Construction project risk mitigation and management for owners A Grant Thornton Thinking Webcast September 8, 2010

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Construction project risk mitigation and

management for owners

A Grant Thornton Thinking Webcast

September 8, 2010

Presented by:

James Schmid, Grant Thornton LLP

R. Edward Boucher, Esq., Kotz Sangster, Wysocki and Berg, P.C.

Michael D. Hastings, Marsh USA Inc.

Joseph Fusco, Marsh USA Inc.

We will begin shortly…

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Grant Thornton LLP Construction Advisory Practice

Grant Thornton LLP’s Construction Advisory Services professionals have

years of experience in providing economic and damage analysis and

litigation support for construction claims. Additionally we help construction

project owners to deter, detect and investigate the fraud, waste and

abuse that can ruin a company and cause undue personal risk.

Our construction advisory team uses state of the art forensic tools,

objectivity, procedural thoroughness and complete confidentiality when

dealing with the issues that affect your business.

If you experience any technical difficulties,

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Agenda

Introduction

Speaker biographies

What is risk and where does it arise?

Fundamental principles of risk management

Risk categories

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Introduction

Effective risk management requires a structured,

comprehensive approach

What is a comprehensive approach to risk

management?

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Speaker biographies

Jim Schmid, CPA, CFE, ABV

Partner and National Practice Leader of Construction Forensic Services

Jim Schmid is a Partner at Grant Thornton LLP, National Construction Forensics

practice leader and practice leader in the Detroit area for Forensic Accounting

and Investigative Services. Jim provides forensic, valuation and general

consulting services for clients in all industries including the construction industry.

He is a licensed CPA, a Certified Fraud Examiner and is accredited by the AICPA

in business valuation. Jim’s background includes both industrial engineering and

accounting/finance.

Contact information

P: 248.233.6910

E: jim.schmid@gt.com

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Speaker biographies

R. Edward Boucher, Esq.

Partner

R. Edward Boucher is a Partner practicing in Kotz Sangster’s Construction Law

practice group. His practice involves drafting and negotiating contracts for

construction managers and general contractors, subcontractors and suppliers,

and owners. His practice also involves litigating claims involving such matters

as unforeseen soil conditions, delay and disruption, and defective workmanship,

and representing contractors before governmental administrative bodies.

Contact information

P: 313.259-8300

E: rboucher@kotzsangster.com

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Speaker biographies

Michael D. Hastings

Managing Director

Mike Hastings is Marsh’s National Project Risk Practice Leader, within Marsh’s

National Construction Practice. Over the past fifteen years, he has taken a

lead role in developing and implementing Marsh’s consultative approach to

construction project risk management, including risk identification, financial

modeling, loss control and mitigation, insurance program design, and

consulting services for contractor and project-specific insurance programs.

Mike has served as consultant, broker and client executive for owners,

contractors, and design firms on commercial and civil projects comprising over

twenty-five billion dollars in construction values.

Contact information

P: 404.995.2680

E: Michael.D.Hastings@marsh.com

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Speaker biographies

Joseph Fusco

Senior Vice President

Joseph Fusco is a Senior Vice President in the Strategic Solutions Group at

MMC (Marsh Companies). He works across all MMC operating companies to

develop and implement operational/construction risk solutions, including risk

transfer and finance. His capital project and operational risk management skills

include: project planning risk, project execution risk, project costing/delivery

range analysis, and the development of deterministic and probabilistic risk

forecasting models and simulations. He is often called upon to present risk

analyses to markets, investors, rating agencies, and internal boards.

Contact information

P: 212.345.8376

E: joseph.fusco@mmc.com

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Polling question #1

Does your company’s Finance and/or Internal Audit

department have a significant role in identifying and

managing construction risk?

a. Yes

b. No

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What is risk and where does it arise?

Risk is an event that is uncertain to occur, which if it does

occur will impose negative financial consequences

Risk lurks in all aspects of your operation:

Organization and operational structure

Project delivery method

Contract bid/award process

Contracts with contractor, A/E’s, and other

Project performance; schedule, quality and cost

Contract and pay application administration

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While different owners in different businesses will face

some different risks, most are common to the industry and

can be addressed systematically

Unless you have a disciplined, structured program, you will

not know whether your company is capable of handling the

risks that arise in the course of a construction project

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Risk infrastructure – what does good look like?

Sponsorship and Positioning

The Board collectively recognizes its on-going responsibility to manage capital project risks, generating specific policies to communicate throughout the organization. There is a clear vision of risk tolerance.

