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Three Contract Options for Differing Site Conditions

The poster child for construction risk is a differing site conditions clause. Construction contract definitions vary, but generally a differing site condition occurs when, unbeknownst to the owner and contractor at the time of the contract signing, the subsurface of a construction site contains a physical object or lacks a physical property assumed to be present.

For example, a physical object could be an old chemical storage tank underground, and an absent physical property could be soil that has the required load-bearing capacity. Regardless of the type of project, subsurface condition clauses consistently top the list of the most important contract provisions and the most common causes of construction disputes. The contract options to allocate the risk are finite because there are only three scenarios available to the parties: the owner bears all subsurface condition risks, the contractor bears all the risks, or the owner and contractor share the risks.

The Owner Bears All the Risk 

Although the owner is typically reluctant to bear all site risks, it does occur under certain circumstances. Examples include a construction manager project delivery method, a cost plus pricing arrangement, a very short construction schedule or a conscious decision that the owner makes to retain all subsurface condition risks in order to lower the contract price.

When the owner bears all the risk for site conditions, the construction contract should clarify this with assumptions, inclusions and exclusions. The contractor’s excluding site investigations and responsibility for any and all subsurface conditions that are known, unknown, visible, not visible, foreseeable or unforeseeable are examples of exclusions in the contract. The change-in-work section of the contract should reflect the site conditions risk allocation, entitling the contractor to a cost and schedule change order for remedying such conditions.

The Contractor Bears All the Risk 

Design-build, EPC, construction manager at risk and, in rare cases design-bid-build, are project delivery methods where the contractor is likely to bear all site condition risks. The common denominators are a fixed price and, at least with design-build and EPC, a turnkey project. Here, the owner wants to pay a fixed or limited sum of money for the contractor to bear all site condition risks. For a design-bid-build delivery, the absence of a site condition provision could effectively shift all risks to the contractor for site conditions without the contractor intending to bear those risks.

The construction contract should reflect this risk allocation with an exclusion that the owner bears no risks or costs associated with an unforeseen or unknown site condition, absent misrepresentation, and the contractor bears all site condition risks—known, unknown, visible, not visible, foreseeable or unforeseeable. Besides providing that the contractor is not entitled to any change orders related to subsurface site conditions, the contract should include language to the effect that the contractor has thoroughly investigated the site. If, as is so often the case, the contractor cannot perform a thorough investigation because of time, cost or site location prior to signing the construction contract or submitting a binding bid, contingency money or an allowance in the contract price for the site risk is the norm.

The Owner and Contractor Share the Risk 

The more common scenario is for the owner and contractor to share the subsurface condition risks; however, the parties may not consider multiple options in the business deal and contract negotiation. Increasingly, custom contracts and standard form contracts contain a variety of site risk-sharing provisions. In fact, the phrase “differing site condition” in the contract makes the most sense when the parties are sharing the site risk because if only one party bears all the risk, then actual site condition differences compared to assumed site conditions are irrelevant.

The good news is that shared risk allocation for subsurface conditions is compatible with all project delivery methods and contract pricing types. When the parties share the site risks, they can shift a specific risk to the party best able to manage it. For example, the owner may have better knowledge about a site it purchased and cleared, or the contractor may better understand the poor soil conditions in a particular region where it has constructed numerous projects.

The first contract option for sharing risk is pure cost sharing. The parties split the costs based on a percentage (e.g., 60/40), a tiered model (e.g., the contractor bears the cost up to $20,000 and then the owner bears any additional costs), or a GMP contract price allowance with the unused balance refunded to the owner at the end of the project.

The second risk-sharing contract option involves the parties’ determination of which party is responsible for a specific subsurface risk. For example, the contractor bears the risk for a subsurface condition that is materially different from what is typically found in the geographical area or from what the owner’s geotechnical report identifies. There are two approaches here depending on the project delivery method.

For design-bid-build and construction manager at risk project delivery methods, the standard form contracts use a Type I and Type II classification for differing site conditions. For a Type I, the contractor is typically entitled to a change order if the subsurface condition is materially different from what the parties agreed to in the contract (e.g., in the site conditions section or an exhibit) or materially different from what the owner represented to the contractor (e.g., in a geotechnical report given to the contractor). In a Type II differing site condition, the contractor is normally entitled to a change order if the subsurface condition was unusual for the area or project type and could not be reasonably anticipated by a prudent contractor.

For design-build and EPC project delivery methods—when the owner needs a turnkey project—the contractor can proceed and sign the construction contract without site risk contingency money and based on a reasonable assumption that there are no adverse site conditions. However, the contractor typically has a period of time, such as 45 days from notice to proceed, to conduct a thorough site investigation and to report to the owner any subsurface conditions materially different from the assumed conditions. If the report yields adverse site conditions, then parties will adjust the contract price with an amendment, change order or other agreement.

In conclusion, the only limit the parties have in drafting a site conditions provision contract is their own creativity in crafting a site conditions business deal.

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