Middle-market construction contractors that bid on projects outside of their historical areas of expertise, such as residential contractors seeking commercial work, are likely to be presented with contract terms and conditions with which they may not be familiar, construction risk management experts say.

Because they could be subject to financial penalties as a result of delays, transferring and mitigating the risk of inability to perform becomes an important consideration for middle-market contractors, who may be playing in a whole new space, experts say.

“If you do electrical work and you've done housing your whole life, but now you're doing hospitals, or you're moving from the private to the public sector, contractors with experience in every field of construction are facing new challenges,” said David Finkelstein, executive vice president in the surety division of Philadelphia-based Arch Insurance Group Inc. “Today, more and more is being required of any contractor, because terms and conditions of construction and the processes that go into it are so much more complex.”

Tim McGinnis, Dallas-based senior vice president in the national construction practice of Willis North America, said: “Contractually, we are seeing very onerous terms and conditions.”

For example, many commercial projects require contractors to pay “liquidated damages,” a form of financial penalty, if any of their activities result in the delay of a project's promised completion date.

“Contractors basically put their corporate balance sheets at risk every time they sign a contract without the ability to transfer this risk,” Mr. McGinnis said.

Such penalties are especially common in the utility sector, where building contractors are required to meet certain performance-based owner specifications, according to Tom Miller, senior vice president at Kansas City, Mo.-based Lockton Cos. L.L.C.

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“Contractors moving into the commercial world are going to find a much stronger focus on project schedule. If the predecessor contractor falls behind schedule, it puts pressure on the successor contractor to complete the job in less time than they negotiated on the front end. So the contract should contain provisions to account for this possibility, either to cover the cost of additional manpower or man hours to complete the job in the compressed time frame,” Mr. Miller said.

In such scenarios, “there might be liquidated damages provisions” or a requirement in the contract that the contractor responsible for the delay pay a specified dollar amount to the project owner, he said. Additionally, “the contract might state that you're on the hook to pay the general contractor for whatever period you delay the project,” he added.

Fortunately, at least one insurer — Philadelphia-based Ace USA — recently introduced a coverage endorsement to its builder's risk policy to partially mitigate this risk for building contractors.

“When we provide this coverage, the trigger has to be something where there has to be an insured physical loss. For example, if the project is delayed because they can't find materials or there's a labor shortage, that's not covered. But if there's water damage, lightning strikes the building, anything covered by the builder's risk policy, it will respond,” said Bruce Jervis, San Francisco-based executive vice president of Ace USA's inland marine division.

The policy, which pays a percentage of the penalty relative to the size of the project, is usually written with a waiting-period deductible, Mr. Jervis said.

Middle-market subcontractors also need to be aware of contractual requirements that they name project owners and/or general contractors as additional insureds on their own liability insurance policies, experts say, because many jurisdictions prohibit such indemnification agreements.

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Increasingly, states are enacting anti-indemnity statutes to prevent contractors from indemnifying another party when that party is partly at fault, said Randy Maniloff, a partner in the law firm of White & Williams L.L.P. in Philadelphia.

“Thirty-five states have statutes that limit the extent of indemnity in some shape or form,” he said. “It's one thing for me to indemnify you for something that I did wrong. It's quite another to indemnify you for something you did wrong.”

Subcontractors should specify in the contract under what terms they will agree to name either the owner or general contractor as an additional insured, then make sure that their insurance policies will permit such indemnification in the state where the project is being built, Mr. Maniloff said.

“When it comes to contractual risk transfer, sometimes it's easier said than done,” he said.

“We still have a lot of additional insured requirements in contracts that are at odds with anti-indemnity statutes,” said Eric B. Smith, Atlanta-based managing director of Marsh Inc.'s U.S. construction practice. “Some rely on boilerplate templates. They don't update them as often as they should. It's very complicated, and the construction industry has a long way to go.”

Mid-market contractors involved in “green” building projects also are being asked to provide guarantees that the end product will meet a specified certification level under the Leadership in Energy and Environmental Design program of the U.S. Green Building Council. But most legal and risk management experts warn contractors against providing any such guarantees, as most professional liability insurers will void coverage if a policyholder offers a warranty of any kind.

“Most of the major projects have strong ambitions to be green, especially flagship properties in the commercial space,” said Mr. Smith. “You've got to have careful crafting of the language so you don't run afoul of any warranty exclusions in the policies.”

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Middle-market contractors increasingly are being asked to participate in public-private partnerships that require contractors to have “skin in the game” by helping to finance a construction project, according to David Bowcott, senior vice president in Aon P.L.C.'s infrastructure solutions in Toronto.

“The owner is resigning himself to the fact that it's not good at designing and building assets. They're telling the private sector to do it all and won't pay until it's up and running, and the payment will be stretched out over a 30-year period. Governments are finding it's effective in creating greater certainty in budgets and the asset's performance over time. It's like buying a house and withholding payment if any of the systems fail. There are more and more middle-market contractors playing in this space,” usually as part of joint ventures, Mr. Bowcott said.

However, “their inability to perform is a risk to the deal if the contractor enters into a design-build contract vs. a bid-build contract where the owner obtains the design. The interaction between design and build, and build and operations, and operations and- design is much greater. That's a new dynamic that middle-market contractors have to get used to and wrap their heads around,” he said.