Managing the Process Capital Project Risk Management is integral to the planning and performance processes and roles and

responsibilities are clearly defined. Process of CPRM is underpinned with appropriate tools.

Risk Identification Capital project risks, including new and emerging risks, are identified systematically and consistently across

the organization, including portfolio and project specific, strategic investment decisions.

Risk Prioritization Capital project risks are assessed and prioritized to focus time and resource on the critical risks. Risk

assessment takes into account risk correlation, and is both qualitative and quantitative.

Risk Treatment / Control Controls are tested and action plans developed and implemented where necessary – CPRM and risk transfer

decisions are fully informed. Risk adjusted returns are optimized.

Reporting There is a strong governance framework in place to facilitate reporting at the appropriate level with

subsequent feedback and communication throughout the organization.

Monitoring The risks faced, and the effectiveness of the capital project risk management process, are monitored by

Management and the Board, and by using independent assurance.

Culture The employees have the knowledge, skills and tools to embed the capital project risk management process.

Communication The organization actively communicates its various capital project risk management activities to its

stakeholders.

The organization has robust capital risk management practices in place when working with external

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Capital project risk management benefits

Internal board and executive

management risk requirements

are satisfied

Access to more favorable

financing options

Corporate governance issues

addressed

Access to more favorable/

comprehensive insurance options

Project rating (S&P, Moody’s, and

Fitch)

Defines level of uninsurable risk

Clear determination of risk

ownership among all stakeholders

Increased certainty of meeting

critical project delivery objectives

Transparency of risk across all

project participants

Enhanced claims forecasting and

control

Reduces litigation

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Fundamental principles of risk management

Identify the risk and its triggers

Allocate between contracting parties - allocate the

risk to the proper party

Mitigate risk with management practices and

insurance

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Risk categories

I.

Performance failure arising out of professional

services

II.

Default of general contractor, subcontractors

or suppliers

III.

Delay in permits or approvals

IV.

Environmental contamination or unforeseen

conditions

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Polling question #2

What project delivery models does your company use?

a. Design/Bid/Build

b. Design build

c. EPC – Engineer/Procure/Construct

d. IPD – Integrated Project Delivery

e. Construction Manager – Owner’s Agent

f.

Construction Manager at Risk

g. Two or more of the above

h. Other

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Risk category

I. Performance failure arising out of professional services

Triggering

Events

Contractual Allocation

Insurance

Mitigation and Management

• Design Defect affecting

constructability or performance

• Avoid waivers in A/E agreement that bar loss of use damages and pass-through of contractor’s claims • Use a delivery method that transfers

design risk to contractor

• Contractual waiver of contractor’s consequential damages, such as lost profits and bonding capacity • Contractual waiver of impact claims

upon contractor’s acceptance of change order

• Contractually limit contractor’s delay and impact damages to

contractually defined cost of work items, verified with right to audit • Contractually require cost and time

impact estimates with notice of claim

• Verify practice professional liability policies for negligent acts, errors or omissions of project design, consulting, and engineering professionals

• Purchase project-specific professional liability policy covering negligent acts, errors and omissions of all project design, consulting and engineering professionals. • Purchase Contractors Protective

Professional Indemnity and Liability insurance to cover vicarious liability of design builder and provide first-party coverage excess practice professional policies

• Put plans and spec through a

constructability review releasing them for bid

• Avoid CCDs for directed schedule acceleration; rather, use lump sum change orders or cost of work or GMP change orders if costs cannot be ascertained

• Include a full waiver of all impact claims in all change orders

• Place design professional on notice of claim and your damages

• Engage a certified expert to review or monitor the project

• Define goals and get agreement in writing

• Define milestones

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Risk category

I. Performance failure arising out of professional services (continued)

Triggering

Events

Contractual Allocation

Insurance

Mitigation and Management

• Isolated

performance

specifications

• Expressly identify in contract

items for which contractor has

design responsibility.

• Verify practice professional

liability policies for negligent

acts, errors or omissions of

project design, consulting, and

engineering professionals

• Purchase project-specific

professional liability policy

covering negligent acts, errors

and omissions of all project

design, consulting and

engineering professionals.

