Latent Conditions – Who Bears the Risk?

Introduction

The Queensland Court of Appeal recently held, on 3 March 2006, Thiess Services Pty Ltd v Mirvac Qld Pty Ltd [2006] QCA 50, that a contractor’s obligation under a contract was absolute and not limited by considerations of what was economically achievable.

Background

A Principal and Contractor entered into a contract for remediation works to be carried out on land the Principal intended to develop for residential and commercial use.  The land was contaminated and was listed on the Environmental Management Register, which meant that the Principal was required to follow EPA directions on remediation in order to remove the land from the Register.

The Principal engaged an independent assessor, who prepared a Remediation Action Plan (RAP) and the Principal subsequently entered into a contract with the Contractor to carry out the remediation works.

Once works commenced, the Contractor discovered that the extent of the contamination was much greater than anticipated by the RAP, to the extent that the remediation works would be uneconomical for the Contractor to perform.  It was estimated that the additional works required by reason of the condition of the site would cost a further $2 million and result in a delay of up to 3 months.

The Contractor applied to the Court for a declaration as to the extent of its obligations under the contract, and in particular sought directions of the Court that the Contractor’s need to discharge its obligations in full arose only if it was economical to do so.

This argument was rejected by the Queensland Supreme Court and the Court of Appeal.

The Contract Documents

The written contract required rendering the contaminated area suitable for any land use, and stated that the Works included “all works to remediate the Site”.  The latent conditions clause provided that the Contractor was entitled to an extension of time and costs if a latent condition was discovered on site, but the clause specifically stated that any contaminant would not constitute a latent condition.

The contract provided that the Contractor was to “make his own determination of the volumes of the various types of materials requiring treatment and of the extent of treatment required to meet the remediation objectives”.

The Principal relied on the fact that nothing in the contract contained any express or implied mention of the possibility of partial or qualified remediation.  As such, the Principal argued that it was not the parties’ intention that a partial remediation could be permitted.

The RAP, however, stated:

The intent of the remediation program is to clean up soil and groundwater across the entire site to a condition such that EPA will remove the site from the Environmental Management Register.  Failing this, the intent is to remediate as much of the site as possible so that the areas remaining with residual contamination have the least possible on-going management requirements….these criteria are provided as a contingency in the event the remediation works cannot economically achieve the desired remediation criteria.

The RAP clearly contemplated that a partial remediation might take place, limited by what was economical.  The Contractor relied on the RAP to argue that the deal struck was that any works undertaken by the Contractor were to be limited to what was “economical”.

The Courts’ Decisions

The Supreme Court and Court of Appeal both held against the Contractor. Both found that the RAP did not form part of the contract and so its terms were not relevant in assessing the Contractor’s obligations.  The RAP was created by the independent engineer for the purpose of advising the Principal and the EPA about the scope of the works required.  The RAP was never directed to or issued for the benefit of the Contractor.

The Court held that the contract imposed an absolute obligation which was not eroded by the informal reference to the RAP.  The terms of the contract were clear – the land was to be rendered suitable for any purpose and to remove the land from the EPA Register.

Both Courts held that determining what level of remediation works would be “uneconomic” would be extremely difficult.  Neither the contract nor the RAP contained any guidelines to assist the Court on this point.  Further, the terms of the contract clearly indicated that the parties had intended that the risk in relation to site condition caused by contaminants was to rest with the Contractor.  The contract provided that the Contractor was to make its own assessment of the extent of treatment required, and it specifically excluded any warranty or representation by the Principal as to the existing site conditions.

The Importance of Contractual Drafting

This case demonstrates the importance of risk allocation in the contracting process.  Particular care must be taken in drafting the latent conditions clause and formulating the definition of ‘latent condition’.

Although the precise extent of the contractual works was obviously unforeseen at the time of contracting, the Contractor could have taken steps to protect its position.  If the Contractor was relying on the information contained in the RAP, the Contractor should have insisted that the provisions of the RAP be expressly incorporated into the contract between Contractor and Principal.

If, in negotiating a contract, you place reliance on another document (whether an engineers’ or architects’ report or a letter from the Council), do not assume that the other document will necessarily form part of the contract terms.  If there is a comprehensive written contract that does not refer to this other document, or refers to it only in passing, chances are the document will not form part of the contract.  If you are in fact placing some reliance on the contents of the other document, you will need to insist that it forms part of the written terms and that the written contract reflects this.

Use of vague terms such as “economical” should be avoided as they are liable to fail in Court.  Avoid using terms such as ‘intent’, ‘objectives’, ‘goals’ and ‘preferred options’ as these are not regarded by the Courts as appropriate for fixing contractual obligations.  The contract needs to specify what each party’s obligations are, including any conditions or circumstances when the Contractor can require further money or an extension of time to complete the works.

Contributor: Kerry Colmer

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