The reasonable person test. The Federal Energy Regulatory Commission concluded in its seminal New England Power Co. decision that "the most helpful test" in resolving issues of "prudent investment" is the "reasonable person" test, which the commission defined as follows:
In performing our duty to determine the prudence of specific costs, the appropriate test to be used is whether they are costs which a reasonable utility management... would have made, in good faith, under the same circumstances, and at the relevant point in time.
NEPCO, supra, at 61,084. This "reasonable person" test has been consistently applied by state public service commissions in evaluating the prudence of costs incurred by utilities under their jurisdictions [e.g., Re Southern California Edison Co., supra, at 168) and has been applied as well in other areas of law involving regulated companies, including occupational safety and health, banking, and government contracting.
The "reasonable person" is widely accepted as a standard in large part because it is an objective test that avoids the adverse policy implications of alternative legal criteria such as strict liability or "guilty knowledge." A strict liability approach would deem a project manager imprudent whenever a management decision produced harm significantly greater than its benefits. Under that analysis, however, regulatory bodies would undoubtedly be inundated with requests by public utilities for advance approval of projects before they undertake substantial capital investments. A "guilty knowledge" approach would consider management imprudent only when the manager acted with a conscious apprehension that his conduct was wrongful or otherwise faulty. That standard tends to exculpate irresponsible management, however, because it would be virtually impossible to prove that management acted with conscious knowledge of its wrongdoing. The "reasonable person" standard avoids these legal pitfalls and provides an appropriate level of regulatory or judicial scrutiny.
The "reasonable person" in the project management context draws its meaning from an extensive body of tort cases involving issues of negligence. It is clear from these well-established principles of tort law that the "reasonable person" standard is, above all, an objective standard, not dependent on individual judgment:
The standard which the community demands must be an objective and external one, rather than that of the individual judgment, good or bad, of the particular individual.
Restatement (Second) of Torts Sec. 283 comment c at 12 (1965), Thus, the "reasonable person" standard does not depend on what a particular person considers reasonable under the circumstances, but rather on a standard of reasonableness imposed by the community. Indeed, the courts have gone to great lengths to emphasize the abstract and hypothetical character of the reasonable person:
The reasonable man is a fictitious person, who is never negligent, and whóse conduct is always up to standard. He is not to be identified with any real person...
Restatement, supra, See. 283 comment c at 13.
Community standards. Community standards as a measure of the reasonable person's behavior may be established in a variety of ways, not the least of which are published treatises by respected project managers such as those presented at this symposium. Professional codes sudi as the Project Management Institute Code of Ethics (e.g., requiring application of state-of-the-art project management tools and techniques to ensure that schedules are met and that the project is appropriately planned and coordinated) and the Canons of Ethics of the American Society of Civil Engineers may also help define the parameters of prudent project management.
In some cases there may even be a statute or regulation mandating a particular level of project management attention. For example, the Department of Interior stipulations that governed construction of the Trans Alaska Pipeline project dictated that the owners should "manage, supervise and implement the construction ... to the extent allowed by the state-of-the-art and development of technology." Agreement and Grant of Right-of-Way for Trans Alaska Pipeline, January 23, 1974.
The U.S. Department of Defense also established very clear community standards for high technology projects in its Cost/Schedule Control Systems Criteria, C/SCSC Joint Surveillance Guide, initially issued in the late 1960s and periodically updated. Courts and regulatory agencies have used these external measures to assess project managers' performance.
Internal project standards. In some instances, however, the most relevant criteria for evaluating project management's prudence may not be set by the community, but by the managers themselves. Certainly the most applicable estimates, schedules, or quality norms are those that were tailored to the particular project at issue. Project management presumptively considered all pertinent constraints when it set those benchmarks, and it may be reasonable to apply those standards to assess project execution. As the California Public Utilities Commission held in assessing schedule performance on the San Onofre project, "one is entitled to assume that the proponents of the project would devise a schedule that contains the least amount of 'float' or avoidable delay." Re Southern California Edison Co., supra, at 187.
The New York Public Service Commission followed this approach in evaluating Long Island Lighting's performance on the Shoreham project. The company argued that it would be more appropriate to compare the procurement cycle actually achieved at Shoreham with those attained at other nuclear construction projects. The commission concluded, however, that such a comparison would not be germane. This is because the cycles planned but unachieved at Shoreham were those that [the utility's] management considered essential if the procurement function was to succeed in supporting the engineering and construction schedules. A cycle short enough to support construction in some other plant's schedule might nevertheless have bee?"» ; ? ngthy to achieve that same objective at Shoreham. C : the failure of procurement to support
(instruction at another plant would not establish that Shore-ham was prudently managed despite such failures.
