Unanticipated Site Conditions & Energy Construction Agreements [Gaille Energy Blog Issue 78]

Unanticipated Site Conditions & Energy Construction Agreements [Gaille Energy Blog Issue 78]

  • Posted by scottgaille
  • On June 28, 2019
  • "site conditions"

Contractors are generally entitled to seek additional compensation (a “price adjustment”) for encountering unanticipated site conditions. The more challenging question is defining what, precisely, constitutes an unanticipated site condition.  For example, in the clause below, unanticipated remains undefined:

If contractor encounters unanticipated site conditions, then contractor is entitled to seek a price adjustment.

The common meaning of unanticipated is “unexpected or unforeseen,” but by whom?  For example, what if the contractor (Mr. Hurry) was in a rush when he visited the site and missed a sandy area?  Mr. Hurry bid the contract based on hard soil conditions and only discovers the sandy area after work starts.  Mr. Hurry subjectively did not expect or foresee encountering sand—but a typical contractor would have undertaken a better inspection and noticed the sandy area.  Mr. Hurry claims that he is entitled to raise his price because his bid did not contemplate working in sand.  The owner, however, assumed that all of the bids were based on the readily observable conditions at the site.  The owner is frustrated because Mr. Hurry is no longer the low bidder when his price adjustment for sandy conditions is added to the initial bid.  In other words, Mr. Hurry shouldn’t have been awarded the project in the first place.

Such disputes have led owners to expand the standard for site conditions along the following lines:

If contractor encounters site conditions that differ materially from site conditions expected to be encountered based on all information reasonably available to or reasonably ascertainable by contractor, then contractor is entitled to seek a price adjustment.

In the above example, the owner would be in a better position to deny Mr. Hurry’s price adjustment because the sandy surface area was “information reasonably available to or reasonably ascertainable by contractor.”  Had Mr. Hurry carefully investigated the site, he would have discovered the sand.  But Mr. Hurry also could respond by arguing that the sandy area was, let’s assume, in a distant corner of the site, hidden behind bushes—and therefore not reasonably ascertainable to him.  So, now there is the question of what “reasonably” means.

To avoid questions of what is reasonable or not, owners and contractors have sought to define reasonableness by reference to industry practices:

Good Industry Practices” means the actions, practices, methods, techniques, and standards (including modifications over time) that should be adopted by a party exercising due care, diligence, and that degree of knowledge, skill, prudence, foresight, and use of funding that would reasonably and ordinarily be expected from qualified, skilled, and experienced professional contractors specializing in the performance of work that is similar to the Work.

The site conditions clause becomes clearer with the incorporation of the definition of Good Industry Practices:

If contractor encounters site conditions that differ materially from site conditions expected to be encountered based on all information reasonably available to or reasonably ascertainable by contractor (in each case, assuming the exercise by contractor of Good Industry Practices), then contractor is entitled to seek a price adjustment.

Reasonableness then becomes a question of whether the site inspection undertaken by Mr. Hurry was in accordance with Good Industry Practices.  If a typical contractor would have studied the entire surface of the site, even the distant corners, then Mr. Hurry’s claim should be denied.

While Mr. Hurry’s example entailed observable surface conditions, how should subsurface conditions be addressed? Pipelines are typically buried using various construction techniques, such as trenching and tunneling.  The contractor’s costs and expenses of doing so depend greatly on subsurface conditions.

To address subsurface risk, owners may undertake geological assessments in which soil and rock samples are taken by boring into the earth.  The reports are then presented to prospective contractors, who must consider the data from the geological report when they propose pricing.  Of course, each bore only reveals the composition of the earth within its narrow pathway.

Consider the example of a geological assessment comprised of ten bores that is undertaken for a tunnel.  Two of the ten bores encountered boulders mixed within the dirt. The contractor (Ms. Mole) designs her tunnel to avoid the boulders encountered by the two bores and then commences her work.  As Ms. Mole tunnels, she encounters more boulders blocking her planned path, which slow down her work and increase her cost.  Ms. Mole seeks a price adjustment on the basis that the precise locations of the boulders she encountered were not shown by the geological report.

The owner rejects Ms. Mole’s argument by responding that the “site condition” identified in the report was not the location of two specific boulders; it was the fact that the area’s soil contained a mix of soil and boulders.  As such, Ms. Mole should have been expecting to periodically encounter boulders and should have priced her work accordingly.

