion
Third party delay
Adiacent ~ r o ~ e r~rotection
tv
LEGALPOLITICAL
RISK
Regulations
Public disorder
NSP = No specific provision
HKIAIRICS
clause nos.
21,23,24
NSP
23
20
11, 12 (2)
36
1 42.44.43
.
1 26.30
9.3, 10, 43, 27,17,30,23
35.5
2, 31, 42.2, 23, 1, 6, 15, 30
30
NSP
NSP
NSP
NSP
29
1, 6, 14
33,34,35
2 1,23,24,26
1 33.35
21.23
135
23,24
1 16. 17
1 18. 19
14
4
,
1
1
NSP
23,26
Fig. 1 Provisions in Standard Forms
Certain risk items listed above are not being explicitly dealt with under contract planning of the standard forms.
In particular, 'accidents' and 'managerial competence' (whether that of the employer, contractor, or subcontractors) are thought of as inherent in business efficacy. The contract provisions tackle some of the
consequences of these two items, for example, accidents are dealt with under indemnity and insurance clauses,
and consequences of managerial competence (or incompetence) are dealt with under defective work, delay,
suspension, payment, determination and removal of personnel from site.
Risk Perceptions
Individuals are known to perceive risks differently. The difference in the individuals' perceptual/judgmental
process is well explained in the literature of organisational behaviour and 110 (industriallorganisational)
psychology (Tversky 1967, 1972, Naylor et a1 1980, Locke and Latham 1990).
A preliminary research was conducted to investigate the major perceived risk factors (under the risk distribution
framework described previously) by various practitioners in both the Hong Kong and the Australian
construction industries. 40 and 20 returned questionnaire were collected in Hong Kong and Sydney
respectively. This pilot test was administered to part-time post-graduate students who were working in the
construction industry.
The questionnaire is in two parts, the first part is to elicit the perceived major risks by asking the respondents to
insert 1 (least important) to 5 (very important) against each of the risk items, the second part is to elicit the
preferred risk distribution pattern by indicating whether 'employer-biased', 'equally shared' or 'contractorbiased', ie. the respondent is asked to indicate against each risk item whether hislher preference is to allocate the
particular risk to the employer (employer-biased), the contractor (contractor-biased) or on an equally-shared
basis. The risk items for the respondents to consider are the same as those listed in Fig. 1.
The findings are to be discussed according to the following:
Overview of the respondents' perceptions of risk items (expressed in weighted average scores) in the two
samples
Major risk items (expressed in weighted average scores greater than 50%) -- comparison of the Hong Kong
and Australian samples
Respondents' preferred risk distribution pattern for the major risk items -- comparison of the Hong Kong
and Australian samples
ANOVA (Analysis of Variance) to test for null hypothesis (Ho: pl=p2) between the two samples regarding
the perception of major risk items and preferred risk distribution pattern
PHYSICAL
RISK
1
I
FINANCIAL
RISK
PERFORMANCE
RISK
I
Importance
5
<--------------------5
1
HK
yo
Site access
18
8
Latentconditions
Weather
25
I
110
Acts of God
Quantity variations 5
Rise and Fall
28
8
Funding
22
NSC's failure
5
Defective work
Accidents
8
Managerial
30
comDetence
I
Labour, materials,ll5
Adjacent property 2
protection
LEGAL/
Regulations
15
POLITICAL RISK Public disorder
5
HK = Hong Kong; AU = Australia
Fig. 2
4
2
3
AU
24
5
14
I
124
10
0
33
14
19
10
19
HK
15
18
28
I
I8
12
22
28
25
28
18
25
AU
24
43
5
I
I
I
I
10
29
24
24
29
29
29
24
1
HK
22
42
22
I
118
40
30
35
30
50
35
22
AU
19
24
38
I
119
24
38
19
29
38
14
33
HK AU
32 19
30 24
18 I 24
I
132 114
28 133
20129
25 10
12 24
15 14
32 33
18 10
I
I
I
I
I
HK
12
2
8
I
132
15
0
5
10
2
8
5
I
( 1 9 125 ( 1 9 ( 3 8 ( 3 3 ( 2 0 ( 2 4 12
AU
14
5
19
I
I43
5
10
14
5
0
14
14
Weighted
average
score
HK AU
48
56
55
49
61
43
I
1
132 I17
41
51
64 44
63
52
59
56
63
54
46
46
64
56
I
I
15
158 156
I
I
1
I
5
5
24
35
29
45
29
12
14
35
44
5
10
15
8
24
10
38
30
33
14
25
35
19
43
8
22
19
24
51
34
44
35
Overview of the respondents' perception of risk items
The weighted average scores expressed in percentages are calculated by allocating weights of 1, 0.75, 0.50,
0.25 and 0 to the 5-point scale in descending order. The percentage of respondents giving an answer of 5 on the
5-point scale is multiplied by 1; the percentage of those giving an answer of 4 is multiplied by 0.75 and so
forth. These are then added and divided by the total percentage of respondents who actually have answered the
question, ie., excluding those who have given no response to the particular question. Respondents answered all
questions in both the Hong Kong and the Australian samples).
