In 1973, Max Abrahamson published an article in the Journal of the British Tunneling Society (Volume 5 and 6, November 1973 and March 1974) in which he first described 5 main principles for risk allocation. These principles (“the Abrahamson principles”) were later adopted in the Construction Industry Research and Information Association (CIRIA) Report on “Tunneling – Improved Contract Practices” published in 1978. The combination of these principles can be summarized as follows: A construction party should bear a risk when it can control its occurrence, control its effect, or transfer it by insurance and/or have a preponderant economic benefit of running it [1].
The Abrahamson principles had emerged at a time when the issues surrounding risk allocation and management in construction contracts were not discussed openly and proactively between the stakeholders in a construction contract. The Abrahamson principles recognized that risk [2] is something that is inherently existent in construction projects [3] and it cannot and must not be ignored. Instead, it ought to be “managed, minimized, shared, transferred or accepted” [4] in order to ensure that the best interests of the parties in a construction project is looked after. In essence, risk is said to be the impact of uncertainty on objectives. If these uncertainties [5] are not managed effectively, parties to a construction contract stand to lose out and this could often lead to an entire project failing. This would be of no benefit to the client nor the contractor.
Abrahamson’s principles were widely accepted in the construction industry as ground rules for a fair and equitable allocation of risks in construction contracts [6]. From the client’s perspective, there were numerous project objectives that were more easily achievable as a result of effective risk identification, allocation and management. When risk is managed effectively, the client has an easier route to achieve their project objectives with little to no hindrances. One such objective would be to ensure that disputes between parties in a construction contract are minimal. If the risk elements in a contract are identified and allocated properly from the very beginning, then there would be lesser disputes arising as to who should bear a risk once it eventuates. This would in turn save time as the risk would be managed without delay by the party who has been allocated that risk (i.e the party that is best able to control it). In essence, this would give the client a higher chance of obtaining a fit for purpose end-product with regard to the aspects of meeting construction and performance criteria as the contractor would be motivated to manage the risk that he has been allocated with from the outset. A client would also want to ensure the bankability of the project (that is to complete the project within budget) and in order to achieve this, it would be necessary to ensure that the project is completed on time or without any prolonged delay. With effective risk allocation, the client would stand a better chance to achieve this outcome.
Finally, the client would also want to ensure that he is not overpaying for the contractor’s services. Effective risk allocation will ensure this as bidding contractors are not expected to take on all risks, but instead are expected to take on only certain risks which they are able to best manage. This would mean that a contractor would not need to price for all risks in his tender, and in turn, this would reduce the overall project cost for the client.
In the construction industry, we often hear the statement that risk should be borne by the party best placed to bear it. This statement is a product of Abrahamson’s principles and it has been of great relevance in many standard form contracts in the construction industry in the years to come thereafter. Whilst Abrahamson’s principles appeared to be effective in theory, reality has shown that just because a party is in the best position to control and manage a risk, it did not necessarily mean that allocating such risk to that party would be fair. Whilst it is true that the principle of control of risk is a matter of significant importance in the determination of risk allocation (as proposed by Abrahamson), it is not the only factor that needs to be looked at. Other principles should also be looked at in deciding how to allocate certain types of risks [7]. Take for example, events of ‘force majeure’: Such events cannot be controlled by either party, however, it is crucial for such risks (and the consequences arising therefrom should such risks occur) to be assessed and allocated to ensure that the risk is properly managed in the event it occurs [8].
Abrahamson’s principles were intended to ensure that the level of uncertainty in a construction contract is reduced to the bare minimum and that these uncertainties (i.e risks) are identified, assessed and allocated. However, in reality, due to dictating market forces where the client is generally in control, bidding contractors are often taking on known and unknown risks (this is because a bidding contractor has a short window to assess risks while having to simultaneously compile all other aspects of its response to the client’s invitation to tender) and accordingly are pricing for uncertainty through their respective bids. Any contingency by the bidding contractors in such circumstance would often be pure guesswork [9]. At the end of the day, if the risk does not eventuate, the contingency would be wasted, and if it did, there is no assurance that the contingency would be sufficient [10]. When a risk event occurs that may not have been properly priced for by the contractor, the entire project could come to a standstill and this would obviously directly affect the client. A much more logical and practical approach would be for the client to retain the risk or in agreeing to adopt a joint strategy with the contractor and the other stakeholders to manage that risk [11].