To better address the complexity of subsurface conditions, construction agreements can include more detailed definitions of Site Condition and Unanticipated Site Condition:

Site Condition” means the natural or man-made physical, surface, subsurface, and other conditions at the site and the surrounding area as a whole, including (a) conditions relating to the environment, transportation, access, waste disposal, handling or storage of materials; (b) the availability or quality of electric power or water; (c) the availability or quality of roads; (d) climatic conditions or seasons; (e) topography, air or water (including raw water) quality conditions; (f) ground surface conditions; (g) surface soil conditions; (h) sound attenuation; (i) subsurface geology; (j) geotechnical or geothermal conditions; (k) the nature or quantity of surface or subsurface materials to be encountered; (l) rock conditions, hard rock, soft rock, glacial mix, boulders, cobbles, slate, transition zones, or bedrock properties; (m) sand or quicksand; (n) caves, karsts, or sinkholes; (o) volcanos, hot springs, mud volcanos, naturally occurring gases, or geysers; (p) hydrographical conditions, hydrological conditions, underground water, or aquifers; (q) abandoned oil, gas, water, or other wells; (r) faults, fault distribution, or seismic conditions; (s) reefs, shell, coral, petrified wood, or tree stumps; (t) sunken vessels or archaeological, historical, cultural, or religious sites, places, or monuments; (u) debris, obstacles, or impediments; (v) endangered species, biological resources, or biological hazards; (w) naturally occurring radiation or radioactive rock; (x) the location of underground utilities, equipment, or facilities; (y) the potential for landslides or slippage of backfill, topsoil, materials, or equipment; and (z) water body conditions, waves, or currents, including those of rivers, lakes, bays, or oceans.

Unanticipated Site Condition” means a Site Condition that satisfies all of the following requirements:

(a) the existence of (or risk of encountering) the Site Condition was not identified in (i) this agreement, (ii) any reports (including geotechnical reports) received by the contractor group prior to the effective date, or (iii) any other written document or communication received by the contractor group prior to the effective date;

(b) a contractor exercising Good Industry Practices would not have discovered or been aware of (prior to the effective date) the existence of (or risk of encountering) the Site Condition; and

(c) none of contractor group otherwise had knowledge (prior to the effective date) of the existence of (or risk of encountering) the Site Condition.

Under the above definitions, Ms. Mole’s claim would be more clearly precluded:

  • Site Conditions include the “quantity of surface or subsurface materials to be encountered”; and
  • Unanticipated Site Conditions exclude those Site Conditions for which Ms. Mole was aware of the “risk of encountering”—the bores had shown the presence of boulders in some places so there was a risk that they would be encountered elsewhere.

With a clearer understanding that Ms. Mole cannot seek a price adjustment for encountering additional boulders, Ms. Mole must then address the risk elsewhere in her construction contract.  For example, she could propose:

  • a higher lump sum price that includes a contingency to cover the cost of encountering additional boulders;
  • two tiers of pricing, one for when the tunnel is going through dirt and a second for when it is going through rock;
  • to be paid an extra amount for each boulder she encounters; or
  • to be paid her actual costs for undertaking the entire tunnel plus a fixed fee—so that the owner assumes her out-of-pocket risks for encountering boulders but Ms. Mole’s profit stays the same no matter how many boulders she encounters.

Thus, the fact that the site conditions clause prevents Ms. Mole from making after-the-fact claims for additional boulders does not necessarily allocate the cost of encountering them to Ms. Mole.  The commercial terms will compensate Ms. Mole for undertaking the risk identified by the geological assessment.

The question is whether the risk compensation is based on an up front estimate of Ms. Mole’s cost (for example, assuming that 20% of the tunnel will encounter boulders since two of the ten bores struck boulders) or whether the compensation mechanism will be based on how many are actually encountered. If Ms. Mole accepts an up front price increase based on the 20% estimate, she then is taking the risk that there may be more or fewer boulders.  For example, she makes more profit than expected if only 10% of the route encounters boulders; she makes less profit if 30% of the route encounters boulders.

The preceding highlights the mutual value of clarity in construction contracts.  Loose drafting is inefficient because the parties never actually agree on how the contractor should be paid for encountering a risk—because the owner thinks the contractor has already included the risk in the quoted price and the contractor believes it can receive a price adjustment if the risk is encountered. This would be like buying an airline ticket without knowing whether the price of the ticket includes the cost of baggage—or alternatively, whether the flyer will be charged for each bag he or she checks or carries on.  It’s better to know in advance.  The ostrich-with-its-head-in-the-sand approach to risk is a recipe for conflict and disputes.

Note: The Gaille Energy Blog is now back after a hiatus due to publishing deadlines for my new book, Strange Tales of World Travel.

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About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 107,244) discusses issues in the field of energy law, with periodic posts at www.gaillelaw.com. Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development), and the co-author of just-released Strange Tales of World Travel.

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