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Are Construction Claims Inevitable? 

By Irvin E. Richter

Copyright, Hill International, Inc., 2000

In recent years, the cost of claims resolution has often equaled or exceeded the cost of the entire project.  Confrontations in court or arbitration have arisen from conditions occurring during the work including differing site conditions, excessive change orders and severely adverse weather, among others.  The time spent in litigation or arbitration often exceeds the time spent in constructing the project.

Sizeable claims harm both the employer and the contractor.  An employer may suffer loss of income, problems with funding and delayed occupancy; a contractor may face financial instability due to loss of payments.  Since it is far less costly to prevent claims than to litigate them, it is wise for anyone involved in the industry to become familiar with claims management.

Although construction projects invariably experience some disputes, the complexity of even a simple dispute intensifies at the international level.  What might be settled with a handshake in the contractor's home country may lead to a major source of dispute in a foreign one.  A contractor should be aware beforehand of significant differences between the legal systems, customs and personalities of his country and those of the country in which the construction will take place.

A major drawback to working in another country is having to rely on that government's mechanisms for resolving a claim or dispute, particularly if that country has a legal system unfamiliar to the contractor.  Thoughtful planning is required to forestall a complicated legal battle.  A party to an international project should try to anticipate the difficulties likely to arise and negotiate a contract that will best meet his needs and expectations.  Assuming that some disputes and claims are inevitable, thought should be given to choosing a mutually satisfactory method of determining the costs and damages arising from them.  The methods useful to a contractor in his homeland may be inadequate or unmanageable in the international sphere.  The standards and guides used for valuation in one country may be unknown or unacceptable in another.  Contracts may be governed by unfamiliar and intricate regulations.

Countries that need to import construction services may also lack the engineers and skilled labor necessary for the project.  A contractor may have to deal with suppliers, professionals and a workforce from a variety of foreign countries.  A mixture of languages, customs and social mores at the site presents a situation that is ripe for confusion unless handled carefully.

Another variable requiring pre-contract consideration is the stability of the government in the country in which the project is to be located.  Delicate preliminary evaluations may have to be made.  Is there political unrest?  Is it intense enough to lead to coup d'etat or a full-scale revolution?  Undoubtedly, fighting in the streets would produce an untenable work situation, but what are the possible effects of a coup d'etat?  For example, the currency could be devalued, and the availability of supplies and payments could be adversely affected.  Consider recent upheaval in the Middle East or Eastern Europe.  If a contractor finds himself involved in such a situation, it is unlikely that the terms of the contract will be the last word in resolving a claim arising from the effects of a revolution. 

Essentially, what is claims management?  Generally it can be described as a process whereby pre-contract risks are evaluated and procedures set up to administer and control contract modifications during the construction phase.  In this way, unmanageable risks can be eliminated or avoided and a claims prevention program can be implemented.

Claims management should begin with a proper perspective on claims in general.  One should recognize that many elements, acting individually or in conjunction, affect the outcome of a claim.  The basic elements to be weighed are: the contract between the parties, the facts of each situation, the law which will govern the dispute and the personalities of the parties involved.  The outcome is never easily predictable.

Adding an exculpatory clause to a contract (e.g. "no damages for delay") could alter the outcome of a claim, even though the facts and law remain unchanged.  Similarly, identical contracts and facts may be interpreted differently under differing legal systems.  The major world systems of law are common, civil and Islamic law.  The likelihood of recovery for a similar set of facts may differ under each system of law.  For example, the common law system places importance on the decisions of prior cases (precedents), but civil law does not.  Therefore, one party may be favored by previous decisions under the common law system, while the other party may prevail based upon a reading of the statutory rule given the facts of a particular dispute under the civil law system.  However, the controlling factor in many claims is the facts of the situation.  A comprehensive review of the facts may indicate clearly which party is entitled to relief.

Perhaps the biggest hurdle in claims prevention is the intangible, unalterable element of personalities.  Good rapport among the parties is an immeasurable asset.  Experience indicates that parties who get off to a bad start are more likely to have disputes that lead to claims.  Strained relations can be alleviated if the parties make an effort to establish good communication.  By that means, problems could be solved during the progress of the work, before they become unmanageable.  Everyone benefits by the effort to put personal differences aside and establish a sound working relationship.

The total claims management process can be broken down into three main areas: 1) claims avoidance, 2) claims mitigation, and 3) claims resolution.

1.  Claims Avoidance

A thorough understanding of the contract documents is important.  They govern the obligations and relationships of the parties and define responsibilities when disputes arise.  Be aware of the impact that contract provisions might have, particularly those that control areas likely to generate disputes.