A weighted average score of over 50% is taken to mean that the respondent considers the risk item as major.
After the calculation of the weighted average scores, it is found that the risk items which both the Hong Kong
and Australian practitioners perceive to be major are those under Performance Risk, ie., NSC failure, defective
work, managerial competence, labour/materials/equipment, and time for completion. Each group of respondents
(Hong Kong and Australia) has nine major risk items, however, not all nine items are common amongst the two
groups and they are also ranked differently by the two groups. Of the nine items in each group, six of these are
common items. They are funding, NSC failure, defective work, managerial competence,
labour/material/equipment and time for completion. Five out of six of these items are under 'PerformanceRisk'.
The results are shown below (fig. 3):
LEGAL/
POLITICAL RISK
Fig. 3
competence
Labour,
materials, 6
equipment
1
Time for completion
9
Regulations
58
4
56
72
51
3
61
Comparison of major risk items
'Latent conditions' is one of the major risks perceived by the Australians and their standard form has expressed
provision to deal with this item. 'Latent conditions' is not explicitly dealt with under the Hong Kong standard
form but there again, this is not a major risk item perceived by the Hong Kong sample. Likewise with the other
item 'Rise and Fall' (price fluctuation), the Hong Kong sample perceives this as a major risk and the standard
form has a fluctuation clause (optional), but the Australian standard form makes no provision for this and quite
justifiably too, since this is not a major perceived risk item. Apart from 'managerial competence' (which is an
inherent part of business efficacy) and the two items just mentioned, all the other risk items are explicitly dealt
with in both the Hong Kong and Australian standard forms to various extent.
Next, the respondents' preferred risk distribution patterns for the major risk items are compared. The risk
distribution preference is again expressed as a weighted average score being calculated as previously described
and shown in fig. 2. The weights being allocated to 'employer-biased', 'equally shared', and 'contractor-biased'
are respectively 1 .O, 0.50 and 0. Therefore a score of over 50% indicates employer-biased distribution whereas
a score below 50% indicates contractor-biased distribution. Fig. 4 shows the weighted average scores of all the
responses regarding risk distribution pattern and a summary is given in Fig. 5.
Note particularly in fig. 5 that the Hong Kong and Australian respondents do not disagree on the distribution
patterns for all common major risk items, ie. those marked "HK and AU". They all agree that contractors should
bear the performance risk and the employer should bear the funding risk. But how significant do they differ in
their judgement regarding 'perceived major risk items' and 'preferred risk distribution pattern'?
ANOVA is then performed on the two samples to test for the null hypothesis (Ho: p 1=p2) at a = 0.01 for all the
questions. The test is conducted upon the two groups of Hong Kong contractors (a total of 17) and Australian
contractors (a total of 14). The results are given below to show the significant difference in perception between
these two samples of contractors:
Fig. 4
Preferred risk distribution pattern
MAJOR RISK ITEMS
(AU = Australian sample
PHYSICAL RISK
FINANCIAL
RISK
PERFORMANCE
RISK
.
1
(
Site access
Latent conditions
Weather
Quantity variations
Rise and Fall
Funding
NSC failure
Defective work
Managerial competence
I Labour,
materials,
/ eaui~ment
availabilitv
'
Time for completion
Regulations
E
AU
IE
I AU
E
E
C
C
IC
(C
HK
HK AND AU
HK AND AU
HK AND AU
( HK AND AU
[ HK AND AU
1
1
C
C
HK AND AU
LEGAL/
HK
POLITICAL RISK
Total of 6 common risk items (HK and AU), 5 of which are marked "C", ie. contractors to bear the risk.
