The basic purpose of the contracting process is to allocate risks among the various parties.
Many risks are easy to identify and evaluate. For example, a contractor can evaluate the risk of labor cost changes or material prices. Similarly, the owner can evaluate and cover the risk of a contractor’s default by requiring a payment and performance bond.
In contrast to quantifiable risks, the risks presented by unknown conditions (such as subsurface conditions) are difficult to identify and evaluate. Also, the costs to address unknown or unexpected conditions (differing site conditions or DSC) can be very substantial.
When Contracts Don’t Have a DSC Clause
Unless a specific exception applies, the contractor generally bears the risk of unforeseen subsurface conditions.
There may be exceptions to this general rule. For example, a contractor may be able to establish that it justifiably relied on information supplied by the owner. The owner may have failed to disclose information it had a duty to disclose. Or, there may be an argument that the DSC requires work outside the contractor’s scope that is not the responsibility of the contractor, even in the absence of a DSC clause.
However, a contractor should never enter into a construction contract without a DSC clause,1 because relying on an exception generally means arbitration or litigation on an issue that should have been addressed up front in the contracting process.
DSC Provisions in Standard Form Construction Contracts
The three most common standard privately produced construction contracts – AIA, EJCDC, and ConsensusDocs – contain default DSC provisions. They all have similar but not identical language. All require either Type I or Type II:
For Type I, subsurface or otherwise concealed physical conditions which differ materially from those indicated in the contract documents.
For Type II, unknown physical conditions of an unusual nature, which differ materially from those ordinarily found.2
All three contain tight requirements that require contractors to put the owner on notice of the potential DSC before any work is done related to the DSC. The owner (or architect) then must properly investigate whether there is in fact a DSC and renders a decision.
The contractor is either directed to do change order work associated with the DSC, or the DSC claim is denied. If the DSC is denied, the contractor must follow the procedural requirements of the contract to reserve its rights for additional compensation for the purported DSC. Most standard specifications adopted by governmental authorities also contain some version of a DSC clause.
Type I DSCs generally occur with underground conditions, when actual conditions encountered differed materially from those indicated in the contract documents. Examples of underground conditions include water, boulders, and rock ledges.
Standard contracts generally require that the conditions could not have been reasonably anticipated from examination of the site and a review of the contract documents, and that the contractor relied on the information in the contract documents.
The contract documents are key – so the contract documents must include the data that the contractor is relying on prove a DSC. Generally, while soil borings are included as part of contract documents, soils reports are generally excluded, and the opinions in the reports then are not generally a basis to support a DSC.
Type II DSCs are unknown or unusual condition 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. The contractor needs to prove:
it did not know about the physical condition;
it could not have anticipated the condition from a reasonable site inspection or general experience; and
that the condition varied from the norm in similar contracting work.
A Type II differing site condition is usually more difficult to demonstrate, because the contractor has to identify the assumptions it made regarding the subsurface conditions it anticipated to encounter, and then show that the conditions differed materially from those that the contractor should have encountered or expected at the project’s location. An example of a Type II condition is encountering a subsurface structure (like buried abandoned construction materials) in an area which appeared only to contain soil.
Remodel projects can be ripe with unknown conditions. Many times as-built drawings, even if available, don’t accurately show what is behind surfaces that cannot be readily observed. A contractor should make reasonable efforts to make a “sight” visit of the proposed site or structure prior to entering into a construction contract. The depth of the pre-contract investigation may be depend on the language in the construction contract.
A contractor should also take steps to secure readily available information, such as local geological surveys, or soils borings from a previous but adjacent project if the project involved the same owner.
Owner Liability in Absence of DSC Clause
If you find yourself representing a contractor who signed a contract with no DSC clause, there may be some sliver of hope. It’s possible you may be able to prevail on a variety of legal doctrines:
breach of implied warranty/defective specification (Spearin Doctrine3);
equitable reliance; or
breach of implied duty of good faith and fair dealing.
Again, the best practice is to include a DSC clause up front when representing a contractor.
Wisconsin Case Law on DSCs
The leading case in Wisconsin on DSC is Metropolitan Sewerage Commission of the County of Milwaukee v. R.W. Construction, Inc.4
This was a case that arose out the deep underground sewer constructed in Milwaukee in the 1970s. The contractor encountered artesian water under hydrostatic pressure which required extensive and difficult dewatering. The owner refused to grant the DSC, and the contractor refused to complete the work, and ultimately prevailed before the Wisconsin Supreme Court. The Court made some key points:
The applicability of the DSC clause depends only upon a comparison of the actual conditions with the indicated conditions.
Indicated conditions need not be explicit or specific, only enough to lull a reasonable bidder not to expect the adverse conditions actually encountered.
If the condition was not known to the owner, then bidders could not be expected to learn what the owner itself did not know.
Contractors are entitled to rely upon borings since borings are the most specific and usually the most reliable indicators of subsurface conditions.
Contractors are held to the standard of what a reasonable contractor should have anticipated on the project.
Contractors are not bound to make a scientifically educated and skeptical analysis of the contract documents and the general situation.
The Court concluded by stating:
The changed-conditions clause is a contractual innovation designed for the mutual benefit of both the government and the contractor. The government benefits by the use of such a clause because the contractor no longer needs to add large contingency sums to his bid in order to cover the risk of encountering adverse subsurface conditions. The contractor benefits because he is awarded extra compensation if adverse subsurface conditions are encountered which materially differ from those indicated in the contract.5
Conclusion: Take Reasonable Steps First
DSCs can be an expensive problem for owners, contractors, or both. It is imperative to take reasonable steps to address the allocation of risk of DSCs up front, and for the owner and contractor to take reasonable steps to learn about as many unknowns about a proposed project before a contract is signed and the work begins.
This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section webpages to learn more about the benefits of section membership.
1 Depending on the circumstances, a time and materials contract with no guaranteed maximum price may not require a DSC clause for a contractor receive compensation, because the contractor is being paid by the hour and for materials. However, it is still best practice to include such a clause in a time and materials contract, when representing a contractor.
2 Some standard forms also contain a Type III DSC clause to address hazardous waste, putting the responsibility of unanticipated hazardous waste on the owner.
3 The Spearin Doctrine is a legal principle that holds that when a contractor follows the plans and specifications furnished by the owner, and those plans and specifications turn out to be defective or insufficient, the contractor is not liable to the owner for any loss or damage resulting from the defective plans and specifications. United States v. Spearin, 248 U.S. 132 (1918).
4 Metropolitan Sewerage Commission of the County of Milwaukee v. R.W. Construction, Inc., 72 Wis. 2d 365, 241 N.W.2d 371 (1976).