• Purchase Contractors

Protective Professional

Indemnity and Liability

insurance to cover vicarious

liability of design builder and

provide first-party coverage

excess practice professional

policies

• Define key milestones underlying

performance specifications

• Require equipment supplier

representations regarding

performance

• Require equipment supplier

warranty and sign-offs

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Polling question #3

How much do you expect your company to spend on

construction in the upcoming year?

a. Less than $50 million

b. $50 to $500 million

c. More than $500 million

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Risk category

II. Default of general contractor, subcontractors or suppliers

Triggering Events

Contractual Allocation

Insurance

Mitigation and Management

• Financial default

of the GC, major

subcontractor or

supplier:

• Work slowdown

or stoppage

• Non-payment of

sub’s or

suppliers

• Liens filed

• Future loaded

pay applications

• Include contingent

assignment of subcontracts

as part of contract

documents

• Express contractual

obligation to bond-off liens

• Express contractual right to

issue payment directly to

subcontractors and

suppliers at owner’s sole

discretion

• Contractually establish a

trust over payments to

contractor that include

funds for subcontractors

and suppliers

• Contractually define

contractor’s insolvency as

an incident of default

• Subcontractor default

Insurance replaces

subcontractor surety

bond

• Implement a contractor and subcontractor

pre-qualification program (financial data,

litigation history, worker’s comp EMR,

references, etc.)

• Obtain contingent assignment of

sub-subcontracts and sub-supplier purchase

orders and agreements

• Require payment and performance bonds

at all contracting levels

• Monitor financial status of the GC,

subcontractors and key suppliers

• Monitor / scrutinize pay applications for

irregularities

• Do not process progress payments ahead

of work completion (e.g. 65% paid, 35%

complete)

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Risk category

III. Delay/Interruption of Schedule

Triggering

Events

Contractual Allocation

Insurance

Mitigation and Management

• Delay in permits / approvals

• Identify responsibility for obtaining different types of permits in contract

• Contractual waiver of contractor’s consequential damages, such as lost profits and bonding capacity • Contractually limit contractor’s

delay and impact damages to contractually defined cost of work items, verified with right to audit • Contractually require cost and

time impact estimates with notice of claim

• Contractually establish an idled equipment rate

• Renegotiate policy effective date(s) as appropriate to save premium

• Note expiration date of underwrite quotes/pricing not bound

• Note policy expiration dates in light of changes to schedule

r

• Set schedule of planned permits and 3rd

party approvals.

• Require GC to monitor the status of permits and approvals and report this on a monthly basis.

• Consider increasing retainage when the planned permits and approvals fall behind schedule.

• Understand and comply with contract notice requirements

• Ensure that RFI’s and related

correspondence are addressed expeditiously • Closely scrutinize proposed change orders • Ensure that all required construction

documents are being prepared, particularly Daily Reports.

• Avoid CCDs for directed schedule

acceleration; rather, use lump sum change orders or cost of work or GMP change orders if costs cannot be ascertained

• Include a full waiver of all impact claims in all change orders

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Polling question #4

Has your company every experienced a major construction

cost overrun?

a. Yes

b. No

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Risk category

III. Delay/Interruption of Schedule (cont.)

Triggering Events

Contractual Allocation

Insurance

Mitigation and Management

• Interruption of

funding

• Contractually establish the

right to suspend or

terminate contractor’s work

for convenience

• Contractually waive

contractor’s unabsorbed

home office overhead and

lost opportunity damages

• Contractually define and

limit contractor’s

suspension and

termination damages

• Determine payment status, exp.

date of all contractor-provided

insurance policies; require direct

notice from insurer or agent for

cancellation, non-renewal or

material limitation of coverage;

collect certificates of insurance

• Determine appropriate property

insurance coverage / rate

• Negotiate extensions / cancellation

of policies as appropriate

• Consider contingent insurance

coverage to apply excess and DIC

over contractor-provided insurance

program in the event of a lapse

(general liability, excess liability)

• Negotiate right to continue

contractor-provided insurance

policies if contractor fails to make

payments

• Secure project fence/security

• Secure or remove unstable

project elements

• Remove signs/banners

• Allow reasonable access to

contractors

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Risk category

IV. Environmental contamination or unforeseen conditions

Triggering Events

Contractual Allocation Insurance

Mitigation and Management

• Exacerbation or release of

contaminated soil or groundwater on projec site or adjacent site

t

• Ensure contract contains a reasonable DSC clause that coordinates with dispute resolution provisions

• Ensure contract contains a reasonable discovery of hazardous materials procedure that coordinates with dispute resolution provisions

• Ensure environmental indemnity clause leaves contractor responsible for its own negligence

