Shifting or Accepting the Risk for Differing Site Conditions in Construction Contracts

INTRODUCTION

A comprehensive investigation of subsurface conditions before the design and construction of a project is generally considered a worthwhile investment that will, for the most part, eliminate surprises and costly change orders to the construction contract. Sometimes, however, even the most comprehensive investigation does not eliminate all surprises during performance of the construction contract and the Owner, Engineer and Architect must decide how to allocate the risk for such unanticipated subsurface conditions. If the risk is shifted to the Contractor, one would reasonably expect that the Contractor would add a contingency to its bid price in order to cover the risk of such unforeseen conditions. By adding a differing site conditions clause to the construction contract, however, the Owner can accept the risk and agree to issue the contractor a change order in the event of such unforeseen conditions. Set forth below is a discussion of how to manage these risks through the construction contract documents and of the pitfalls to avoid in preparing such contract documents, which normally include soil boring logs and a geotechnical report.

Key Contract Clauses and Related Court Decisions

1. Differing Site Conditions, Changed Conditions and Concealed or Unknown Conditions

The terms “differing site conditions”, “changed conditions”, and “concealed or unknown conditions” are perhaps best defined by the Federal Acquisition Regulations as follows:

(1) subsurface, latent or physical conditions at the site materially different from those indicated in the Contract; or
(2) unknown physical conditions at the site of an unusual nature, differing materially from those ordinarily encountered and generally recognized as inherent in work of the character provided for in the Contract (48 CFR Section 52.243.5).

In Other Words . . .
+ Type I = Bid documents differ significantly from the actual site conditions

+ Type II = Bid documents show nothing, but site conditions are significantly different than what would normally be expected

New York law allows a contractor to prevail on a differing site condition claim, but the contractor is first required to prove six elements:

(1) the contract documents must have affirmatively indicated the subsurface conditions; (2) plaintiff must have acted as a reasonably prudent contractor in interpreting the contract documents; (3) plaintiff must have reasonably relied on the indications of subsurface conditions in the contract; (4) the subsurface conditions actually encountered must have differed materially from those indicated in the contract; (5) the actual subsurface conditions encountered must have been reasonably unforeseeable; (6) and plaintiff’s claimed damages…must have been solely attributable to such materially different subsurface conditions.

Fruin-Colnon Corp. v. Niagara Frontier Transp. Authority, 180 A.D.2d 222, 226, 585 N.Y.S.2d 248 (4th Dept. 1992). “[T]o the extent [that] the conditions described in the contract materialize, the contractor bears the risk, while the government assumes the risks for conditions [that] the contract documents fail to disclose.” Id. at 227.

2. Shifting the Risk to the Contractor by use of Disclaimer and Exculpatory Clauses

As a defense against differing site condition claims, Owner’s have successfully enforced disclaimer and exculpatory clauses in the bidding documents. Typically, a disclaimer or exculpatory clause states that the conditions depicted on the bidding documents are not to be treated as a representation of the actual conditions and the information is not to be substituted for the personal investigation to be performed by the contractor prior to bidding on the documents. A. S. Wilkstrom, Inc. v. State, 52 A.D.2d 658, 381 N.Y.S.2d 1010 (3d Dept. 1976).

Several types of Contract Clauses attempt to limit the Contractor’s right to make or prevent such claims. Disclaimer and exculpatory clauses are used by Owners to shift the risk for “differing site conditions:, “changed conditions” or “concealed or unknown conditions” to the Contractor.

Disclaimer clauses, for example, are used to avoid responsibility for incorrect or incomplete information which may be contained in the Contract Drawings and Specifications. Such clauses generally require the Contractor to investigate the site and determine the risks associated with the job, state that the Owner does not warrant the information it provides, and state that the information is provided for estimating purposes only. For example, the New York State Department of Transportation has previously used a clause which disclaims the accuracy of stated conditions and quantities. It reads as follows:

SPECIAL NOTE – Unclassified Excavation:
The excavation table appearing on this sheet was prepared by the State from the best information available. The Contractor’s attention is called to the fact that conditions and quantities, as shown on the table are estimated and not actual, and in any event they are not to be determined or considered by the Contractor as a warranty or a representation by the Superintendent of actual field conditions or quantities.

