Drafting Construction Contracts: How to Avoid Risks at the Contract Drafting Stage?

Introduction

Thorough planning during the contract drafting stage is essential for effectively managing risks in construction projects. A well-drafted construction contract serves as the backbone of any building project, clearly defining the rights and obligations of all parties to ensure project success and compliance with legislation such as the Design and Building Practitioners Act 2020 (NSW).

This guide provides owners, developers, and contractors with practical strategies to mitigate common risks such as project delays, financial losses, and costly legal disputes. By focusing on clear term definitions and fair risk allocation, parties can create a resilient framework that protects their time, money, and professional reputation throughout the construction process.

Interactive Tool: Check Your Building Contract for Hidden Risks & Liability

Understanding Key Risks in Construction Contracts

Ambiguous Scope of Work & Essential Terms

Vague descriptions of the work to be performed remain a primary source of conflict in construction projects. When the scope omits detail on materials, specifications, or project milestones, mismatched expectations quickly arise.

This ambiguity can:

• trigger disputes over performance standards
• result in sub-standard workmanship
• force costly contract variations

For a construction contract to be binding and effective, several terms must be defined with absolute clarity. Key terms that demand such certainty include:

• The parties: Clearly identifying all entities involved in the contract.
• The price: Stating the exact cost or a precise method for its calculation.
• The time: Defining firm start and completion dates for the project.
• The description of works: Providing a comprehensive and unambiguous outline of all tasks and deliverables.

Ineffective Risk Allocation & Management

Construction contracts are designed to allocate project-related risks, yet problems emerge when this allocation is unfair or inefficient. If a party receives risks it cannot realistically manage, serious consequences follow.

This imbalance often results in:

• increased project costs
• prolonged delays
• a higher likelihood of disputes

When contractors must price in uncontrollable risks, they may inflate bids to cover potential liabilities. Likewise, weak or poorly drafted indemnities expose parties to unforeseen financial burdens, underscoring the need for balanced risk sharing.

Vague Payment Provisions & Cash Flow Issues

Unclear payment provisions frequently cause financial strain within the construction industry. When contracts fail to spell out payment schedules, progress-payment milestones, or the approval process for variations, contractors and subcontractors face cash-flow uncertainty.

The result can be:

• late payments
• disagreements over entitlements
• severe financial pressure from poorly structured retention clauses

These issues highlight why precise, transparent payment terms are essential to maintain financial stability throughout a project.

Essential Clauses to Mitigate Risk in Your Construction Contract

Defining Scope Deliverables & Timelines

A detailed scope of work forms the foundation of a solid construction contract, ensuring both parties have a clear understanding of what is being built. Vague descriptions can lead to mismatched expectations and disputes, so it is essential to set out precisely what the project includes.

To enhance clarity and control, agreed-upon deliverables should be matched to specific construction milestones:
• Approvals tied to each stage confirm that work meets the required standard before the project moves forward.
• An early warning system flags deviations from the plan, giving parties time to correct course.
• Firm start and finish dates provide structure for financing and occupancy planning, making scheduling far more predictable.

Managing Variations & Change Orders

Changes to the project scope are common during a build, and managing variations in construction contracts without a formal process can trigger significant cost increases and disputes.

A robust variation clause should require:
• Written approval before any change is implemented.
• A clear pricing method so both parties know how additional costs will be calculated.
• Comprehensive documentation of every variation, preserving an accurate project record.

This balanced approach allows builders flexibility to handle unexpected issues while protecting owners from uncontrolled costs.

Structuring Payment Terms Retention & Security

Clear payment terms are a crucial tool for managing a builder’s performance and protecting your investment. Construction contracts can use various payment structures, such as milestone-based payments, and should clearly define the contract sum. Linking payments to the completion of specific project stages ensures that work is progressing as agreed before funds are released.

To provide security for performance, contracts often include provisions for:

• Retention money – a percentage of each payment claim is withheld as security until defects are rectified.
• Bank guarantees – an alternative form of security that can be called upon if the builder fails to meet contractual obligations.

Typically, half of the security is returned at practical completion, with the remaining half released at the end of the defects liability period.

