The construction industry does not have clearly defined borders and its characteristics range from simple to complex. Construction supplies basic materials (such as aggregate, cement, steel reinforcement and pre-packaged mixtures) right up to cutting-edge technology developed and used by experts. The industry has contributed to, and is a vital element of, almost everything we see around us. For example, the diversion of water courses, land reclamation, houses, shopping centres, offices, factories, health care facilities and large infrastructure-related civil engineering works such as bridges, tunnels, highways, airports and harbours. Others installations include water treatment plants, dams, nuclear power plants, wind power plants and projects in the field of electricity generation. The contribution made by the construction of factories, warehouses and production lines that serve other industries, (including mining and research centres) cannot be ignored. The particular activities relate not only to new construction works, but also repairs, extensions, reconstructions and demolitions.

The diverse nature of the construction industry reflects the complexity of contemporary society as a whole, leading then to necessary specialization of particular activities in construction. A construction project is further comprised of complex processes, services and supplies reaching beyond the scope of this industry alone. For example, insurance, financing, bonds and guarantees, purchase of plant and equipment, security guards, operations and maintenance of work processes.

A construction project is a specific process or, rather, a sum of many processes. Mostly, it is an individual process. There are variables relating to the positions of its participants, their assignments and relationships, external conditions (concerning the economy, the nature of the site, climatic conditions, project risk and hazard levels in general), project management and delivery methods, procurement methods and public support.

Construction projects face hazards of various kinds, caused either by humans or natural elements. Therefore, people, time and environmental elements play a major part here. The construction project itself tends to be a unique set-up of processes with unpredictable impacts caused by individual hazards. For large construction projects, their duration will often exceed two years. These projects are realized over extensive areas and are often difficult to safeguard perfectly. Therefore, a construction project is not a production line you can just program to smoothly create a product, within a well-defined time, quality and financial outlay.

Design errors, extremely adverse climatic conditions, unforeseeable on-site conditions in physical or social terms, site access-related issues, building permit problems, delays due to the requirements of environmentalists and variations are just some examples of potential complications.

Effective risk management must be the aim of everyone involved in a construction project. In other words, to identify patterns and potential problems, variations, hazards and risks in order to manage them effectively. This can only be achieved through the perfect preparation of each particular project. This is the theory.

However, in practice, the lowest bid price tends to be the most important criterion in public tender evaluations nowadays. This is also a reason why contracts (for works or for design) that determine particular project relations must anticipate and involve transparent, efficient and reasonable solutions to potential problems and complications.

In the course of time, five main groups of construction project participants have emerged as major players in the construction industry. These groups are directly involved in construction projects or have an influence or a particular function within the industry. They are the contractors, designers, regulators, employers and users (Murdoch and Hughes, 2008). Lenders (banks), insurance and reinsurance companies must also be mentioned as further (indirect) construction project participants because of their significant influence on construction projects. We will now discuss these important roles in the construction project.

Construction contracts are different from other commercial agreements because of the high degree of uncertainty. While the contract documents will provide a definition of the scope of works to be performed, a high degree of project complexity still leaves a lot of room for uncertainty along the way to the final result. This makes the task of administering the contract an important part of the larger process of ‘managing uncertainty’.

Furthermore, the question of ‘moral hazard’ is sometimes mentioned (Winch, 2010), i.e. the difficulties the employer can face in ensuring that the contractor will perform the contract in good faith and bring it to its desired outcome. As a rule, the contractor possesses better technical and managerial skills than the employer. The absence of a proper contract that will provide clear terms and procedures regarding all relevant aspects and an efficient risk allocation may leave the less informed employer exposed to the risks associated with moral hazard and suffering from a potentially severe compromise regarding the desired outcome.

On the other hand, large public procurement construction projects are often accompanied by political irresponsibility on the employer’s side, mainly when problems are encountered. Nobody wants to be responsible for cost overruns and delays. To avoid responsibility, employers sometimes shift the risk of negative consequences of badly prepared projects onto contractors (e.g. delayed expropriation risk or bad ground conditions risk in underground works). Such ‘one-sided contracts’ actually negatively affect the smooth implementation of projects and consequently are considered disadvantageous to the borrowers due, amongt other things, to the late completion of the project (JICA, 2011). If this is done systematically, it is also dangerous for society. From a socio-economic point of view, it leads to frustration and a waste of resources in the short term and more expensive construction works and damage to the local economy over the long term.

Corruption is another ‘moral hazard’, which is much more serious and afflicts the construction industry as a whole.

There are certain well-known rules of risk allocation. The ultimate rule is that risk allocation must be efficient and if there is a non-insurable risk that is hard to quantify, the risk should be borne by the one who bears the majority benefit. It is self-evident who bears the majority benefit if it is a public construction project. In this case, it is the employer and the users. Furthermore, the state as an employer is often the stronger party (applying a take it or leave it approach to contracts). Thus it seems to be appropriate to apply the principles of protection of the weaker party (the contractor) in such public construction projects.

Another principle that must be stressed is the principle of good faith protection. The governing law usually does not protect the one who is not fair, misuses their position and, as in the case of public employers, invites contractors to deliver projects where risks are speculatively shifted onto contractors and the terms of reference of the particular contract happens to be a sophisticated trap.

Another problem seems to be the fact that international contract forms are often ‘imported’ to developing countries. Naturally they are less familiar to the local employers in both legal terms and working procedures (Banica, 2013). Employers in both the private and public sectors do not pay enough attention to the uneven knowledge asymmetry when facing and entering an agreement with a contractor, as well as to the need to manage this risk through contractual means and by employing a consultant as contract administrator or project manager. Employers tend to show an exaggerated optimism and focus extensively on establishing an initial contract price, without a clear understanding of the importance of setting clear rules regarding the management of change, regardless of the source of the change such as claims, variations, disputes, additional work, etc. (Banica, 2013).

Add to this the fact that the construction industry in developing countries (still in the first stages of modernization) has not yet formed a body of knowledge or produced a significant number of contract managers/consultants familiar with international contracting and procurement practice and the local specificities and working culture (Banica, 2013).

The position of the ‘contract administrator’ is of key importance. A contract administrator hired by the employer on a professional service agreement basis deals with coordination, monitoring, supervision of compliance with standards, certifies the works done, testing, taking over, participates in variation, price and time management, claim evaluation, contract interpretation and dispute avoidance. They should help to complete a successful project in a fair way and in accordance with the contract, achieving the demanded standard in the agreed time and for the agreed price.

The contract by itself is not enough to solve the problem of moral hazard and the asymmetry of knowledge between the employer and the contractor. The second key element required is the presence of a third contractual party—namely, the contract administrator (Banica, 2013).

In terms of contract administration, there are three usual arrangements in force:

• The ‘engineer’ as an employer’s agent, whose job is to monitor and supervise the work, whose duty is to make fair determinations on certain matters (e.g. on claims for extension of time and additional payments; see an example of such determination in Appendix 6). The engineer issues certificates on payments, taking-over and performance.
  
• The employer’s representative where the contract is administered directly by the employer or its representative. If the contractor is to achieve the certainty of time and price stipulated, then the involvement of the employer must be limited to a minimum during construction.
  
• The construction manager as an employer’s agent hired to coordinate all processes on a professional service agreement basis without direct responsibility for design and works (see Chapter 3).