Brian Allan, MD, Chartered Surveyor, Construction Claims Specialist and practicing Expert Witness at QSI Consultancy Group discusses Dispute avoidance in major projects under the NEC form of contract.

Disputes can be avoided through the successful administration of the time and cost provisions of the contract. Under NEC3 (unamended standard form), we are principally referring to the handling of Compensation Events, and the related matters of Programme management and Early Warning notices.  This article considers these matters and related issues.

PROGRAMME

The core clauses concerning programme under NEC3 are 31 and 32.  The baseline programme is established under Clause 31.  Thereafter, the Contractor submits revised programmes, typically at the intervals stated in the Contract Data (e.g. monthly).  The latest programme accepted by the Project Manager is the ‘Accepted Programme’ (Clause 11.2(1)).  These clauses principally create the following obligations for the Contractor and the Project Manager:

In practical terms, the Contractor must ensure that the programmes it submits capture the full scope of the Works and contain realistic durations with properly logic linked activities.  Key Dates (if any) should be complied with, allowing an element of float where possible.  The Works Information should be adhered to and method statements provided.  In turn, the Project Manager should audit the submitted programme and be satisfied that the programme complies with the Works Information.  The programme should not be unreasonably rejected.

Properly maintained programmes are essential when evaluating time impact for compensation events.  The Contractor is required (under Clause 62.2) within its quotation for a compensation event to show the impact of the event on the Accepted Programme.   If the programme logic is flawed, for example, the Contractor may not be able to persuade the Project Manager of the impact.  Failure to properly maintain the programme can lead to non-agreement of compensation events, which in turn can cause cash flow problems for the Contractor and ultimately formal disputes.

EARLY WARNING

Under Clause 16 both the Contractor and the PM are under an obligation to issue an early warning notice to the other as soon as they become aware of a matter that could:

• Increase the total of the Prices.
• Delay Completion (and/or a Key Date).
• Impair performance of the works.

Early warning notices are added to the Risk Register (16.1).  Early warning notices are not required for matters that are already the subject of a compensation event notice (16.1).  Either the Contractor or the PM may ‘instruct’ the other to attend a risk reduction meeting (16.2), at which efforts will be made to mitigate the impact (16.3) by exploring solutions together.

If the PM considers that the Contractor should have issued an early warning for a compensation event, the compensation event may be assessed as if the early warning had been given; e.g. costs may have been less if the PM or Employer had the opportunity to mitigate (clauses 61.5 and 63.5).  However, not all compensation events are necessarily known to the Contractor prior to the compensation event notice.  The Contractor might also ask, if it was obvious, why did the PM not issue an early warning?

The early warning initiative supports collaboration and tends to reduce the risk of formal disputes arising. 

COMPENSATION EVENTS

Compensation events are principally managed under NEC3 Clause 60.  Compensation events are admissible variations, claims and other events as listed under Clause 60.1.  The Compensation Event mechanism is intended to be substantially prospective, although the time and cost impact may start as early as the early warning notice.

Notifying Compensation Events – Clause 61

Both the PM and the Contractor have notification obligations under Clause 61.  The PM is required to notify the Contractor of a compensation event if it arises from an action of the PM (e.g. instruction, decisions, certificate) [61.1].  The Contractor can notify the PM of a compensation event, if it has not already been the subject of a PM notice [61.3].

Clause 61.3 states that the Contractor will have no entitlement to time and price compensation if it fails to notify the event within 8 weeks of ‘becoming aware of the event’.  Following the receipt of notice from the Contractor, the PM decides if the event gives rise to entitlement and notifies the decision to the Contractor [61.4].  The PM may instruct the Contractor to provide a quotation(s) at this point [61.4, 62.1].

Quotations for Compensation Events – Clause 62

Clause 62 envisages collaboration between the PM and the Contract as to the best ways of dealing with the event, following which the PM may instruct the Contractor to provide a quotation(s) [62.1].  This approach also allows the PM to make the best decision for the project, having considered the options.

The quotations are required to address both the time and price impacts of the event [62.2].  The Contractor is obliged to submit the quotation within 3 weeks of the PM’s instruction and the PM has 2 weeks thereafter to respond [62.3].  If the PM does not respond in time the quotation may be deemed accepted, subject to Contractor notice [62.6].

