Compensation events for ‘physical conditions’

Compensation events  for ‘physical conditions’

The common-law position, in the absence of express contract provisions, is that risks for ‘physical conditions’ principally lie with the contractor. Many standard forms of contract, including NEC, are founded on an equitable risk-sharing principle. This includes the ‘physical conditions’ clauses, whereby a contractor is not obliged to include potentially significant allowances within its tender and the client pays for what actually occurs.

But the theory does not always work in practice. Let us a look at a typical example: while excavating on site, an NEC contractor unexpectedly encounters a brick structure that requires the use of specific equipment to break out. This takes additional time to that shown on the accepted programme. The contractor notifies a compensation event under NEC4 Engineering and Construction Contract (ECC) clause 60.1(12) (NEC3 ECC is similar) stating, ‘the site information does not refer to this structure, so it is a compensation event.’

After reading through the notification and corresponding clauses – namely 60.1(12), 60.2 and 60.3 – the project manager could be justified in thinking that the matter is not perhaps so ‘cut and dried’ as the contractor’s notification suggests. From my experience this is a common situation and one that is not easily resolved. This is partly due to an element of subjectivity with some of the important terms within the clauses, as considered in more detail below.

Physical conditions


Clause 60.1(12) says a compensation event occurs when the contractor ‘encounters physical conditions’ which are ‘within the Site’ and ‘are not weather conditions’. 

The term ‘physical conditions’ is not defined in NEC contracts and is often associated with ground conditions. It is commonly linked with related familiar terms including ‘physical obstructions’, ‘artificial obstructions’, ‘ground conditions’, ‘pollutants’ and ‘contaminants’. These all point to something more specific whereas the NEC term embraces a broader spectrum, applying both above and below ground.

Physical conditions must also actually be encountered, which implies a direct encounter as an indirect encounter would likely invoke another compensation event. Physical conditions are stated not to be weather conditions, although it is unclear whether certain effects of weather conditions may constitute physical conditions.

An experienced contractor


Clause 60.1(12) goes on to say the physical conditions are those which, ‘an experienced contractor would have judged at the Contract Date to have such a small chance of occurring that it would have been unreasonable to have allowed for them’.

The term ‘experienced contractor’ has been used in construction contracts for many decades, with various attempts made to define it. The context here is of a contractor making a judgement with regard to the likely occurrence of certain physical conditions, so it follows that the experience relates to having previously constructed and delivered works of a similar nature. Whether the actual contractor in question resembles this description is immaterial to the assessment of a physical conditions compensation event.

The meaning of ‘small chance occurring’ is not defined although it includes a test of reasonableness, further factoring in chance and probability as a considered-opinion-based prediction. It would seem reasonable, therefore, to include an allowance if a matter is more likely than not to occur, as determined by an experienced contractor, possibly on a sliding scale rather than an all-or-nothing approach.

Difference assessment


The last paragraph of clause 60.1(12) states, ‘Only the difference between the physical conditions encountered and those for which it would have reasonable to have allowed is taken into account in assessing a compensation event.’ The ‘difference’ is therefore relative to the quantum of the physical condition as opposed to any commercial consideration. 

In demonstrating the occurrence of a compensation event, a contractor’s tender allowance would be a good starting point, especially as that complies with the test of being, ‘judged at the Contract Date’. If detailed records of the allowances for physical conditions are maintained, then the action effectively passes to the project manager in determining whether the allowances comply with the starting point of a ‘difference’ assessment.

Other information

Clause 60.2 says that, ‘In judging the physical conditions for the purpose of assessing a compensation event, the Contractor is assumed to have taken into account: the Site Information, publicly available information referred to in the Site Information, information obtainable from a visual inspection of the Site, and other information which an experienced contractor could reasonably be expected to have or to obtain’ (bullets omitted for clarity).

The term ‘other information’ could mean publicly available information not referred to in the site information, but it must encompass the experienced-contractor test, which points towards the knowledge and understanding gained through experience.

Site information


Clause 60.3 says, ‘If there is an ambiguity or inconsistency with the Site Information (including the information referred to in it), the Contractor is assumed to have taken into account the physical conditions more favourable to doing the work.’
Notwithstanding obligations under the CDM Regulations, the client has no particular responsibility to provide site information. Furthermore, there is no warranty regarding the accuracy or completeness of any such provided information. 

Although clause 60.3 states how an ambiguity or inconsistency is to be resolved, this does not determine a misrepresentation issue, which is addressed by statute. Some users also add Z clauses to limit their liability, either partially or fully, including using a ‘no reliance’ clause.

Issues to consider


As the risk of physical conditions varies from one project to another, it may be appropriate to incorporate specific provisions within NEC contract documentation, including the scope, to address the particular requirements of a project.

However, some users – even respected public sector clients and contractors – appear to exploit the NEC’s equitable risk allocation by inserting additional clauses to limit their liability or excluding the physical conditions clauses in their entirety. As courts are reluctant to interfere with the allocation of risks under a negotiated contract, this creates a significant issue to consider for tendering parties. 

Further, a tender period may be very short, and a contractor may not have been given an opportunity to inspect the site, although an assessment assumes this has actually occurred.

Recommendations


Contractors should take the site information, in conjunction with other experienced-contractor information, and form a considered opinion on what physical conditions are likely to be encountered. They should then include appropriate tender allowances and maintain detailed records of these.

Clients should undertake detailed site investigation works, where time and budget allow, presenting clear, accurate and relevant information to prospective tenderers. Where significant groundworks are anticipated, they should consider setting baseline reference conditions that practically and precisely set out the parties’ risk allocation. 
 
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