Fig. 5
Comparison of the preferred risk distribution pattern
1
1
AUSTRALIAN CONTRACTORS
HONG
CONTRACTORS
KONG
risk Rank of risk 1 Preferred
risk
item
distribution
2
E (54%)
NA
C (26%)
NA
C (34%)
NA
E (66%)
8
E (54%)
Rank of risk 1 Preferred
distribution
item
11.04 17 Rise and Fall
NA
E (74%)
11.3560 Site access
4
E (67%)
12.0684 Latent conditions
8
E (64%)
8.4394
Quantity variations 9
E (90%)
2 1.2043 Funding
1
E (86%)
E= employer-biased; C = contractor-biased;
NA = not perceived as a major risk item, ie. weighted average score <50% in Fig. 2
Fig. 6
ANOVA results -- Hong Kong vs. Australian Contractors
The percentages given in brackets in Fig. 6 are the weighted average scores being calculated for risk
distribution as described previously (ie., weights of 1, 0.5 and 0 being allocated to employer-biased, equally
shared, and contractor-biased distribution). A score of over 50% indicates employer-biased and under 50%
indicates contractor-biased. These five items shown above are perceived quite differently by the two groups.
'Rise and Fall' (fluctuation clauses) of prices are regarded as a major risk item in Hong Kong whereas it does
not even come within the nine ranked major risk items in the Australian sample (see fig. 3). 'Site access', 'latent
conditions' and 'quantity variations' are all perceived by the Australians as major risk items, but they in turn do
not come within the nine ranked risk items in the Hong Kong sample. The preferred risk distribution patterns
are significantly different too. When the mode is examined, it is found that the mode is the same for 'latent
conditions' in the two samples, ie. an equally shared pattern. The rest of the above items in the two samples do
not even share the same mode. In the Australian sample, the modes of the risk distribution for 'quantity
variation' and 'funding' are both of the employer-biased pattern, but in the Hong Kong sample, these are both of
the 'equally-shared' pattern. 'Site access' provokes two distinct views, the Australian sample favours 'employerbiased' and the Hong Kong sample favours 'contractor-biased'.
Discussion
Only the ANOVA results regarding the two groups of Hong Kong contractors and Australian contractors are
presented above. In the Hong Kong total sample, there are three groups of project participants, 42.5%
employers, 15% consultants and 42.5% contractors. ANOVA has also been performed to test for significant
differences amongst the different groups of participants within both the Hong Kong and the Australian samples.
In this pilot survey, it is found that the three groups of participants in the Hong Kong sample hold different
views as to the risk distribution of 'Third Party Delay' and 'Time for completion'. The difference (multiple range
test: Tukey-HSD test with significance level of 0.05) arises mainly from the fact that the consultants hold a
different view to the employers and contractors regarding risk distribution in 'Third Party Delay'. Both the
employers and contractors favour an equally-shared distribution but the consultants favour a contractor-biased
pattern. As for 'Time for Completion', there is a significant difference between the employers and the
contractors. The contractors favour an equally-shared pattern but the employers favour a contractor-biased
pattern. The Australian total sample on the other hand, contains mainly contractors (70%), and there are no
other significant ANOVA results found.
Risk distribution affects contractors' pricing (Levitt et a1 1980) and various research indicate that a ljust and
acceptable' risk distribution between the parties should be a goal in contract planning. If so, the preferred risk
distribution must first be found between the two parties to the contract.
Most of the perceived major risk items, except managerial competence which is an inherent part of business
efficacy, are dealt with by the standard forms to various extent. Both the Hong Kong and the Australian
practitioners identify nine major risk items, of which six are common to these two groups of practitioners.
Mostly these are related to contractor's performance, such as defective work and time for completion. The
majority of the practitioners in the two groups agree that these risks should be borne by the contractors.
In the Hong Kong sample, the preferred risk distribution pattern for seven out of the nine major risk items are
labelled as contractor-biased. No significant difference in perception is identified between the three groups of
participants, contractors, employers and consultants. Therefore, contractors in Hong Kong do, and are expected
to, take more risks. In the Australian sample, on the other hand, only the preferred risk distribution pattern for
the 'performance risks' (ie. five out of the nine major risk items) are labelled as contractor-biased. The other
four items are preferred to be allocated to the employer.
It is also found that in certain aspects, the consultants hold a different view to these two parties and this may
affect project management. Since this type of 'third party assistance' which provides 'gaps filling' and
'flexibility' in contract planning has become an essential element in contract administration, the consultants'
subjective judgements are relied upon in all stages of the construction process. Their different perceptions may
result in undesirable biased decisions. A better understanding of the views of different parties is thus beneficial.
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