The construction industry is full of risks, from personal safety risks on construction sites, to financial risks and risks of business failure. Construction projects have several tiers, and every tier faces its own unique challenges and specific risks.

While the risk of nonpayment is fairly universal in construction, the way that risk is shifted between parties and the tug-of-war to accomplish that financial risk-shifting provides interesting insights into the actual apportionment of risk in the construction industry.

Financial Risk

The terms risk, risk-shifting and risk management get thrown around a lot in the industry, but what exactly do they mean?

As noted above, there are all kinds of risks associated with the construction industry and construction projects. Attempting to create an exhaustive list of everything that could go wrong and expose a subcontractor's company to financial hardship is a fool's errand. However, an understanding of a project's (or a company's) risk potential requires a basic understanding of why and how specific risks arise.

Since the construction industry is such a credit-heavy industry, and the payment scheme on construction projects is intimately tied into this credit-based approach, there are always questions and worries regarding the risk of nonpayment somewhere in the payment chain.

The interconnectedness of the construction payment scheme means that a delay in payment (or absence of payment) anywhere throughout the payment chain can affect everybody else. Specifically, parties purchase materials (usually on credit) and then show up and perform labor.

However, they typically bill their customer and get paid after completion or partial completion. That party, then, assumes the financial risk of nonpayment, and if they are not paid on time (or at all), they will be forced to make difficult choices about which of their own bills — for expenses they've already fronted — don't get paid.

Know Where the Risk Comes From

The construction industry is aware of risk-shifting and knows there are significant financial risks on nearly every construction project, but the knowledge of specific things to look for is less wide spread. Many parties do not know what to look for, or where to look to determine financial risk on a project, or how to know if certain risk-shifting measures have been deployed by the parties with whom they are doing business.

When looking up the chain, the first place to discover potential risk-shifting is the company's contract itself. Despite this seemingly basic idea — "read the contract first" — many parties don't even read through the contracts they are signing. They just accept whatever is put in front of them and sign it as a requirement of doing business.

This can lead to significant consequences. It doesn't matter whether the contract isn't read because the company feels it can't be changed anyway, or if it isn't read because the company isn't educated on the risks that could be found inside — the risks can still be there and can come back to bite.

While reading the contract is a good first step, it's not a catch-all. For one, contracts contain a lot of clauses and specialized language, and it can be tough to know what to look for. And, two, even if you know what to look for, once you find it, it may be difficult to understand the legal complexities. It's good to have a construction lawyer handy to help out.

Once it's known that contracts contain a number of clauses that attempt to shift financial risk, they can be more easily looked for. Most of the time, these risk-shifting clauses will be in the form of contingent payment provisions, such as "pay when paid" or "pay if paid" clauses. It's a good idea to refuse to sign "pay if paid" clauses altogether, and to be stingy on "pay when paid" provisions.

These are not the only provisions that can shift the financial risk on a construction project. It's also worthwhile to look for change directive clauses, change order restrictions, claim notice provisions, liquidated damage clauses, and the like.

Stay Secure

For all this talk about industry risks, it may seem odd that the industry was designed to be incredibly unrisky and secure for parties furnishing labor and/or materials to construction projects. Shockingly enough, however, that is exactly the case.

Mechanics lien and bond claim laws, with the explicit purpose of protecting parties in the construction industry against nonpayment, are built directly into the law in every state. This security interest in the property that is being improved dates back all the way to Thomas Jefferson, and provides a huge amount of protection to construction industry participants when used correctly.

It is foolish for construction professionals to ignore these protections or to dismiss them as too complicated. Savvy companies use these security rights, and the industry knows about these rights and expects them. Understanding these rights can keep your company in a secured position at all times.