Contract Risks (1)

Toshihiko Omoto

Contract Risks
Exogenous risks
Risk events because of outside reasons

Endogenous risks
Risk events arising from inside human beings

Toshihiko Omoto

Exogenous Risks of Construction Contract

Politcs
Economy
Society
Force Majour
Contract

Toshihiko Omoto

Risk sharing principles for Exogenous Risks

1st Principle
The party who can assess and control the risk
should bear.
2nd Principle
If none of the parties can assess or control the risk,
the party who can bears it easier or procure the
insurance from market should bear it.
(if the Employer is a public sector, it has usually
more capability (deep pocket) or has advantage in
taking risks)
Toshihiko Omoto

Exogenous Risks and Peril-Hazard relation

Peril: Cause of any loss
Hazard: Situation of danger
Risk taker may do something to the Peril so that
he may control the Hazard.
example:
Currency fluctuation: by procuring foreign currency in
advance
Archeological or geological discovery risks: detailed site
survey and investigation
Note: PDF for Peril-Hazard relation
Toshihiko Omoto

Endogenous Risks
Prohibition of cancellation of contract
cancellation only for limited reasons, e.g., for nonpayment, but not for change of the works

Relation-specific investment
Claims for loss/damages are observable but
unverifiable
Natures of the contract above lead to
Hold-up problem
Moral hazard
Toshihiko Omoto

Structure of Contract
To avoid hold-up problems and moral hazard, the
contract shall be designed to give incentive to the
parties not to take advantage of endogenous risks
One proposal: Partnering
NEC (New Engineering Contract, UK)
The Employer, the Contractor, the Project Manager
and the Supervisor shall act as stated in this contract
and in a spirit of .mutual trust and co-operation.
Target price contract/ compensation event
Early warning/ Risk register/ Risk reduction meeting
Toshihiko Omoto