With respect to the State’s production of soil boring logs along with plans, specifications and other bid documents, which are used by a prospective Contractor in preparing its bid, the State has also used the following clause effectively:

This information is intended for State design purposes only, and is made available to bidders only that they may have access to identical subsurface information available to the State. It is presented in good faith, but is not intended as a substitute for the personal investigations, interpretations or judgments of the Contractor.

Another form of disclaimer requires the Contractor to investigate the site and to determine the risks associated with the job. In Article III of the State’s Standard form contract there is a requirement that the Contractor examine the Contract Documents and the site of the proposed Work which reads as follows:

ARTICLE 3. EXAMINATION OF DOCUMENTS AND SITE.
Contractor agrees that before making his proposal he carefully examined the Contract Documents, together with the site of the proposed Work, as well as its surrounding territory, it is fully informed regarding all of the conditions affecting the work to be done and labor and materials to be furnished for the completion of this contract, including the existence of poles, wires, pipes and other facilities and structures of municipal and other public service corporations on, over or under the site, and that this information was secured by personal investigation and research and not from the estimates or records of the department, and that he will make no claim against the State by reason of estimates, tests or representations of any officer or agent of the State.2

Despite a disclaimer clause, the State may still be liable “if said conditions are not as represented and (1) inspection would have been unavailing to reveal the incorrectness of the representations or (2) the representations were made in bad faith.” A. S. Wilkstrom, Inc., 52 A.D.2d 658, 381 N.Y.S.2d 1010 (3d Dept. 1976).

The State and for that matter any Owner should disclose all information it has regarding subsoil conditions from either tests it has performed or prior knowledge of the conditions, but if the disclosed information was the same as the undisclosed information and the bid would not have differed otherwise, the State or the Owner is not liable. Id. By signing an agreement which stated that the documents make no representation regarding existing sub-surface conditions, character and extent of the soil data or other subsurface conditions to be encountered during the work and no guarantee as to their accuracy, the contractor waived the right to hold the architect liable unless the architect withheld information which would have affected the amount of the bid. Wrecking Corp. of America v. Memorial Hospital for Cancer and Allied Diseases, 63 A.D.2d 615, 405 N.Y.S.2d 83 (1st Dept. 1978).

In Wrecking Corporation of America, the agreement between the parties clearly imposed upon the excavation subcontractor the responsibility and risk of subsurface conditions. One part of the Contract provided that “no representation is made by the General Contractor, Owner, Architect or Engineer in any Contract Document regarding the existing subsurface conditions”, and in another part of the contract it further provided that “the Owner, Architect and Consulting Engineers make no representations regarding the character and extent of the soil data or other subsurface conditions to be encountered during the Work and no guaranty as to their accuracy or interpretation is made or intended”. Based on these Contract provisions, the excavation subcontractor’s complaint that subsurface conditions encountered differed materially from those represented in the design drawings furnished by the Contractor and the Owner was dismissed. The Court found that plaintiff clearly assumed full and complete responsibility for all excavation and construction costs relating to the foundation, including total responsibility for subsurface conditions. Also with respect to the excavation subcontractor’s claim that the Owner withheld relevant information and failed to determine subsurface conditions in a reasonable manner it was found that there was no showing that the as-built drawings, which plaintiff claimed were not supplied to it at the time of bid, were actually in existence, let alone that they were in the Owner’s possession or control and were withheld by it. The usefulness of the as-built drawings was also seriously questioned in the depositions of the parties.

In Depot Const. Corp. v. State of New York, the State included a disclaimer in the bidding documents stating that the information provided was for “design purposes only” and was “not intended as a substitute for personal investigations, interpretations or judgment of the Contractor.” Depot Const. Corp. v. State of New York, 19 N.Y.2d 109, 114, 224 N.E.2d 866 (N.Y. 1967). The State was not liable for fraudulent misrepresentation when it provided to the contractor the boring data results, as well as any other information it had on the subsoil conditions. Id. “No reasonable bidder could have assigned to the borings a more significant role of specificity; or could have expected them to represent more than a small number of samplings over a large area.” Id. Therefore, the State, by providing all the information it had on underground conditions and using a disclaimer in the bidding documents, successfully transferred the risk of differing site conditions to the contractor.