Clarifying Defect Liability Insurance & Indemnities

A well-defined defect liability period ensures long-term protection against the costs of fixing issues, as not all faults are apparent upon completion, and can be crucial when seeking damages for defective building work. This clause obligates the contractor to return and fix faults that emerge within a set timeframe.

Verifying adequate insurance coverage is equally important. A good contract allows you to request proof of insurance—such as certificates of currency—at key stages.

Furthermore, indemnity clauses establish who is responsible for losses or damages resulting from events like personal injury or property damage. Drafting these clauses clearly helps manage risk and prevents disputes over liability.

Including Dispute Resolution & Termination Rights

Even with careful planning, disputes can arise. A structured dispute resolution clause is key to resolving construction disputes without courts, offering a mechanism to resolve issues without immediately resorting to litigation. Effective contracts often require negotiation or mediation first, which is faster, confidential, and less damaging to business relationships.

Clear termination rights provide a workable exit strategy if one party defaults on its obligations. These clauses should detail the specific conditions for termination and the procedure to follow, giving you a clear path forward if the builder misses deadlines, abandons the work, or otherwise fails to deliver as promised.

The Critical Role of Fair & Effective Risk Allocation

Applying Best Practice Principles for Efficient Allocation

The efficient allocation of risk in a construction contract demands careful consideration of the nature of each risk and of which party is best positioned to manage it. A foundational guide for this process is the Abrahamson Principles, which have gained widespread support across the construction industry.

According to the Abrahamson Principles, a risk should be allocated to a party if:

• the risk stems from that party’s wilful misconduct or lack of reasonable care;
• the party can transfer the risk through insurance at the most economically beneficial and practical cost;
• the primary economic benefit of taking the risk accrues to that party;
• placing the risk on that party promotes efficiency, innovation, and long-term industry health;
• the loss initially falls on that party and it is not practical or sensible to transfer it elsewhere.

For risks that lie outside the control of any party, other factors come into play. In such cases, the risk should be assigned to the party that can best control its consequences, foresee it, or bear its impact.

Applying these principles ensures that risks are managed by the party most capable of doing so, which can reduce disputes and overall project costs.

Addressing Unforeseen Conditions & Force Majeure

Construction projects can be disrupted by events beyond the control of both principal and contractor. Typical examples include:

• unforeseen site conditions, such as unexpected geology or hazardous materials;
• force majeure events like extreme weather.

A well-drafted contract must therefore include provisions that allocate these risks fairly. It should set out a clear process requiring prompt notification and objective evaluation of the event’s effect on time and cost.

Including a force majeure clause is essential, as it defines uncontrollable events and the rights and obligations of each party when one occurs. By planning for these contingencies, the contract provides a clear path forward and helps prevent disputes over liability for delays or extra costs.

Using Rise & Fall Clauses for Cost Fluctuations

A “rise and fall” clause is a contractual mechanism that adjusts the contract price in response to fluctuations in material and labour costs. This protection is particularly vital on long-term projects where cost variability is more likely.

The inclusion of a rise and fall clause offers several key benefits:

• Financial stability – contractors are shielded from significant, unexpected cost increases, especially during delays;
• Dispute reduction – because the method of handling escalations is clearly agreed, arguments over who bears extra costs are minimised;
• Work continuity – contractors are incentivised to keep working through delays, knowing they will be compensated for substantial, uncontrollable increases.

Navigating Different Construction Contract Models & Their Risks

Comparing Lump Sum Cost-Plus & Time & Materials Contracts

Different types of construction contracts are used to define the terms between an owner and a contractor, with each structuring payment and risk differently. Understanding these models is crucial for effective project management.

Common contract types include:

• Lump Sum Contracts: Also known as fixed-price contracts, these specify a total price for the entire project. This model provides cost certainty for owners, protecting them from unforeseen changes, but contractors may include a contingency fee to balance their risk.
• Cost-Plus Contracts: These are used when project expenses are uncertain. The contractor is reimbursed for all accumulated costs as they occur and receives a predetermined fee for overhead and profit, offering flexibility when the scope may change.
• Time and Materials Contracts: This model is suitable when the project scope is difficult to define upfront. Contractors charge an hourly rate for labour and are reimbursed for the cost of materials, providing flexibility for owners who pay only for the actual work performed.

