Allocating the risk of physical conditions in NEC4

Normally, these risks are borne entirely by the contractor, except in the cases of severe events. NEC4, a suite of contracts built for environment procurement of construction projects, divides the risk by allowing some unforeseen conditions to be compensated for giving contractors entitlement to time and money if certain criteria are met.

To be considered a compensation event, the physical conditions encountered by the contractor have to be within the site, not caused by weather conditions; and an experienced contractor would have to judge at the tender closing date that the event would have such a small chance of occurring that it would have been unreasonable to plan for it to occur.

Importantly, only the difference between the physical conditions encountered and those for which it would have been reasonable to have allowed for is considered in assessing a compensation event.

Physical Condition

The term “physical condition” is not defined in NEC4 contracts, but authorities suggest that a wide interpretation should be given to the term and can include underground or above ground, natural or man-made, such as pollution.

For instance, the International Federation of Consulting Engineers (FIDIC) offers a wide definition of physical condition, including “natural physical conditions and physical obstructions (natural or man-made) and pollutants”.

Physical conditions can come in many forms, for example the presence of unsuitable infill material within an on-site pit area. In another case it was held that soil which behaved in an unforeseeable manner when put under ordinary stress was also a physical condition.

Within the Site

A physical condition must occur within the site, and how the term “site” is defined in the contract is crucial to contract interpretation. If the physical condition is triggered by an external cause, for example the bursting of a pipe or other works at a nearby piece of land, as long as the external event causes a change in physical condition within the site, it can be argued that the change in the physical condition has occurred.

Not Weather Conditions

Weather-related disruptions are not considered physical conditions, however, it is unclear whether the effects of weather conditions, such as landslides that occurred after heavy rain, can constitute physical conditions. In contrast, the physical condition clause in FIDIC clarifies that physical condition excludes “climatic conditions at the site and the effects of those climatic conditions”.

Objective probability criteria

The objective probability criteria referred to in NEC4 states that only physical conditions that an experienced contractor would have considered to have a “small chance of occurring” at the tender closing date will be compensated. Although the physical condition encountered isn’t required to be unforeseeable, the probability of it occurring has to be so small that it is reasonable for the contractor not to have made an allowance for it.

The probability-based test adopted in NEC4 can be contrasted with the physical condition clause in FIDIC Yellow/Red Books, where a test of foreseeability is used.

The NEC test appears to be more favourable to experienced contractors, whose experience would allow it to disregard conditions that have a small chance of occurring are reasonable to disregard then in a tender.

Clauses 60.2 and 60.3 are also relevant in considering whether it is reasonable for a contractor not to have made allowances for the physical conditions.

Clause 60.2 in particular states 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 under the contract, 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.

The line between matters that the Contractor is assumed to have taken into account and matters which an experienced contractor should have “allowed for” is unclear.

From the project employer’s perspective, they may want to ensure that any event or risks to which the contractor is contractually obliged to “take into account” under clause 60.2 are deemed to have been allowed for and thus cannot be considered a compensation event under clause 60.1.

If the site information is unclear or inconsistent, then clause 60.3 further provides that the contractor is assumed to have considered physical conditions that are more favourable to completing the work.

Although this may allow a contractor to increase its recovery for physical conditions encountered as a compensation event, the potential conflicts between what should have been taken into account and what is reasonably allowed for under Clauses 60.1 and 60.2 is still present.

Conclusions

NECs attempt to achieve an equitable allocation of the risk of physical conditions between all parties, not just contractors, as other contracts have in the past.  The NEC’s use of probability criteria as opposed to FIDIC’s foreseeability criteria is another innovative and welcomed feature of the NEC.

Despite this, physical condition clause claims are not straightforward, and, in practice, are notoriously difficult to substantiate. Given the assessment for compensation event depends largely on the contractor’s judgement and allowance under the contract, contractors should specify in the tender the extent of allowance made for certain risks for future claims.