• Define contractor’s failure to follow owner’s safety program as an incident of default

• Contractually limit contractor’s delay

damages in manner stated above

• Endorsement to CGL policy can provide coverage for bodily injury or property damage arising out of sudden and accidental release of known or unknown contaminants

• Contractor’s Pollution Liability policy covers contractor for own liability and vicarious liability arising out of subcontracted operations for bodily injury, property damage, or government-mandated clean-up costs arising out of creation or

exacerbation of an environmental condition during construction operations

• Project-specific CPL policy covering contractor wrap-up form to include the liability of all or selected subcontractors; available in occurrence and claims-made forms

• Practice or project-specific policies provided by all environmental remediation subcontractors

• Owner may procure site-specific Owner Controlled Pollution Liability policy including combined Pollution Legal Liability (covering owner) and CPL (covering the contractor and all subcontractors

• EIL insurance requirements

• Establish a clear contamination and hazardous material response plan. • Ensure GC contract and subcontracts

require indemnification for the failure to follow DSC and discovery of hazardous material procedures

• Ensure project staff knows DSC and discovery of hazardous materials procedures

• Know before beginning the project who is responsible for contaminated soil related costs

• Require immediate notification of owner upon discovery of contaminated soil and engage an expert to assess

• Clean up ASAP and document all direct and indirect costs

• Monitor levels of contaminants in soil as redistributing soil may create a

concentration requiring remediation

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Polling question #5

Do you plan to engage in any international construction

projects?

a. Yes

b. No

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Risk category

IV. Environmental contamination or unforeseen conditions (cont.)

Triggering Events

Contractual Allocation

Insurance

Mitigation and Management

• Asbestos in

existing structure

• Ensure contract documents describe scope of remediation • Ensure contract contains a

reasonable DSC clause that coordinates with dispute resolution provisions • Ensure contract contains a

reasonable discovery of hazardous materials procedure that coordinates with dispute resolution provisions

• Ensure environmental indemnity clause leaves contractor

responsible for its own negligence

• Define contractor’s failure to follow owner’s safety program as an incident of default

• Contractually limit contractor’s delay damages in manner stated above

• Pollution Legal Liability (PLL) policy

covers owner’s liability arising out

of release of known or unknown

asbestos in building materials

(protects contractor)

• Contractors Pollution Liability policy

(CPL) covers unintended release or

exacerbation of known or unknown

asbestos, including transportation

and Non-Owned Disposal Sites

(NODS)

• Require the GC and sub’s to

indemnify the owner for the

failure to follow DSC and

discovery of hazardous

material procedures

• Ensure project staff knows

DSC and discovery of

hazardous materials

procedures

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Risk category

IV. Environmental contamination or unforeseen conditions (cont.)

Triggering Events

Contractual Allocation

Insurance

Mitigation and Management

• Hazardous materials required by contract documents

• Ensure any owner obligation to indemnify contractor for

hazardous materials required by contract documents excludes damages caused by contractor’s own negligence and wrong-doing.

• To extent permitted by law, ensure contractor’s obligation to indemnify owner includes incidents arising out of owner’s negligence

• Define contractor’s failure to follow owner’s safety program as an incident of default

• Contractually limit contractor’s delay damages in manner stated above

• CPL policy covers third party bodily injury, property damage, and government-mandated clean-up costs arising out of unintended release of hazardous materials • Builders Risk policy may be structured to

provide first-party coverage for clean-up of materials spilled but contained within the project site

• Require the GC and sub’s to indemnify the owner for the failure to follow DSC and discovery of

hazardous material procedures • Ensure project staff knows DSC and

discovery of hazardous materials procedures

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Polling question #6

Do you have a full service construction management

department?

a. Yes

b. No

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Conclusion

Effective risk management requires a structured,

comprehensive approach

Retain professionals to help you develop a

structure that is appropriate for your company

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Summary

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Stay tuned for our next webcast

ƒ Our next webinar will be

Controlling Construction

Change Orders and Claims in October.

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Thank you for joining us today!

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James T. Schmid, CPA, CFE R. Edward Boucher, Esq. Michael Hasting Joseph Fusco

Grant Thornton LLP Kotz, Sangster, Wysocki & Berg Marsh USA Inc. Marsh USA Inc.

E Jim.schmid@gt.com E rboucher@kotzsangster.com E Michael.D.Hastings@marsh.com E joseph.fusco@mmc.com T 248.233.6910 T 313.259-8300 T 404.995.2680 T 212.345.8376

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