Understanding the Specific Risks of Design & Construct Contracts

Design and Construct (D&C) contracts place comprehensive responsibility for both the design and execution of a project onto a single contractor. While this offers clients a single point of accountability, it significantly increases the contractor’s risk profile, particularly when the initial brief from the owner is limited.

The primary risks associated with the D&C model include:

• Heightened Design Liability: The contractor assumes responsibility for ensuring the final construction is fit for purpose, blending building and design expertise. This dual responsibility can lead to complex liability issues if defects arise.
• Insurance Challenges: Obtaining adequate professional indemnity insurance for D&C projects is becoming increasingly difficult. Policies often exclude activities related to construction and installation, focusing only on professional design services, which can leave contractors exposed.
• Subcontracting Risk: Head contractors often delegate design and construction tasks to subcontractors. However, as seen in the case of Alstom vs Yokogawa Pty Ltd (No 7) [2012] SASC 49, poorly drafted subcontracts can fail to transfer risk effectively, leaving the head contractor liable.

A comprehensive and detailed initial design brief from the principal is essential to reduce the contractor’s risk. The more developed the design documentation is before the contract is signed, the lower the risk of disputes and financial strain.

Watching for Hidden Design Risks in Construct-Only Contracts

A concerning trend has emerged in construct-only contracts, where contractors are unexpectedly exposed to design risks. In a traditional construct-only model, the principal provides the design, and the contractor is only responsible for building according to those specifications.

However, the inclusion of “buildability” or “constructability” clauses can shift design liability. These clauses often require the contractor to:

• Identify any ambiguity, inadequacy, or inconsistency in the design documents.
• Warrant that the works, when completed, will be suitable for their intended purpose.

These obligations can transform a construct-only agreement into a design and construct contract by stealth. Contractors who are unprepared for these hidden liabilities may fail to engage necessary design consultants or account for the additional risk in their pricing, leading to significant financial and legal exposure.

Best Practices for Your Construction Contract Drafting & Negotiation

Conducting Good Faith Negotiations for Fair Outcomes

Negotiations for construction contracts should always be conducted in good faith, with a focus on achieving fair risk allocation and managing cash flow efficiently. There is often a tendency during negotiations to transfer as much liability as possible onto one party, which disproportionately affects subcontractors with unmanageable risks and can lead to legal disputes.

Principals, developers, and head contractors should engage in responsible contract negotiations to ensure fairness for all involved.
Common issues that responsible negotiations must tackle include:

• short-sighted terms that ignore long-term project needs
• unfair risk distribution that overloads subcontractors
• poor cash flow management that strains every level of the supply chain

Performing Holistic Tender Evaluations

When evaluating tenders for a construction project, it is essential to look beyond just the price. A comprehensive evaluation considers a range of criteria to ensure the chosen contractor is the right fit for the project’s demands.

Key factors to assess in a potential contractor or supplier include:

• financial stability and resources to adequately support the project
• the capacity to meet critical delivery deadlines and project milestones
• a competitive and transparent pricing structure

Opting for the lowest bid without this holistic assessment can lead to significant challenges later, including supply disruptions or quality control issues. A thorough evaluation is vital for the smooth execution and overall success of the project.

Seeking Specialised Legal Advice for Your Construction Project

Engaging experienced construction lawyers is a critical step in mitigating contractual risks. Legal professionals can draft, review, and negotiate contracts to ensure they are clear, comprehensive, and legally sound, thereby protecting your interests.

Potential issues that specialised legal advice can resolve include:

• ambiguous scope that leaves work undefined
• unfair risk allocation that skews responsibilities
• unclear payment terms that threaten cash flow

By ensuring your construction contract is robust and balanced, you can significantly reduce the likelihood of costly disputes and project delays.

Conclusion

Drafting a clear and balanced construction contract is essential for mitigating risks such as project delays and costly disputes. Addressing ambiguous terms, ensuring fair risk allocation, and clarifying payment provisions at the outset is crucial for achieving project success and maintaining positive working relationships.

Implementing these strategies with professional guidance can substantially reduce the likelihood of conflicts and protect your investment. To safeguard your interests and ensure your agreements are legally robust, contact PBL Law Group’s experienced construction law lawyers for expert assistance in drafting and negotiating your next project contract.

Frequently Asked Questions