Shifting Risk for Unknown Subsurface Site Conditions in State and Federal Site Conditions

Risk for unknown subsurface site conditions is shifted differently between the public owner and the contractor depending upon whether the project is state or federally funded.  Additionally, aside from the employment of disclaimer or differing site conditions clauses in state and federal contracts respectively, who bears the risk for unknown subsurface site conditions is contingent upon an exacting factual and legal balance of considerations, to include the entirety of the contract and the specific facts attendant to the project.  As the recent cases cited in the article illustrate, however, a determination of shifting risk for unknown subsurface conditions is one that cannot be made in a vacuum.

The New Jersey Practice

The general practice in New Jersey is to shift the risk for unknown subsurface site conditions from the owner – the state – to the contractor.  The bidding and contracting documents for state projects typically include an exculpation clause that precludes the contractor from recovering monetary damages for claims of delay and extra work caused by unknown subsurface site conditions encountered during the course of the project. 

The rationale for the state’s disclaimer of liability for unknown conditions is to prevent the escalation of project costs through the paying of claims for delay and extra work.  The practice is premised on the theory that by exculpating itself from damages resulting from unknown subsurface conditions, the state “forces” the contractor to perform whatever pre-bid investigation is necessary to become familiar with the site – both surface and subsurface.  For example, if the contractor bids on a project for which it will assume the extra costs associated with encountering unknown subsurface conditions, it is theorized that the contractor has an economic incentive to thoroughly investigate the subsurface in order to minimize its own exposure for the unknown. 

A legitimate question exists as to whether the state’s general practice truly results in lower project costs.  The practical effect of the public owner’s exculpation of liability for unknown subsurface conditions is the artificial inflation of bids to capture the contractors’ “contingency” costs for the existence of unknown conditions.  Contractors bidding on state projects must factor their exposure for the unknown into their bids, with the potential result being escalated project costs.

            The New Jersey Department of Transportation Standard Specifications’ exculpation clause is contained in Section 102.06:

It is expressly understood and agreed that the department assumes no responsibility whatsoever in respect to the sufficiency or accuracy of the subsurface investigations, the records thereof or of the interpretations set forth therein or made by the department in its use thereof other than as used to establish a design for the project in its as-built condition.  There is no warranty or guaranty either express or implied, that the conditions indicated by such investigations or records thereof are representative of those existing throughout such areas, or any part thereof, or that unlooked-for developments may not occur, or that materials other than or in proportions different from those indicated may not be encountered.

This exculpation clause is typical of the state’s practice in that it shifts the risk of unknown subsurface site conditions from the public owner to the contractor.[1]

            The Supreme Court of New Jersey addressed the issue of shifting risk for changed conditions – or unknown subsurface site conditions – in the seminal case of P.T. & L. Construction Company, Inc. v. State of New Jersey, Department of Transportation, decided in 1987 and reported at 108 N.J. 539 (1987).

In P.T. & L. Construction Company, the Court considered a contractor’s claim against the state for damages resulting from changed conditions on a public roadway project.  The contractor had expected dry site conditions, in part, based on language contained in the contracting documents, but instead encountered unanticipated wet site conditions.

The contract in P.T. & L. Construction Company contained a standard exculpatory clause disclaiming the state’s responsibility for changed site conditions.  The clause provided, in relevant part: “[t]he Contractor agrees that he will make no claims against the State, if in carrying out the Project he finds that the actual conditions encountered do not conform to those indicated by said borings, test excavations and other subsurface investigations.”  The Court found that the contractor could recover for damages resulting from the fact that the site was generally wet as opposed to dry.  Importantly, though, the Court based its decision on the state’s nondisclosure of material facts which amounted to a misrepresentation of the site conditions.  The Court stated, “had [the contractor’s] claim been premised only on its conclusion that dry working conditions were implicit in the contract specifications, recovery would have been precluded by the specific disclaimers of State responsibility for site conditions.” 

