ALLOCATION OF RISKS IN A PRIVATIZED CONSTRUCTION PROJECT

As with all risks that are inherent to a construction project, the risks of a privatized construction project, that is, a public project that is built and financed with private funds, are usually allocated among the parties who are involved in the project. The three ways of allocating the risks are avoiding or reducing the risks, assuming or retaining the risks, or transferring or sharing the risks.

Avoiding or reducing the risks can be accomplished by a developer or a project sponsor if the procurement process is carefully monitored, if supplies and raw materials are properly checked for availability, or if contacts are made with the host government regarding legislation that may affect the viability of the project.

Assuming or retaining the risks can occur by a project sponsor's acknowledgement of its negligence with regard to the project or by a lender requiring the project sponsor to retain errors and omissions insurance. The host government assumes or retains the risks if it agrees to reimburse the project sponsor for any increased costs as a result of delays that are within the control of the government.

Transferring or sharing the risks is accomplished when a contractor seeks to be released from liability for the project or seeks to be indemnified from the project sponsor. The risks may also be transferred or shared when the contractor requires its subcontractors to provides workers' compensation or general liability insurance.

In order for any party to the project to agree to assume or to share the risks, the party must estimate the costs of assuming the risks, which costs must be weighed against the costs of avoiding the risks. The party normally relies on historical data and on the judgment of experts in determining the risks that it can profitably assume and whether the risks should be shared, transferred, or avoided.

Contracts that are entered into between the parties to a privatized construction project usually allocate the risks between the parties. The contracts most often allocate the risks to the party who is in the best position to control the risks.

If the project sponsor's bid is not accepted or if the project does not materialize, all of the risk for development costs falls on the project sponsor and the lenders. The project company retains the risk of cost overruns and delays that are incurred prior to the completion of the project. The operating and maintenance company assumes the risk for operating cost overruns and for increased labor costs after completion of the project. The host government is generally responsible for political risks, such as adverse changes in the law, currency issues, or political violence or war.

Most insurable risks in a privatized construction project are required to be covered by insurance. The insurance companies first determine whether the risks are insurable. The insurance companies then determine the cost of the insurance for the risks. Most privatized construction projects require general liability and workers' compensation policies. Some projects require professional liability or environmental liability policies. There are even more specialized policies that are available, such as cost overrun insurance, delay insurance, force majeure insurance, and liquidated damages insurance. When the project is an international project, government-backed insurance may be required for political risks.