Latent Conditions & duty of care

Project disputes concerning Site Conditions or Latent Conditions (internationally referred to as unforeseeable physical conditions) are recognised as one of the top five leading causes of disputes on construction projects both worldwide and within Australia (CRUX, 2020).

Presently the contaminated soil claim of the West Gate Tunnel in Victoria (soil contaminated with PFAS chemicals) is mooted at approximately $1 billion (SMH, June 2021), and if substantiated represents the largest latent conditions claim in Australian history. It is set to be resolved by arbitration. The Snowy Hydro project has also been beset with ground conditions issues but it is unclear at this stage (2023) just how that will play out.

Besides these high profile projects the general extent of latent condition claims within the construction industry is difficult to quantify as only a very few proceed to litigation in the public domain however there is enough practitioner evidence within the broader construction industry both within Australia and globally to show that such claims are rife within all construction sectors.

A.???????? Typical risk allocation

The typical risk allocation in standard industry contracts generally provide for a latent conditions clause along similar lines where the Principal bears the risk of the contractor encountering a 'material difference' in the ground conditions encountered. The rationale for this approach is that the Principal only pays for those conditions actually encountered, and does not have to pay any contractor's price contingency for conditions which may not be encountered. Why pay for the price of excavating rock when the contractor only encounters sand?

The assessment of payment only for actual conditions is tempered by the requirement that the Contractor is deemed to have inspected and examined the Site, its surroundings, all written information made available by or on behalf of the Principal and other available information reasonably obtainable by the making of reasonable enquiries, and to have been satisfied before submitting the Tender as to all matters relevant to the execution of the Works.

Some of the latent conditions which could be encountered in marine projects and that I have personally worked on are shown below :

The Australian Standard and GC 21 Contracts include one of the most common used and most amended latent condition clauses as provides that latent conditions are physical conditions on the site and its near surrounds, (including artificial things but excluding weather conditions) and which differ materially and substantially from the site conditions which could have been ascertained or anticipated by a competent contractor as at the date of contract. The Contractor, upon becoming aware of a latent condition and where possible before the latent condition is disturbed, give the Superintendent written notice of the general nature thereof.

This structure and the notion of a competent or experienced contractor is also seen in the FIDIC Suite of Contracts, the FIDIC 2017 Red Book provides that the Contractor must give the Engineer opportunity to inspect and investigate the physical conditions promptly and before they are disturbed and set out the reasons why the experienced Contractor considers the physical conditions to be unforeseeable.

In the NEC4 ECC contract, the compensation provisions allow for time and price adjustment if the Contractor encounters physical conditions (not weather conditions) that an experienced contractor would have judged to have a such a small chance of occurring that it would be unreasonable to have allowed for them.

In the various delivery models identified above there are a number of key aspects where claims arise these being the status and quality of the Site data information made available by or on behalf of the Principal and other available information which the Contractor should be required to obtain. The NEC4 ECC is the only industry standard contract which includes the Site Data as an integral part of the Contract documents. The Site information for the other industry contracts remains outside the bounds of the contract even though it is being relied on by the Contractor in formulating his execution method and deriving the Contract Price.

B.???????? Outcome of typical risk allocation – time, cost and quality

When Principals are faced with the choice between an industry standard or bespoke contract one of the most often requests to the legal team is to ‘de-risk’ the contract for the Principal as much as possible. The Site Data & latent condition clause often is looked at by project financers as one of the key ‘open-ended’ project risks and the legal team will then set about the task of making substantial amendments and passing latent conditions risk to the Contractor.

Typical actions include drafting of waiver of liability clauses and no-reliance on the accuracy or completeness of factual site investigation information, requiring the Contractor to “verify” or “endorse” the site investigation information prepared on behalf of the Principal or raising impractical time bars to substantiate a latent conditions claim. This form of risk transfer depends heavily on the construction markets appetite for accepting latent conditions risk.

Bespoke or heavily amended Latent Conditions clauses offer a false form of assurance as bespoke provisions are not proof tested by the courts and are drafted by lawyers not engineers when the former have no in-depth knowledge or experience of the project latent condition issues and the potential issues which need to be addressed. These deviations from the industry standard latent condition provisions are then put to the test in the dispute resolution process of adjudication or litigation with a high rate of incidence as the CRUX 2020 Report shows.

C.???????? Recommendation for balanced risk allocation

Lawyers owe a duty to whoever they are advising to be up front with the consequences of poor, unbalanced & improper risk allocation when dealing with Site Data / Latent Conditions. The ‘de-risking’ should not solely be in the form of drafting draconian latent condition clauses shifting commercial liability rather the project’s latent condition risk should be look as a whole and the latent condition clause reflect the true nature of the latent condition risk.

My suggestions for a balanced form of de-risking latent conditions include :

• Promoting the early interaction between Principals and Contractors with market feedback and early contractor involvement in determining the extent, type and amount of site investigation which is needed to realistically determine the Contract Price;
• Consider the use of an early works contract with one of the shortlisted tendering parties to carry out a comprehensive site investigation which meets the Contractors requirements. This means the Contractor buys into the scope of the minimum amount of site investigation is needed to determine the Contract Price and avoids later disputes as to the extent of investigation which should have been done;
• Avoid using ‘non-reliance’ clauses disclaiming all liability for factual site investigation information provided by the Principal to tenderers. Existing case law that shows this is a false sense of security especially where the only site investigation information available is that provided by the Principal;
• Avoid waiver of liability clauses for accuracy of factual site investigation information provided by the Principal to tenderers. The provisions of the Australian Consumer Law and misleading and deceptive conduct cannot be contracted out of;
• Avoid any stated requirement for tendering parties to “verify” or “endorse” the site investigation information prepared on behalf of the Principal. This is impossible / impractical / cost prohibitive for all tenderers.
• Reiterating that the burden of proof of differing soil than expected lies with the contractor but that the Principal is obliged to witness reported conditions. Only if there is a ‘material’ difference in soil characteristics that directly causes an increase in duration will the contractor be entitled to reimbursement and extension of time. When considering how a material difference defined, look to describe this in the contract specifications.
• Require the inclusion of site investigation information as a Contract document as provided in the NEC4 ECC Contract (this then clearly identifies what baseline information has been used);
• In the case of a construction project which involves significant sub-surface works, it is recommended to consider the use of Geotechnical Baseline Reports (GBR) to form the basis of a balanced risk allocation for all tendering parties. GBR’s are widely used in the tunneling industry and create a common playing field by defining the criteria that only certain pre-determined conditions are classed as latent conditions. Use the guidelines published by CIRIA in the UK to develop your GBR.

Reason for recommendation

There is an often quoted saying in the site investigation industry.

?The investment of money in soil investigation is similar to that of a policy of insurance, it is only a fraction of a project cost but reaps its benefits in terms of time, cost and quality.

The extent of latent conditions and the resultant capital cost increases are commonly linked to an under investment in ground investigation. International research shows a strong correlation exists between low spend on ground investigation and high capital cost over-runs (Figure 1)

The last word is...

Proper de-risking of latent conditions needs a new approach to the traditional model of passing risk using the contract alone. With the change in market conditions contractors are being more selective as to the projects that they take on and are looking to move away from high risk contracts where ground condition risk is passed to the contractor.

The new regime is a more collaborative approach to dealing with project risk. It is a keystone of a collaborative contracting undertaking to properly deal with ground conditions risk from the outset. The recommendations above will hopefully give industry practitioners insight into realistically resetting the allocation of risk of latent conditions.