LILCO, supra, at 286. Similarly, the Missouri Public Service Commission used the definitive estimate for the Callaway project as "the proper starting point for an investigation of cost overruns and a determination as [to] whether costs incurred on the project are reasonable." Re Union Electric Co., supra, at 229.
Internally approved project standards have an initiál attractiveness that has seduced some fact finders to divine imprudence whenever project goals are not met. That conclusion is clearly inappropriate. Project objectives may be set for a variety of purposes — i.e., to provide an ambitious target that will always be just beyond the reach of all but the most capable managers. Moreover, the project managers may simply have erred and established standards or procedures that are impractical. Finally, circumstances may have changed so that the norms conceived at the beginning of the project no longer have any relevance. Thus, judges and commissioners should not blithely adopt the project's standards as coincident with prudent management without first testing the objective reasonableness of those criteria within the framework of the conditions that actually existed.
Standards that exceed common practice. Even compliance with an established precedent—whether set by the community or by project management internally—may not be sufficient, however, to demonstrate prudence. The reasonable person standard applied by courts and juries reflects an observation made by Judge Learned Hand more than half a century ago in his opinion in The T. f. Hooper: "in most cases reasonable prudence is in fact common prudence." 60 F.2d 737, 740 (2d Cir.), cert, denied, 287 U.S. 662 (1932). Thus, evidence of the usual and customary conduct of others under similar circumstances is normally relevant and admissible as an indication of what the community of project managers regards as proper.
Proof that project management practices and organizational structures consistently fell short of contemporaneous industry standards and practices serves a particularly useful function for the trier of fact:
Proof that the defendant took less than customary care has a use different from proof that the defendant followed business usages. Conformity evidence only raises questions, but sub-conformity evidence tends to answer questions. If virtually all other members of the defendant's craft follow safer [or more efficient] methods, then those methods are practical; the defendant has heedlessly overlooked or consciously failed to adopt common precautions.
Morris, Custom and Neghgence, 42 Colum. L. Rev. 1147, 1161 (1942).
It should be emphasized that although failure to conform to industry standards establishes imprudence, proof of limited conformity to the practices of others does not carry the same weight in establishing prudence. Consequently, even if one or more specifically identifiable "real world" project managers would have acted in a particular fashion, such evidence of limited conformity would not establish prudence. For unlike the fictional "reasonable manager" of the law, "real world" managers, even though th ;en-
erally considered "reasonable" by their peers, sometimes act unreasonably or imprudently.
Because even people who are generally reasonable may sometimes act negligently, it is not surprising that the law refuses to allow any one individual to set the standard of prudent behavior by her conduct alone. Indeed, thé courts have consistently held that even adherence to an industry-wide custom or practice will not insulate a defendant from liability because an entire industry may be negligent. This principle was perhaps most eloquently articulated by Judge Hand in his oft-cited opinion in The T.J. Hooper:
In most cases reasonable prudence is in fact common prudence,- but strictly it is never its measure; a whole calling may have unduly lagged in the adoption of new and available devices. It never may set its own tests Courts must in the end say what is required; there are precautions so imperative that even their universal disregard will not excuse their omission.
The New York Public Service Commission applied a similar analysis to the Shoreham Nuclear project and found that "if gross inattention to cost and schedule control was typical of the industry, industry practices on their face would be unreasonable and could not excuse [the utility] from its responsibility to act reasonably." LILCO at 278. Indeed, commissions have also found that utilities are not necessarily prudent simply because they produced project results that were better than the norm. The Illinois Commerce Commission found that although the Byron Nuclear Power Plant was one of the cheaper plants to be built recently, that certainly does not preclude investigation into particular aspects of the project to determine whether there were reasonably avoidable diseconomies... .The favorable plant cost comparisons do, however, help to prevent the Commission from inferring mismanagement simply from cost increases, increased project ratios, or other such simple arithmetical comparisons.
Re Commonwealth Edison Co., supra, at 101.
Requirement for expert project management. The common use by commissions and courts of a reasonable manager standard implies application of the qualifications required from a specialist, which differs substantially from the criteria applied to the ordinary person engaged in ordinary activities. This expert standard, again, is a familiar facet of negligence law, which has traditionally demanded more than ordinary care from those who undertake any work calling for unique skill. Specialists have always had a duty to display "that special form of competence which is not part of the ordinary equipment of the reasonable man, but which is the result of acquired learning and aptitude developed by special training and experience." Restatement (Second) of Torts, Sec. 299A comment a.