P.T. & L. Construction Company, thus, stands for the proposition that when the state owner makes false representations in the contract documents – positive statements of fact about the character of the work to be performed – the state owner will be liable to the contractor for claims of delay and extra work notwithstanding the existence of an exculpatory clause.  Further, concealment of information regarding surface or subsurface site conditions are considered false representations of fact.  Still, a contractor’s inferences drawn from contracting documents are not considered false representations on the part of the state provided that the state’s disclaimer as to actual site conditions is clear and unambiguous. 

            More recently in SMC Corporation v. New Jersey Water Supply Authority, a New Jersey Appellate Division case reported at 334 N.J. Super. 429 (2000), the Court considered a contractor’s claim against the state for damages resulting from unknown subsurface site conditions.  The contractor claimed damages resulting from the existence of a scour hole that prevented the construction of planned cofferdams.  The scour hole was not depicted in the specifications and drawings.   

            The contract in SMC Corporation contained a disclaimer of liability for unknown subsurface site conditions as follows:

The contractor acknowledges that he has satisfied himself as to the nature and location of the work, the general and local conditions particularly those bearing upon transportation, disposal, handling and storage of materials, availability of labor, water, electric power, roads and uncertainties of weather, floods or similar physical conditions at the site, the topography and conditions on the ground, the character of equipment and facilities needed preliminary to and during the execution of the work, and all other matters upon which information is reasonably obtainable and which can in any way affect the work or the cost thereof under this Contract.  The Contractor further acknowledges that he has satisfied himself as to the character, quality and quantity of information regarding the above that is reasonably ascertainable from an inspection of the site, including all exploratory work done by the [New Jersey Water Supply] Authority or the Engineer, as well as information contained in the Drawings and Specifications forming part of this Contract.  The Contractor further acknowledges that he has satisfied himself as to the availability of timber, stone, fill material, etc. both as to quality and quantity required to execute the work.  Any failure by the Contractor to acquaint himself with all the available information will not relieve him from responsibility for estimating properly the difficulty or cost to successfully perform the work.

The Contractor’s attention is drawn to the fact that As-Built Drawings of existing work do not exist and some dimensions shown on the Contract Drawings have been estimated.  All dimensions shall be field checked by the Contractor.

Additionally, the drawings contained a notation stating that the “information shown on the existing conditions of the culvert and adjacent areas are based on field inspections performed [several years earlier], and other information available at the time.  Actual field conditions may vary from that shown on the contract drawings.”

            The Court determined that the state made no false statements of fact in the contract documents.  Still, the Court ruled for the contractor, finding that the state’s “exculpatory” clause (quoted above) to be ambiguous with respect to the allocation of risk for unknown subsurface conditions.  The Court determined that “where ambiguities exist they are to be taken most strongly against the draftsman.”  As such, the state assumed the risk for unknown subsurface site conditions.

            The Court in SMC Corporation compared the disclaimer clause in this case with the disclaimer clause contained in P.T. & L. Construction Company.  The Court determined that while the P.T. & L. Construction Company clause was unambiguous in placing the risk for the subsurface condition on the contractor, the clause in SMC Corporation implied that conditions not known to the public owner or contractor – conditions which are not “reasonably obtainable” or “ascertainable” may be the basis of a claim for delay and extra work.  In sum, the disclaimer used by the state in SMC Corporation was not as strong as that used in P.T. & L. Construction Company.

The Federal Practice

The federal practice shifts the risk for unknown subsurface site conditions from the contractor to the federal public owner.  The bidding and contracting documents for federal projects include a differing site conditions clause that permits the contractor to recover monetary damages for claims of delay and extra work caused by changed conditions, such as unknown subsurface site conditions encountered during the course of the project.

Again, as with the state practice, the rationale for the federal practice is to prevent the escalation of project costs.  In the context of federal contracts, however, the rationale of the practice is to prevent the escalation of project costs by preventing the contractor’s inclusion of “contingency” costs in its bid.

The federal practice is premised on the theory that by assuming the risk for unknown subsurface site conditions, the federal owner eliminates the contractor’s need to artificially inflate its bid to cover for problems that may or may not be encountered during the course of the project; the result being a lower bid, a lower project cost, and the elimination of a windfall to the contractor.  Moreover, should there exist problematic subsurface site conditions, and both the contractor and federal owner are in agreement as to the changed site conditions, then an equitable adjustment is made to the contract price.

