Equitable Risk Allocation

Risk Allocation is a process by which the possibility of loss associated with each of the identified risks is contractually assigned between the contracting parties. In place of the current adversarial contracting approach, we need a culture of more collaborative contract negotiation practices in order to minimize inappropriate risk allocation. For example, industry lawyers, instead of leading the negotiations and engaging in risk allocation battles with the opposing attorney(s), will need to play a supporting role. This change requires top down leadership. (RS210-1, p. 6)

There is ample empirical evidence showing that inappropriate risk has significant adverse financial consequences to both the party trying to avert the risk (by transferring it to another) and party accepting the risk. For example, the owner pays a risk premium (usually in the form of contingency) for transferring risk to contractors. Refer to RS210-1.

RT-210 identified 14 “hot button” risks – these are the risks which are most frequently allocated inappropriately. (RS210-1, p. 10)

The research describes two categories of risk allocation principles: “general risk allocation principles” and “legal risk allocation principles.” See IR210-3, Equitable Risk Allocation: A Legal Perspective, pages 2-5, for the complete list and explanations / examples of these principles. 

The following are some of the general risk allocation principles:

• Many risks cannot be entirely eliminated, but can be controlled.
• Eliminating one risk may cause new risks to materialize.
• Many risks are interdependent so it is important to evaluate risk dependencies to be able to predict the cumulative impact or “domino effect” that may materialize with the realization of one individual risk.

Some legal risk allocation principles are listed below.

• Stricti Juris – Courts will construe contractual provisions exactly as they are written; extreme care should be taken in drafting the contract language, to mean exactly what both parties agree.
• Strictisimus Juris – Courts will construe a contract in a manner that will do substantial justice to the parties.
• Contra Proferentum - Contractual ambiguities will be construed against the drafting party.