In the real world, bidding contractors would often discount risks (the extent of the discount would depend on the hunger for work or the need for cash flow) at the tender stage in hope to successfully secure the job. Once the job has been secured, the contractor may attempt to make monies by other means (to mitigate the heavily discounted risks in the event they eventuate) by adopting aggressive claimsmanship tactics or treating subcontractors harshly [12]. In most cases, it is unlikely that the contractor who has won the tender has priced for the worst-case scenario (if he did, he is unlikely to succeed in the tender). More often than not, the contract will be awarded to the contractor who has discounted the risk the most. This would never be ideal for the purposes of large construction projects (experience shows that when a risk does eventuate, contractors are often unable to deal with it financially) and this goes to show how Abrahamson’s principles required improvisation.
The issue wasn’t just about identifying and allocating risks (in return of a price premium). That notion was far too simplistic and was not ideal for large construction projects where standard form contracts are typically used and can have unintended consequences in so far as risk allocation and management is concerned [13]. What was truly required was an appreciation of the identified risks by the parties involved in the project and a true desire by the parties to jointly manage such risks to ensure the success of the project. This would after all be in the best interest of all parties. In certain situations, it has been said that the earlier the whole project team is appointed, the better the risk management process will be [14].
In conclusion, it would be fair to say that Abrahamson’s Principles (if used solely on its own) would not be effective and appropriate for the procurement and management of large construction projects vis a vis the concerns regarding risk. As mentioned by Grove [15], it is not sufficient to say that there should be a balance of risk or efficiency in risk allocation. What is more important is to ensure that an appropriate contract strategy is adopted to allow for the active joint management of risk by all parties. This is seen to be more suitable than risk allocation on its own which is what Abrahamson had focused on.
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[1] Abrahamson M, ‘Risk Management’ [1983] ICLR 241
[2] Risk has been defined as ‘an uncertain event or set of circumstances that, should it occur, will have an effect on the achievement of one or more of the project’s objectives’ – Peter Simon, David Hillson and Ken Newland, Project Risk Analysis and Management Guide, Association for Project Management, (1997) pp. 17
[3] Tah J, Carr V, ‘Information Modelling for a Construction Project Risk Management System’ (2000), Engineering, Construction and Architectural Management, Vol. 7 Issue 2, pp. 107
[4] Latham M., ‘Constructing the Team, Final Report of the Government/Industry Review of Procurement and Contractual Arrangements in the UK Construction Industry’ (1994) pp. 13
[5] This uncertainty can be expressed in two parts that is the likelihood of the occurrence of an event and the consequences of the event upon its occurrence – See British Standard ISO 31000:2009, Risk Management – Principles and Guidelines (First Edition, ISO, 2009)
[6] Arent van Wassenaer, ‘In Search of the Holy Grail: Taking the Abrahamson Principles Further’, (2006) Construction Law International, Volume 1 No. 4 pp. 11
[7] Bunni N in ‘The Four Criteria of Risk Allocation in Construction Contracts’, International Construction Law Review, (2009) Vol 20, Part 1, p.6 proposed the following four criteria: 1) Which party can best control the risk and/or its associated consequences?; 2) Which party can best forsee the risk?; 3) Which party can best bear that risk?; 4) Which party ultimately most benefits or suffers when the risk eventuates
[8] Ellis Baker, Richard Hill, Ibaad Hakim, ‘Allocation of Risks in Construction Contracts’, (January 2020), White & Case Client Alert on Construction
[9] Walton J, ‘Unforeseen Ground Conditions and Allocation of Risks, Before the Roof Caved In’; See pp. 11 at https://projectmax.typepad.com/files/allocation20of20risk20-20unforeseen20conditions.pdf
[10] Ibid
[11] Smith, N.J., Merna, T. and Jobling, P. (2006), ‘Managing Risk in Construction Contracts’, 2nd Edition Oxford Blackwell, pp. 62 and 63
[12] Barber J, ‘The Foresight Saga Revisited’ (1992 – Revised in 2017), pp. 26
[13] Rahman R., Kumaraswamy M., ‘Revamping risk management in Hong Kong construction industry (Proceedings of the RICS Foundation – COBRA Conference, Glasgow Caledonian University, 2001), pp. 8.
[14] Bennett J. & Pearce S., ‘Partnering in the Construction Industry: a Code of Practice for Strategic Collaborative Working’ (Butterworth – Heinemann, Oxford, 2006), pp. 249
[15] Grove J., ‘The Grove Report’, Humphrey Lloyd [2001] 2 ICLR 302
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This article is intended to be informative and not intended to be nor should be relied upon as a substitute for legal or any other professional advice.
About the Author
Ankit Sanghvi
Partner
Halim Hong & Quek
ankit.sanghvi@hhq.com.my