            Section 36.502 of the Federal Acquisition Regulation requires the use of a “differing site conditions” clause in most federal construction projects.  A typical differing site conditions clause is as follows:

(a)  The Contractor shall promptly, and before the conditions are disturbed, give a written notice to the Contracting Officer of (1) subsurface or latent physical conditions at the site which differ materially from those indicated in this contract, or (2) unknown physical conditions at the site, of an unusual nature, which differ materially from those ordinarily encountered and generally recognized as inhering in work of the character provided for in the contract.

(b)  The Contracting Officer shall investigate the site conditions promptly after receiving the notice.  If the conditions do materially so differ and cause an increase or decrease in the Contractor’s cost of, or the time required for, performing any part of the work under this contract, whether or not changed as a result of the condition, an equitable adjustment shall be made under this clause and the contract modified in writing accordingly.

(c)  No request by the Contractor for an equitable adjustment to the contract under this clause shall be allowed, unless the Contractor has given the written notice required; provided, that the time prescribed in (a) above for giving written notice may be extended by the Contracting Officer.

(d)  No request by the Contractor for an equitable adjustment to the contract for differing site conditions shall be allowed if made after final payment under the contract.

The above quoted differing site conditions clause was contained in the Kiewit Construction Company contract discussed below.

The United States Court of Federal Claims addressed the issue of shifting risk for unknown subsurface site conditions in Kiewit Construction Company v. The United States, reported at 56 Fed.Cl. 414 (2003).  In Kiewit Construction Company, the Court considered a contractor’s claim against the federal government for differing site conditions on a project involving the construction of a lock and gate bay.  The contractor brought a claim against the government for damages resulting from unexpected water encountered at the work site – a claim falling under the parameters claim type (1) in paragraph (a) of the differing site conditions clause.  The contractor claimed that the owner’s specifications represented five conditions that differed from actual site conditions; and, that such differing site conditions resulted in extra, unforeseeable costs to the contractor.

The contract work called for the creation of a dewatering system.  The contract provided “mandatory minimum performance and design information” with respect to the dewatering system.  In addition to the differing site conditions clause, the contract contained a provision stating that the assumptions underlying the minimum dewatering system “may or may not be completely valid,” and that “it shall be the Contractor’s sole responsibility to control and pump any water that may leak through the existing structures . . . for whatever conditions that may exist.”

The Court in Kiewit Construction Company held that for the contractor to prevail on this claim, it must demonstrate by a preponderance of the evidence the following: (1) that the contract “affirmatively represented” the subsurface conditions forming the contractor’s claims; (2) that the contractor acted as a reasonably prudent contractor in interpreting the contract; (3) that the contractor reasonably relied upon the subsurface conditions identified in the contract; (4) that the subsurface conditions differed “materially” from the subsurface conditions identified in the contract; (5) that the subsurface conditions encountered were “unforeseeable;” and, (6) that the contractor’s claimed extra costs are purely the result of the materially different subsurface conditions.

The Court rejected the contractor’s claim, noting that the contract listed “baseline assumptions” regarding subsurface conditions, and not factual representations as to the subsurface.  Further, the Court noted the contract’s numerous disclaimers regarding the minimum work, and the necessity of the contractor to determine whether or not site conditions require augmentation to the minimum work in order to effect performance under the contract.  The Court found that these assumptions, and the accompanying disclaimers, put the contractor on notice that the contractor may be required to augment the “minimum prescribed” work if the actual subsurface site conditions differed from the baseline assumptions.  Thus, according to the Court, the contractor’s claim was not properly a differing site conditions claim at all because the contract did not reference actual conditions at the work site.

Conclusion

Shifting risk for subsurface site conditions differs between state and federal projects.  The prudent public owner and contractor should have a command not only of the differences between the exculpatory and differing site conditions clauses utilized by state and federal owners respectively, but in the subtle nuances presented by the balance of the contract and the factual realities presented by the project.