On the other hand, the reasonableness of the contractor’s reliance on the bidding documents may depend on the timing requirements for the bid. For example, the State was liable for fraudulent misrepresentation when after ten years of investigation, the bidding documents indicated that the “boulders…were the least predominant” in the soil, when in reality, the contractor found “nested boulders” which were “so large and numerous and so close together as not to allow room for pile insertions.” Conduit and Foundation Corp. v. State of New York, 74 A.D.2d 684, 685, 425 N.Y.S.2d 874, 877 (3d Dept. 1980). The court found it was reasonable for the contractor to depend on the bidding documents as an accurate representation of the subsoil conditions since the State had investigated the area for over ten years, the contractor only had one month to prepare its bid, and did not have sufficient time to conduct its own subsoil inspections. Id.

Similarly, the State was liable for fraudulent misrepresentation despite a disclaimer clause in the bidding documents when the State knew exactly how much work would need to be performed to obtain acceptable subsoil conditions, but intentionally specified only half of such work in the bidding documents. County Asphalt, Inc. v. State of New York, 40 A.D.2d 26, 337 N.Y.S.2d 415 (3d Dept. 1972). The fact that the contractor’s bid would have been significantly higher if it had known of the actual amount of work to be performed and that the contractor only had three weeks to prepare its bid weighed against the State, because in such conditions, it was reasonable for the contractor to rely on the bidding documents as an accurate representation of the subsoil conditions. Id. The limited amount of time to prepare the bid also meant the contractor did not have sufficient time to perform an independent subsurface exploration to determine the actual conditions. Id.

3. Misrepresentation Theory

“To rely on fraudulent misrepresentation, claimant [has] to prove that the additional work performed resulted directly from the State’s [or Owner’s] concealment or nondisclosure of material facts either known to it or within its possession.” D. A. Elia Const. Corp., v. New York State Thruway Authority, 289 A.D.2d 665, 666, 734 N.Y.S.2d 295, 297 (3d Dept. 2001). A clause in the bid documents advising bidders to conduct their own field inspections can be relied on as a defense, as long as there is no evidence that sufficiently thorough inspection could not have been made before the contractor submitted its bid. Id. Since the contractor failed to perform its own inspection, the contractor “could not reasonably rely on the bid documents for anymore than an approximation of the repair areas.” Id.

Despite a disclaimer clause, the State may still be liable “if said conditions are not as represented and (1) inspection would have been unavailing to reveal the incorrectness of the representations or (2) the representations were made in bad faith.” A. S. Wilkstrom, Inc., 52 A.D.2d 658, 381 N.Y.S.2d 1010 (3d Dept. 1976).

While disclaimers can be effective to protect an Owner from a Contractor’s claim of changed conditions, such clauses will be strictly construed against Owners. For example, in Andrew Catapano Company v. The City of New York, 116 Misc.2d 163, 165, 455 N.Y.S.2d 144 (New York, 1980) the Court determined that even where a contract disclaimed responsibility for conditions “on, about or above the site,” the Owner had not disclaimed responsibility for subsurface conditions, because of the stated language and because the changed conditions clause in the Contract specifically provided for adjustments in the event of unanticipated subsurface conditions.

Such disclaimers will also be unavailing when conditions represented by the Owner are highly inaccurate. In Warren Bros. Company v. New York State Thruway Authority, 34 A.D.2d 97, 99, 309 N.Y.S.2d 450, 452 Aff’d. 34 N.Y.S.2d 770, 358 N.Y.S.2d 139, the court stated:

In a construction contract between the State and an individual, which contains representations as to existing conditions affecting work thereunder as well as an exculpatory clause relieving the State of liability and requiring personal inspection of the contract site, liability, nevertheless, may attach to the State if said conditions are not as represented and (1) inspection would have been unavailing to reveal the incorrectness of the representations or (2) the representations were made in bad faith.