An expert generally is held to "the standard of skill and knowledge required of the actor wh- : a profession or trade"—the "skill and knowledge," in other \v is commonly possessed by members of
that profession or trade in good standing." Id. Sec. 299A comment e. Thus, as members of a particularly skilled group, project managers will normally be held to a standard based on the distinctive skill and knowledge commonly possessed by members of the profession they undertake to practice.
The level of expertise demanded by regulatory commissions or the courts will be commensurate with the complexity and challenge of the project. For instance, significantly greater talent and experience will be expected from the manager of a multi-billion dollar nuclear power plant project than from the project manager responsible for the addition to a residential home. In general, the greater the risk of calamitous outcomes (e.g., runaway costs or injury to the environment or populace from quality shortcomings), the greater the burden that will be imposed on the project manager.
Reasonable Project Management "Under the Circumstances"
Hindsight prohibited. Courts and regulatory agencies have uniformly applied the criteria for prudent project management applicable at the time decisions were made based on the facts that were available to the decisionmaker at that time. For instance, in adopting a reasonable utility manager standard in NEPCO, the FERC remarked that while in hindsight it may be clear that a management decision was wrong, our task is to review the prudence of the utility's actions and the costs resulting therefrom based on the particular circumstances existing ... at the time the challenged costs were actually incurred.
NEPCO, supra, 31 F.E.R.C. Para. 61,047, at 61,084. Thus, the commission made it clear that the standard to be used is not one of perfection, that is, judging the reasonableness of management decisions with the benefit of hindsight. Instead, management conduct must be evaluated according to the circumstances that existed at the time the relevant decision was made.
Some project managers have attempted to invoke severe time constraints as a mitigating circumstance that might justify less than optimal procedures. The courts, however, have imposed two important limitations on the rule that an actor's conduct must be evaluated according to the circumstances (including "crisis circumstances") that existed at the time of the challenged conduct. First, crisis conditions are not considered as a mitigating circumstance when the manager's own negligence creates the crisis. "The fact that the actor is not negligent after the emergency has arisen does not preclude his liability for his tortious conduct which has produced the emergency." Restatement, supra, Sec. 296(2), at 64. Thus, a utility project manager may be held responsible for cost increases in a situation in which he acts "reasonably in [a] crisis which he has himself brought about." Id. Sec. 296 comment d at 65. Second, a person who engages in an activity in which crises arise frequently is required to anticipate and prepare for those situations. In particular, experts or professionals who perform work that is characterized by frequent crises (i.e., most project managers) are required to have particular skill and training to deal with those situations. Restatement, supra, Sec. 296 comment c at 65.
As part of the "reasonable person" standard, the FERC has expressly held that "management must operate its systems to avoid circumstances that give rise to emergencies." In Texas Eastern Transmission Corp., 2 F.E.R.C. Para. 61, 277 ( 1978), the FERC precluded the gas company from recovering the costs of emergency gas purchases because the commission found that the company imprudèntly operated its system so as to create a situation in which emergency purchases were necessary. The commission emphasized that it was not judging the company's behavior with the benefit of hindsight; rather it found that, based on information available to the company at the time, it was imprudent in failing to take steps early in thè year that would have eliminated the need for later emergency gas purchases. Id. Para. 61,277, at 61,617-18.
The "large complex project." A few commentators have argued that some projects (which they dub "large complex projects" or "LCPs") are sui generis and that their peculiar circumstances (e.g., size, complexity, application of new technology) make it impossible to define meaningful management criteria for assessing performance. This position has been soundly rejected. In the proceeding before the New York Public Service Commission to establish the allowable costs for the Shoreham nuclear project, the utility advocated a "theory which suggests that large-scale complex projects are inherently unmanageable" and a standard of conduct that "would insulate [the utility's] management from a finding of imprudence short of outright fraud, self-dealing, blatant carelessness, or gross negligence." LILCO, supra, at 269. The commission disdained this approach because "the public is entitled to expect that such undertakings by public utilities are controllable." Id. The development of the project management discipline over the past twenty-five years would appear to confirm the Commission's judgment. Project managers are unlikely to be able to hide their failures behind rationalizations that their projects were somehow unique and not amenable to standard project management techniques.
Project Managers' Responsibility for Vendors' Actions
In most instances, the focus of any judicial inquiry will be on whether the project manager acted prudently. Of course, that investigation should include an examination of the project manager's role in selecting contractors, defining the scope of their work, supporting their efforts, and monitoring performance. Any dereliction in these duties would obviously be the project manager's direct responsibility.