A further consideration in avoiding disputes is the value of proper examination and review of the specifications and drawings, ensuring that these documents are understandable, unambiguous and consistent.  Field personnel should become familiar with the drawings and specifications and the purposes they are intended to serve, since they may be the first to notice any discrepancies.  An alert, informed field staff can save money by acting quickly to correct a mistake discovered in the midst of construction.

A frequent cause of contract disputes and claims is unresolved variation or change orders, e.g., employer-initiated additions or substitutions.  In resolving variations, it is of the utmost importance to move quickly.  Negotiations should be entered into before additional costs accrue.  Impartial analysis by the parties and legal review, if necessary, are preferable to permitting valuable time to be lost as the engineer and contractor argue the merits of changes.  

The idea behind claims avoidance is to rid the project of unmanageable risks, ambiguities and impossible requirements in the contract documents prior to performance.  The magnitude of the project may influence the kinds of procedures put into operation.  On smaller projects, a claims avoidance approach may involve a detailed review and analysis of the general conditions and technical specifications of the contract documents.  This process entails making recommendations to revise, clarify and "tighten-up" contract language, to delete conflicting provisions, to provide uniformity, and to incorporate a risk-sharing philosophy by assigning the risk to the party best able to handle it.

In more complex projects, in addition to the above, it is recommended that procedures be implemented for the delegation of authority, the coordination of effort and responsibilities among the engineer and owner, claims processing, and dispute resolution.

On a large wastewater treatment project, for example, one problem involved the apportioning of responsibility between the employer and the engineer.  The problem surfaced after interviews with employer personnel were conducted.  A series of questions relating to potential claim situations revealed that the project personnel were unaware that certain conduct on their part could transfer obligations that were contractually assigned to the engineer to the employer.  Thus, it became apparent that a training program was needed to educate the employer's personnel on the subject of claims.

On the same project, a procedure was developed that routes a potential claim through a specified path, indicating who was to take an active role in the analysis and who was to be merely informed.

Finally, recommendations were made to the employer regarding a dispute resolution review procedure.  The options included 1) selecting a specified number of construction experts to form a permanent tribunal during and after the project to render decisions on disputes; 2) allowing each side to select a permanent "judge" who, in turn, chooses on a third individual to form a permanent body; and 3) appointing a "hearing officer" to
initially review the dispute and advise on the merits.  In the latter instance, the contractor would then have a limited number of days to decide whether to appeal such a decision (the customary procedure whenever a party is dissatisfied with a decision).

2.  Claims Mitigation

Hill has been involved in two large-scale construction projects (a nuclear power plant and a major hotel/casino) in which claims mitigation and management procedures were effectively utilized to reduce costs and to analyze and process changes and claims as soon as possible.

After becoming involved with and analyzing the contractor's claims and everyday problems at the site of one project, two points needed to be emphasized to the employer: 1) that contractors should receive responsive answers to their inquiries as soon as possible, and 2) that contractors should be reimbursed only for the reasonable cost of the harm caused by the actions or omissions of the employer.

It was evident on both projects that, despite the problems occurring, the employers were spending much more than was necessary.  These projects did not have the benefit of utilizing the previously discussed claims avoidance procedure from the outset.  (Claims had already been filed and potential claims were continuing to surface.)  Claims mitigation and management procedures were implemented on both projects to resolve the outstanding claims and minimize any potential ones.

3.  Claims Resolution

An important first step in any type of claims resolution procedure is to "get a feel" for the situation.  An effective way of doing this is to interview all parties involved, if availability and time permit.  The parties may include the employer's on-site personnel, the construction manager, the engineer, respective consultants and all contractors.  A broad overview may be developed showing how each party perceives its role in the project, who did what, what went wrong, how it went wrong and what is needed to remedy the alleged problem.

Second, it is important to review and assess the current status of the construction.  The third and most important step is to review the contract documents.  The primary focus should be on the contract terms between the engineer, CM, contractors and employer.  The contract terms and conditions are the legal-contractual provisions under which claims will be resolved.  Of particular importance to an employer/contractor dispute are the variations or change clause, the disputes clause, the program and time provisions, and the payment terms.

Finally, it is important to review the project records to become familiar with the project and its current status.  Such review includes an overview of the correspondence files, any programming and cost data, and miscellaneous material relevant to the disputed issue.  On this foundation, contractor claims can be properly prepared or intelligently and impartially evaluated.

