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July 21, 2020

Covid-19 compensation events under ECC – an NEC users’ perspective

Covid-19 compensation events under ECC – an NEC users’ perspective

Key Points

  • There are many grounds in ECC clause 60.1 for contractors and project managers to notify compensation events during the Covid-19 epidemic.
  • In the absence of an early warning, the project manager needs to give a valid clause 61.5 notice, which may lead to a reduction in the value of the compensation event and a possible dispute.
  • Under clause 61.6 the project manager may change its assumptions about the compensation event as the pandemic develops, possibly resulting in a new compensation event.
  • Clients may find it more cost effective to suspend works by mutual agreement rather than terminating the contractor’s obligation and mobilising a replacement contractor.

The current Covid-19 pandemic, and the subsequent measures imposed by international governments to combat it, is clearly having a severe impact upon the construction industry. This article considers the various mechanisms under the NEC Engineering and Construction Contracts (ECC) for notifying and assessing compensation events that could arise from the current restrictions being placed upon the industry.

Early warning and prevention

Clearly the world’s NEC users are now well past the stage of giving an early warning of Covid-19 and its likelihood to increase the total of the prices and delay completion. Such a notice should have been given by either party under NEC4 ECC clause 15 (16 in NEC3) before the lockdowns.

An early warning (risk reduction in NEC3) meeting should have followed the initial notification, at which the parties should have discussed likely impacts and possible mitigation measures. The impacts would include effects on the programme, disruption to the supply chain and resources being confined due to self-isolation. With the benefit of hindsight, proposed mitigation measures may have been severely limited due to the unprecedented impact of this event.

As discussed by Higgins (2020) as well as Shield and Groom (2020), Covid-19 would almost certainly bring into play the provisions of clause 19 on prevention, by satisfying the three necessary conditions

  • it stopped the contractor completing the works by the date shown on the accepted programme or at all
  • neither party could have prevented it
  • an experienced contractor would have judged at the contract date that is had such a small chance of occurring that it would have been unreasonable to allow for it.

However, clause 19 only empowers the project manager to instruct the contractor on how to deal with the event − the contractor is unable to initiate the process itself. A further caveat is that, to qualify under clause 19, the event would have to delay completion of the works. While lockdown restrictions would be highly likely to cause such a delay, if mitigation measures could pull back the potential delay then this provision would not be applicable − any resultant compensation event would only address additional costs. Any instruction that was issued here though would constitute a compensation event on one or more of the grounds considered below.

Grounds for notifying a compensation event

There are many grounds in ECC clause 60.1 for contractors and project managers to notify compensation events during the Covid-19 epidemic, as follows.

  • 60.1(2) – the client does not allow access to part of the site by the date shown on the accepted programme. This could arise if, for example, the site was in a restricted or builtup area.
  • 60.1(3) – the client does not supply something by the date for providing it shown on the accepted programme. This is very relevant if there are free-issue materials and subsequent problems with the supply chain.
  • 60.1(4) – the project manager gives an instruction to stop or not start any work. This will be a very common ground as the restrictions bite.
  • 60.1(5) – the client or others does not work within the times shown on the accepted programme. This is a common problem if there are many activities on the programme reliant upon utilities providers.
  • 60.1(6) – the project manager or supervisor does not reply to a communication within the period required by the contract. This could become an issue if either of these client’s representatives entered a period of selfisolation without first delegating a replacement.
  • 60.1(14) – a client’s liability occurs. Although unlikely, the outbreak of a pandemic could be listed as an additional client’s liability in the contract data part one.
  • 60.1(16) – the client does not provide materials or facilities for testing as stated in the scope. A possibility if prevented by unforeseen restrictions.
  • 60.1(17) – the project manager notifies a correction to an earlier assumption. As the full effects of a Covid-19 compensation event may be too uncertain to forecast reasonably, the project manager may state assumptions. As events unfold, they may see the need to correct or amend their earlier assumption.
  • 60.1 (19) – this mirrors the criteria set out in clause 19 on prevention, save that the event cannot be one of the other compensation events listed. A Covid-19-linked event would certainly satisfy all of the criteria listed here.

