Contractual Considerations

A project owner wants (i) price certainty and (ii) to eliminate contractor claims for cost and schedule relief for circumstances the contractor should have accounted for in its contract price and project schedule. On the other hand, a contractor wants to account for the specific known risks in its contract price and project schedule (which lets it establish a clear baseline of risk allocation and change order relief). But because the parties cannot see risks beneath the earth’s surface, drafting contract language to allocate that risk is challenging.

Most often, the parties tie the risk to the knowledge of subsurface conditions the parties have at the time of contract execution. For example, a contractor may have a right to a change order for “Unknown Subsurface Conditions” (often defined as (i) subsurface or latent physical conditions at the project site that differ materially from those indicated in the geotechnical report (or any other owner-provided information), or (ii) previously unknown subsurface physical conditions at the project site of an unusual nature or conditions that differ materially from those ordinarily encountered and generally recognized as inherent in work). Here, relief for the contractor could include change orders for any subsurface condition not identified in the geotechnical report or any other owner-provided information.

An owner may agree to the above change order right and defined term, but it will also push to broaden the contractor’s responsibility and shift some risk back to the contractor. For example, the owner may add a “reasonably inferable” standard to the definition of Unknown Subsurface Conditions to push additional responsibility to the contractor to investigate any potential concern, or even push the contractor to assume all risk associated with certain subsurface conditions (like variations in the soils). Each added element or qualifying language creates a new possibility to disqualify the contractor from change order relief. The following example illustrates how this defined term may appear (certain elements underlined for emphasis):

“Unknown Subsurface Conditions” means Site Conditions meeting the following requirements: (a) the existence of the Site Condition is subsurface and was not identified in this Agreement, including any Owner Provided Information; (b) it is either manmade or a materially disruptive condition (such as voids, fissures, underground rivers, or caverns, but excluding Local Soils Conditions) , and including Pre-Existing Hazardous Materials; and (c) the Site Condition did not arise out of a breach of, or any other failure or performance under, this Agreement by the EPC Contractor. This shall exclude in all cases subsurface conditions that should have been reasonably inferable by EPC Contractor pursuant to its review of the Owner Provided Information.

A contractor, on the other hand, may seek to exclude certain types of subsurface work from its scope and refuse to accept responsibility and liability for such work in the event it results from the discovery of a specified subsurface condition. The contractor may try to carve out this responsibility within the example definition, or, alternatively, ensure the responsibility is clearly set forth within the body of the agreement itself, e.g.:

Contractor shall not be liable for the costs and any schedule delays resulting from subsurface or latent physical conditions at the Site (i) differing materially from those indicated in the Geotechnical Report, (ii) constituting previously unknown physical conditions at the Site of an unusual nature (including unknown and unexpected archaeological or religious sites, places, monuments or areas) or conditions that differ materially from those encountered and recognized by a reasonably experienced contractor as inherent in work similar to the Work or which should have been specifically known by Contractor based upon the information in the Geotechnical Report, or (iii) that requires, or is, work expressly excluded from the Contractor’s scope of Work, as such exclusions are specified in Section 2.3.9 of Exhibit A (Scope of Work).

In this situation, owners should review any exclusions in the contractor’s scope of work to avoid bearing that financial risk in the event contractor encounters a subsurface condition within the excluded scope. Both parties should be vigilant about contractual language, like the above examples; a few words can greatly shift the allocation of risk.

Practical Considerations and Creative Approaches

Sometimes, both parties want more than the standard clauses and seek unique language to account for extremely specific subsurface issues. For example, solar projects use piles as a part of the foundation to ultimately hold up the modules. When the piles are driven into earth, they may be driven to refusal (i.e., they stop moving before they reach the required depth). An owner might be wary of that potential on a greenfield site due to unknown or uncertain soil conditions and the additional cost of the associated change orders. Both contractor and owner can review the information and determine the level of risk each is willing to take based on the quality of information known at the time of contract execution. An owner may agree to pay the contractor a fixed amount of money per pile refusal encountered (often, up to a specific overall cap). In this situation, both parties have already agreed upon the risk allocation for this potential issue and can factor it into their respective financial model and contingencies.

The parties should also consider the timing of the performance of subsurface exploration compared to the execution of the contract. For example, the contractor may be performing additional due diligence based on owner-provided geotechnical reports only to discover karst conditions throughout the project site (which are an issue because, when water soluble rock types like limestone interact with water, they can form cracks, fracture, and holes in the subsurface and create an unstable foundation for any vertical construction). For the contractor, these karst conditions now become a known risk at the project site that would eliminate change order relief, yet the contractor has not factored the cost of these conditions into its contract price.

If the parties need to quickly execute the contract for whatever reason, they can agree upon an allowance where the contractor adds a certain number into the contract price but to the extent it incurs costs that extend above and beyond that number, it is entitled to those additional costs. The owner, on the other hand, should try to establish reasonable parameters and caps on those numbers based on the contractor’s reasonable estimates of costs it may incur. The owner will also want the benefit of any cost savings to the extent the costs incurred are less than the original agreed upon allowance price.

Conclusion

Early due diligence and a healthy level of communication can go a long way in alleviating many concerns. Nonetheless, when the time comes to resolve any issues, it is essential to have appropriate contract language within EPC contracts to address the subsurface risk that the parties will inevitably face. Be aware of the information provided on the subsurface reports in addition to the timing of contract execution. Awareness can help in crafting the appropriate legal and commercial solution. And, typically, the only limitation the parties have in preparing such a solution is their own imagination. Legal assistance helps contracts truly capture commercial intent and offers the benefit of experience and knowledge of market approaches to risk shifting.

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