Exculpatory clauses meant to relieve an Owner of liability for the information that it provides and for damages incurred due to changed conditions, are generally valid and enforceable, even when they are intended to relieve the Owner of responsibility for its own negligence. Such Exculpatory clauses will, however, not insulate an Owner from liability where the conditions are not as represented in the Contract and inspection by the Contractor would not reveal the representations to be false Rusciano Construction Corp. v. The State of New York, 37 A.D.2d 745, 746, 232 N.Y.S.2d 21, 24 (3rd Dept., 1971). Furthermore, a Contractor is not to be foreclosed by standard exculpatory clauses which place the burden to investigate the site and discover potential problems wholly upon it, when the State or municipality is chargeable with knowledge of their existence and location (see Laura Roofing & Renovation Co., Inc., v. The Board of Education of the City of New York, 57 A.D.2d 586, 393 N.Y.S.2d 593 (2nd Dept., 1977)). Without exception, an exculpatory clause will not insulate an Owner from liability when the Owner intentionally misrepresents the conditions. Rusciano Construction Corp. v. State of New York, 37 A.D.2d 745, 323 N.Y.S.2d 21 (3rd Dept., 1971). The bottom line is that even when such disclaimer and exculpatory clauses are included in a contract, an Owner may be liable for both innocent and intentional misrepresentations. Under either theory, however, the misrepresentation must be material in order for a Contractor to recover damages. See A.S. Wilkstrom, Inc. v. State of New York, 52 A.D.2d 658, 381 N.Y.S.2d 1010 (3rd Dept., 1976).

4. Owner’s Acceptance of the Risk for Changed Conditions

If the Owner decides to accept the risk for unforeseen subsurface conditions, there are many ways to address this in the construction contract. For example, AIA Document A201 – 1997 provides the following clause covering changed conditions but does not limit the location of the condition:

4.3.4 Claims for Concealed or Unknown Conditions. If conditions are encountered at the site which are (1) subsurface or otherwise concealed physical conditions which differ materially from those indicated in the Contract Documents or (2) unknown physical conditions of an unusual nature, which differ materially from those ordinarily found to exist and generally recognized as inherent in construction activities of the character provided for in the Contract Documents, then notice by the observing party shall be given to the other party promptly before conditions are disturbed and in no event later than 21 days after first observance of the conditions. The Architect will promptly investigate such conditions and, if they differ materially and cause an increase or decrease in the Contractor’s cost of, or time required for, performance of any part of the Work, will recommend an equitable adjustment in the Contract Sum or Contract Time, or both. If the Architect determines that the conditions at the site are not materially different from those indicated in the Contract Documents and that no change in the terms of the contract is justified, the Architect shall so notify the Owner and Contractor in writing, stating the reasons. Claims by either party in opposition to such determination must be made within 21 days after the Architect has given notice of the decision. If the conditions encountered are materially different, the Contract Sum and Contract Time shall be equitably adjusted, but if the Owner and Contractor cannot agree on an adjustment in the Contract Sum or Contract Time, the adjustment shall be referred to the Architect for initial determination, subject to further proceedings pursuant to Paragraph 4.4. (underlining added for emphasis)

Unless otherwise addressed in the Contract Specifications, the above Changed Conditions clause would permit the Contractor to recover additional costs associated with a subsurface condition, such as rock, which differs materially from what was indicated in the Contract Documents (e.g. soil borings, geotechnical engineering reports, or geological profiles). If the Contractor has no control over the extent of soil borings (e.g. quantity, quality and depth) taken by the Owner or other geotechnical studies performed on behalf of the Owner, it would seem fair that the risk of such changes in subsurface conditions should be carried by the Owner. The Owner, however, should be cautious in how the fair and reasonable value of the necessary extra work is determined. For example, having the Contractor insert a unit price for the removal and disposal of increased quantities of rock in its bid proposal up front may not always work in favor of the Owner as the real cost will depend on the actual quantity and character of the rock to be removed. Negotiating a fair and reasonable price for such work may be the best alternative depending on the size of the Project and the parties involved.

5. Conclusion

The geotechnical engineer and/or design consultant needs to gather all available subsurface information at the planning stage of the project and to determine with the Owner and other design consultants the scope of the preliminary geotechnical investigation. Depending on a number of factors including the size of the project, the parties must then decide how to allocate risk with respect to unforeseen conditions, etc. and to draft the appropriate provisions in the construction contract to meet their objectives.

1. A.S. Wilkstrom, Inc. v. State of New York, 52 A.D.2d 658, 381 N.Y.S.2d 1010 (3rd Dept., 1976).
2. Id.

If you would like more information regarding this topic please contact Gerard P. Brady at gbrady@wbgllp.com or call (914) 607-6410