Updated February 9, 2024
Most organizations rely on contractors to provide construction services at times. Although construction often signifies positive growth and change, contracting with an outside third party creates significant risk exposure for these organizations. Navigating the intricacies of a construction project while also tracking and controlling costs can be an overwhelming responsibility. And yet, without sufficient oversight or project management controls in place projects can quickly spiral out of control.
Inadequate controls frequently lead to cost overruns, costly change orders and even contractor non-compliance and fraud. Construction project audits performed by experienced experts typically reveal overcharges that average 1%-3% of the total cost, making project oversight and controls an important risk management priority.
Common risks to owners that arise when they utilize contractors for construction projects include:
Minimizing risk exposure that arises from construction projects demands a vigilant stance by owners to identify and remedy potential vulnerabilities immediately.
An active and engaged approach to contract due diligence is the most significant step owners can take to meaningfully mitigate construction risk. Creating a thorough, airtight contract at the outset of the project helps keep construction aligned with the organization’s objectives and intended timeline, reduce financial risk and prevent future complications. Set your project up for success by including each of these key clauses in the contract, tailoring them to reflect the specific needs and goals of your project.
Make sure every contract you sign has a “right to audit” clause included in the terms and conditions. The “right to audit” clause not only provides you with the contractual and legal right to conduct an audit of the outside party’s compliance with the contract, but also puts them on notice that their records are subject to an audit and acts as a preventative control. Every contract should have a clause allowing the owner full audit rights to ensure transparency and open book rights by preserving access to key documents and data for at least three years (minimum) beyond project completion, such as:
The contract should spell out expectations and commitments around billing and payment application as your project progresses. Define what constitutes complete and appropriate supporting documentation and include clear, detailed descriptions of proper protocol in every billing scenario, such as:
Most GMP contracts are considered open book, but contract language often fails to define the specifics. Using specific open book contract language is the best way to establish adequate transparency. Carefully worded open book requirements help ensure the contractor will provide the project owner with timely (typically monthly) deliverables and consistently enable access to:
Self-performed work can often result in excessive payments. Carefully address self-performed work in your contract, paying especially close attention to these areas:
Allowance contract language is a common pitfall for owners, as overly vague language in the contract can lead to misunderstanding and unexpected cost overruns. Be sure this clause includes:
For every construction project, your contract should have contingency language that:
Regardless of the contract type you are using, it must fully explain and define general conditions. The GC/GR clause should:
Shared savings normally occurs when a GMP contract comes in under budget. A shared savings clause stipulates the agreed upon percentages of shared savings that will go to the owner and the contractor. Language is important as poorly worded clauses can add risk to the owner’s budget.
Properly worded lien waiver requirements from the contractor and subcontractors reduce risk for all parties. Clearly defining this language up front mitigates back-end confusion should any project liens occur.
While contract due diligence is crucial for reducing owner risk, it does not stand alone — nor is it sufficient to fully protect owners from risk exposure. Once complete, it’s important to monitor contracts and closely scrutinize progress on the project to ensure compliance with all clauses.
Assign one or more employees to the role of contract monitor, depending on the number of contracts involved. Educate these employees on the critical terms and conditions of each contract as well as an understanding of the risks. Then empower your monitors to review and question invoices and change orders. Catching mistakes or failures to comply with the terms of the contract early enables you to correct issues before they grow into insoluble problems or create excessive cost overruns.
Exercising your “right to audit” clause is another powerful strategy to help you rein in risks effectively. When considering a construction project, it’s important that you include construction audit responsibilities within the scope of your internal audit function or contract with professional construction auditors. Generally speaking, it is best to get your construction auditors involved as early as possible, although the process can begin at any stage of your project and can be broken down into three distinct phases: pre-construction, construction and post construction.
Our infographic below provides valuable insights into strategies that help manage construction project costs effectively. To help mitigate overcharges or inaccuracies by scrutinizing labor rates and verifying fee calculations. And by monitoring equipment rentals and maintaining vigilance over general conditions, you maximize your project value.
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Construction projects can be affected by a variety of risks, and some are less obvious than others. Contact our construction audit and advisory experts today to make your next project more cost-effective, more successful and much less stressful.