Assessing Compensation Events – Clause 63 / 64

Compensation events are assessed relative to the current Accepted Programme, not the historical baseline.  i.e. impact the Accepted Programme with the compensation event. This ensures that the true impact of the event is taken into account [63.3].  However, if the Contractor is already in delay for other reasons the compensation event may have no effect on completion and therefore have no entitlement (similar approach to SCL Protocol).

As always, it is essential that the Contractor maintains proper records (capable of being audited) to support its quotations for compensation events (and other matters) including; procurement records, progress reports, correspondence / emails, photographs, site diaries, etc.

The change to Prices takes into account on a ‘but for’ basis [63.1]; the Defined Cost impact to date, the forecast Defined Cost, and the Fee.  This avoids a wholly retrospective assessment and provides early certainty for the parties.  The assessment is not revised if the assumptions made later prove to be wrong.  If the Contractor has not given early warning, the PM may assess the compensation event ‘as if the Contractor had given early warning’ [63.5].

The Defined Cost reflects actual costs incurred (excludes costs deemed to be within the overhead Fee).

The Schedule of Cost Components contains categories and components of costs, used as the basis for assessing compensation events (Options C, D, E); i.e. scope change, prolongation type costs, disruption / reduced productivity.

The Fee would usually include head office overheads and profit.  Staff not identified by the Contractor in Contract Data Part 2 will be deemed to be included within the Fee.

Material price inflation

At the pre-contract stage Option E contracts might be adopted, which are cost reimbursable; whereas Option A are fixed price.  The secondary option X1 allows Price adjustment for inflation.  The parties might elect by agreement to modify option X1 to capture only specific materials, for example.   Another solution may be to include provisional sums for certain materials (actual cost is paid).  The parties should consider including express terms to deal with entitlement to compensation for material price increases arising as a consequence of Contractor culpable or non-culpable delays (i.e. the entitlement may differ).

The handling of price escalation post contract depends on the options included in the contract, e.g. X1 or Z additional conditions.  If there are no express provisions for price escalation a Clause 16 early warning should be given by the Contractor, to facilitate discussion, and the item added to the Risk Register.

If a change in materials is necessitated due to Clause 18 impossibility, this would arguably allow a change to scope via Clause 60.1 and related compensation.

Other collaborative means of dealing with material price escalation made include; varying contract by agreement, alternative materials, re-negotiated rates, early or delayed procurement.  The NEC contract contains no force majeure provisions.

NEC4 v NEC3

NEC4 is intended to further enhance collaboration, which tends to reduce the likelihood of disputes.  Notable changes versus NEC3 include:

• Employer is now Client.
• Works Information is now Scope.
• The Risk Register is replaced with an Early Warning Register.
• Clause 16 introduces value engineering, enabling the Contractor to propose scope changes to reduce cost.
• Clause 19 – Prevention – the event prevents completing the whole of the works.
• Under Clause 36, the Contractor can now also make an acceleration proposal to bring forward completion.
• Clause 53 – new stricter rules for the PM concerning final account, bringing more certainty for the Contractor.
• Option W – new dispute resolution provisions; senior representatives discussions, use of DABs option (if HGCR Act does not apply).
• New secondary Option X21 – Whole Life Cost – Contractor proposals to reduce whole life cost.  Contractor shares in benefit.
• A new compensation event allows the Contractor to be compensated for its proposal costs if a PM proposed instruction does not proceed.
• All contracts now include Schedules of Cost Components (used to assess Defined Cost).
• Programme – Clause 31.3 – inaction by PM on submitted programme can become ‘treated as acceptance’.

CONCLUSIONS

A key principle of the NEC contracts is that the time and price impact of compensation events is assessed at or around the time that the event arises.  This encourages early agreement, supports prospective completion dates, maintains cashflow and avoids retrospective assessments. 

The parties should follow the contract, collaborate and ‘act in a spirit of mutual trust and cooperation’ [10.1], all of which tends to mitigate against formal disputes.  Consistent with this, a recent judgement of the Scottish Inner House of the Court of Session concluded:

‘In our view clause 10.1 is not merely an avowal of aspiration.  Instead it reflects and reinforces the general principle of good faith in contract’ [Van Oord UK Ltd v Dragados UK Ltd [2021] CSIH 50, CA143/19].

-Brian Allan, QSI Consulting Ltd.