The Reality of Risk in Construction Projects

The Reality of Risk in Construction Projects

by Ronald Steinkamp
May 22, 2017

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.

Common Construction Risks

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:

  • Cost mischarging — The contractor charges the organization for costs (material or labor) that are not allowable, not reasonable or not allocable to the contract.
  • Change order abuse — The contractor increases the price or extends and expands the contract scope through the use of multiple change orders. While change orders are sometimes necessary, proper review is essential as the associated costs can add up quickly and sometimes act as hidden profit centers for a contractor.
  • Performance — The contractor fails to meet timelines and/or fails to perform in accordance with terms of the contract. Proper project management or audit oversight from the start of the projects can help mitigate risk exposure to owners stemming from poor contractor performance.
  • Compliance — The contractor fails to comply with terms and conditions governing the performance of the contract.
  • Non-conforming goods — The contractor delivers goods or services not conforming to the contract documents (drawings and specifications).
  • Reputation — The contractor damages the reputation of the owners’ organization through their actions, or lack thereof.

Minimizing risk exposure that arises from construction projects demands a vigilant stance by owners to identify and remedy potential vulnerabilities immediately.

Contract Due Diligence

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.

Audit rights

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:

  • Project cost information from the contractor: payment applications, computer and payroll system data, equipment rental and purchase log, AP data and records
  • Project contract information: change orders and support, subcontractor and supplier subcontracts/agreements, purchase orders, invoices
  • Project reports: meeting minutes, cost reports, status reports

Contractor billing rules and requirements

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:

  • Billing for certain portions of work
  • Verification of percentage of work complete
  • Supporting back-up for stored materials being charged

Open book guaranteed maximum price (GMP)

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:

  • Allowance and contingency tracker logs
  • Detailed project cost reports and committed cost data including buyout savings and forecasting
  • Contractor-issued subcontract agreements, change orders and purchase orders

Work self-performed by the contractor

Self-performed work can often result in excessive payments. Carefully address self-performed work in your contract, paying especially close attention to these areas:

  • Transparency on the costs and supporting back-up making up the self-performed work
  • Complete scope description of the self-performed work and what is and is not included (to avoid self-performed work potentially being charged to other cost areas within the project)
  • Clarity on mark-ups for self-performed work
  • Clarity and understanding on sub-tier subcontractors and suppliers included under the self-perform umbrella or scope of work


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:

  • Detailed explanation of the scope and amount of each allowance
  • Precise language to minimize allowance quantity and dollar amount
  • Requirements for allowance tracking and status reporting to the owner at specified intervals (usually monthly)
  • Details on what happens when allowances are exceeded or excess allowance funds (specifically how funds are to be used or refunded at the discretion of the owner)


For every construction project, your contract should have contingency language that:

  • Defines explicitly what contingency funds can and cannot be used for under the terms of the contract
  • Specifies that final approval for use of contingency funds should always favor the owner
  • Details what happens to unused contingency funds
  • Defines the owner’s right to contingency reductions during the project

General conditions and requirements (GC/GR)

Regardless of the contract type you are using, it must fully explain and define general conditions. The GC/GR clause should:

  • Spell out exactly what is and is not included in GC/GR budgets and estimates
  • Reference a detailed list of mutually agreed upon GC/GR staff for the project and labor rates
  • Be clear that work associated with the GC/GR scope should not be subject to extra self-perform markups
  • Clarify whether the general conditions are lump sum (fixed) or whether they are treated as a cost of the work so that they can be billed accordingly (determined by a mutual understanding between the contractor and the owner)

Shared savings

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.

  • Consider alternatives to shared savings that could be more beneficial to the owner and contractor
  • The contract should be clear on exactly what should and should not be factored into shared savings, such as whether to include leftover general conditions funds, self-performed scope funds, unused contingency funds, etc.

Lien waivers

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.

  • The contract should stipulate that the contractor is responsible for lien resolution and that payments are held until the lien is removed
  • Be sure to include language requiring the contractor to track, log and report lien waivers monthly with project billings and/or payment applications
  • At the owner’s discretion, missing lien waivers should pause project payments

Additional Construction Risk Reduction Strategies

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.

5 Cost Areas Construction Project Owners Should Watch For

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.

5 Cost Areas Construction Project Owners Should Watch For

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Do You Know Your Construction Project Risks?

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.

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