Typically, on a large-scale construction project, a number of contracts among an assortment of parties are involved.  Therefore, there is a greater potential for claims to develop.  As a result, it becomes important to assemble and review all documents pertaining to each claim.  Depending upon the size, complexity and value of the claim, a priority list for negotiating each claim should be established by an employer who is defending them.  The next step for an employer is to request input from its own personnel and that of the CM or engineer regarding the basis for and the validity of each claim.  It is beneficial to all concerned to keep lines of communication open, despite the dispute at hand.  As long as this is done, the possibility continues to exist that the claim can be amicably resolved, saving all parties unnecessary time and expense.

A claims procedure should be established in a manner similar to that of the claims avoidance process.  This includes establishing the documentation and format required for submissions of claims.  A priority list of critical contract claims should be assembled by the employer.  Using this list, he might establish a negotiating timetable for resolving these claims.  If a good-faith atmosphere prevails at these sessions, the employer may be allowed access to the contractor's files for supplemental information and verification.  This is quite useful to the employer in the event the dispute is arbitrated, since there may be no right to discover such information.  If the dispute is litigated, discovering this same information may involve added time and expense.

If negotiations are successful and the parties reach an oral agreement, the next step is to draft a written settlement agreement.  In a large-scale project, it may be good practice to draft at the outset a standard form of agreement to be used in all settlements.  This form could be modified to suit each particular claim settlement agreement.

Important provisions to be included in such an agreement may include:

1.      Performance guarantee

·        Definition of the program for completion

·        Retention of right to direct work

·        Record of overtime

·        Right to accelerate in lieu of time extension

2.   General releases

3.   Conditional releases (third-party claims)

4.   Assignment of contractor claims (for owner)

5.   Agreement to cooperate in future arbitration or litigation

6.   Access to opposing party's records

7.   Right to audit

8.   Payment terms (settlement, contract balance, and retainage)

9.      Indemnification

Success in dealing with claims depends upon effective preparation of the claim.  It should be organized so that the issues in controversy are clearly identifiable, avoiding unnecessary argument over peripheral issues.

Both parties should avoid rash actions and maintain open lines of communication. However, if all attempts at an amicable resolution (e.g., negotiation or on-site discussions) fail, litigation may become necessary.  On an international project, the proceedings generally would be conducted within the legal framework of the country named in the contract's choice-of-law clause, or, if none is named, in the place where the dispute arose.

The United States literally leads the world in construction claims.  This may be due to the fact that the society as a whole is more litigious than other areas of the world. Employers and contractors in the United States recognize this fact and are increasing their attendance at claims seminars designed to help them prevent or resolve claims.  Both sides have found that expert involvement in claims assertion and defense is a wise investment in comparison to the cost and effort required for litigation.

Many of the items previously discussed under claims mitigation and management have already been used effectively on large projects.  A major international manufacturer and contractor, for example, has recently worked with Hill to develop a system of claims avoidance, mitigation, and management procedures that will enable him to best utilize capital, equipment, and manpower.

Developing this system means placing the initial emphasis on differentiating between manageable and unmanageable risks during the proposal stage so that an understanding of the potential risks will result in a comprehensive bid.  The contractor will then provide an extensive training program for its personnel on how to implement a cost and schedule monitoring and reporting system as a claims prevention and remediation measure.  In addition, personnel will be instructed on ways to identify conduct in the field that may lead to claims against the contractor or may prevent him from recovering for extra work or owner-caused delays.  They will also be taught the significance of keeping detailed and organized project records for purposes of claim recovery or claim rebuttal.

It is difficult to measure the effectiveness of a claims avoidance procedure, since there is no measuring stick that can determine how many claims were avoided because of preventive actions taken up front.  However, experience has shown that the recommendations proposed will very likely provide extensive savings to both employers and contractors.  Implementation of the recommended claims mitigation and management
procedures have drastically cut employer expenses and have caused contractors to realize that an owner's resources are not without limits.  On the other hand, claims mitigation and management work for contractors has disclosed additional avenues of recovery, that had previously been unknown to them.

First-time construction employers may have some difficulty in agreeing to an outlay of funds for work they feel should have been or will be adequately handled by the engineer, CM or themselves.  However, experienced employers, particularly those who have suffered financially on previous projects, realize the need for and benefits of such a program.  Contractors benefit from such systems because, as the party who customarily submits the claim, they have the burden of establishing that they were harmed, that the harm was caused by the employer or his agent and resulted in the damages now being claimed.  (Courts and arbitrators place the burden of proving damages upon the party bringing the claim.)  Carrying such a burden of proof is dependent on adequate record-keeping and adherence to contract requirements.  A claims management program ensures such adherence.

Are construction claims on a project inevitable?  Over the past two decades, our firm has been involved in construction projects and claims worth billions.  We have found that most claims can be avoided or minimized given the proper understanding of how construction claims evolve.