According to some regulatory commissions, however, the project manager may also be vicariously liable for the imprudent conduct of her agents. For example, the Maine Public Utility Commission found that under its regulatory scheme, the ratepayers should "pay no more than the reasonably necessary costs to serve them. Any other reading [of the statute] is likely to lead to economic inefficiency, to excess costs, and sometimes to dubious practices between utilities and their suppliers." Re Seabrook Involvements by Maine Utilities, 67 P.U.R. 4th 161, 168-69 (Me. PU.C. 1985). The Maine commission held explicitly that "a supplier's unreasonable charges, even when not found to have been imprudently incurred by the utility, cannot be passed on to the utility's ratepayers." Id.
Similarly, the Pennsylvania Public Utility Commission found that because the project manager, not the ratepayers, chose the contractor, the risk of performance failures shr^ld be borne by the stockholders.
It must be recognized that the basic question is who should pay for the cost of the improper design and manufacture of the Salem 1 generator. ... Including these costs in [the utility's rates] means that all ratepayers are charged for [the contractor's] actions. This insulated both [the utility] and [the contractor] from responsibility for the generator failure. Conversely, denying ... recovery places the costs on the party most capable of pursuing legal remedies and negotiating future contractual protections, [the utility]. Only [the utility] can structure its operations in such a fashion as to minimize the costs of contractor error or pursue damages should errors occur.
Re Salem Nuclear Generating Station, 70 P.U.R. 4th 568, 606-607 (Pa. P.U.C. 1985).
The Michigan Public Service Commission has also held the utility strictly liable for the derelictions of its construction contractors and vendors.
It is the responsibility of [the utility], and not its ratepayers, to ensure that the selected vendors perform the assigned work. The fact is that repair and rework were necessary regardless of how and when it was performed or whose fault it was. As a result, additional expenditures occurred which otherwise should not have. The Commission believes it is more appropriate that this expenditure becomes the responsibility of the company and not the ratepayers. To do otherwise might be detrimental to the ratepayers because utilities would be less inclined to be diligent in their supervision and negotiations with contractors in the resolution of problems such as this.
Re Detroit Edison Cosupra, at 8.
Although these cases ostensibly hold the project manager responsible for contractor negligence regardless of his own fault, good policy may not dictate so harsh a result. The fundamental premise underlying the commission's holdings is an expectation that the project manager can control the contractor's performance, either through negotiation of strict contract terms that make the contractor accountable for any mismanagement or through careful monitoring and direction of the contractor's work. If the utility can demonstrate that its project manager took reasonable steps to preclude contractor misfeasance, that evidence should provide an adequate defense, particularly if the contractor withheld material information about its failures from the project manager. The manager should be penalized only if there were steps that she could reasonably have taken to avoid or mitigate the contractor's imprudence.
An Alternative Standard: "Efficient" Project Management
In some jurisdictions, regulated companies should anticipate being held to a somewhat more rigorous performance standard if they expect to obtain full recovery for their project costs. In Texas, for instance, the legislature has determined that a utility seeking to include an allowance for construction work in process (CWIP) in its rate base must show that a project has been man-
aged ''prudently" and "efficiently." Tèxàs Public Utility Refeiilatory Act, Sec. 41(a). Under the most likely interpretation of this statute, utilities will have to show more than the reasonableness of their conduct; they will have to show that the project used "the most effective and least wasteful means of doing a task or accomplishing a purpose" and performed in "the best possible manner." Houston Lighting é) Power, Docket No. 5779, Examiner's Report (December 20, 1984) at 17, aff'd (January 11, 1985). Similarly, the Illinois Commerce Commission has held that its statute requires a demonstration of more than mere reasonableness before a utility can recover its project costs: %
In addition to prudency, considered narrowly, the act now directs the commission to consider efficiency, economy, and timeliness, so far as they affect costs.
Re Commonwealth Edison Co., supra, at 94.
These seemingly broader mandates for project review have not been fully tested in the courts, but they appear to imply a greater focus on the results that are actually achieved. All projects are plagued with niggling inefficiencies, and management's task is to minimize them to the extent possible. Rigid application of the efficiency standard, however, might mean that no project, no matter how well managed, would be able to demonstrate absolute efficiency and recover 100 percent of its costs, at least in the context of extraordinary rate relief such as CWIP. In these cases, there will be an even greater premium on the project manager's skill.
Was this article helpful?
What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.