Which party’s responsibility it is to notify the compensation event in the first instance will determine whether the time bar set out at clause 61.3 applies. Of all the grounds listed above it is the project manager’s responsibility to notify grounds 60.1(4) and 60.1(17).

In theory, therefore, the contractor could be time-barred if it fails to notify within the eightweek time period set out in clause 61.3 in relation to all of the other listed events. Contractors need to be wary here though as this eight-week time period is often reduced by clients. This time bar creates a potential area for disputes, so the contractor should endeavour to notify as soon as possible when it becomes aware that any of the Covid-19 restrictions constitutes grounds for a compensation event.

Assessment of compensation event

With global lockdowns and associated restrictions clearly constituting compensation events on several grounds, it is difficult to envisage a project manager rejecting any compensation event notified by a contractor upon any of the grounds listed at clause 61.4. Thus, the project manager should instruct the contractor to submit quotations to progress the matter.

There is a potential sting in the tail at clause 61.5, however, in that if the project manager considers that the contractor should have issued a prior early warning but did not, the project manager could notify this to the contractor at the same time as instructing it to submit quotation(s). The project manager has to so notify at the time of instructing quotations though and cannot rely upon this sanction at a later date, for example after receiving the contractor’s quotation.

If a clause 61.5 notice is validly given then, pursuant to clause 63.7 (63.5 under NEC3 ECC), the project manager assesses the event as if the contractor had given an early warning. This means that mitigation measures can be assumed that the project manager may have instructed to deal with the event, had they been given timely notification. Adopting such a stance could clearly be considered as very subjective and, as such an assessment would almost certainly lead to a reduction in the value of the compensation event, leading to a dispute between the parties. Such a scenario could clearly be avoided in the first instance if the contractor had simply submitted an early warning in accordance with clause 15.1 (16.1 under NEC3).

The current Covid-19 situation is a matter contemplated by the mechanism at clause 61.6, as the project manager may consider the effects of the compensation event to be much too uncertain to be forecast reasonably. Thus, stating assumptions about the event within their instruction to the contractor to submit quotations could well lead to a lower value quotation, as the contractor would not feel compelled to price a myriad of unknown cost-risk and time-risk allowances to protect its position. The project manager could correct their assumptions as events developed and government policy evolved. This correction of assumptions by the project manager would constitute a new compensation event under clause 60.1(17), entitling the contractor to further costs and time.

Whichever of the above-mentioned grounds for a compensation event were relied upon by the contractor, it would have an entitlement to both costs and time, including also allowances for both cost risk and time related risk. These  entitlements are set out more fully at clause 63.1 dealing with changes to the prices and the defined cost, clause 63.5 (63.3 under NEC3) addressing the delay to the completion date as shown on the accepted programme, and risk allowances in accordance with clause 63.8 (63.6 under NEC3). It is worth considering further the express provisions of the aforementioned clause: ‘The assessment of the effect of a compensation event includes risk allowances for cost and time for matters which have a significant chance of occurring and are not compensation events.’

As mentioned above, the contractor’s risks that have a significant chance of occurring are many, including the length and scope of a lockdown, the magnitude of the parties’ human resources placed in self-isolation, and social distancing upon the works. As many, if not all, of these risks are too uncertain to be forecast reasonably, it would seem a sensible course of action for the project manager to state assumptions when instructing quotations.

Under ECC target contracts options (C or D) clearly, after following the above mechanism and a compensation event is implemented in accordance with clause 66 (65 under NEC3), then the target cost would be adjusted by the value of the compensation event. It is difficult to imagine a project manager not accepting the outbreak of Covid-19 as grounds for a compensation event, unless perhaps some very onerous amendments or deletions had been made to the compensation event mechanism to make this event a contractor risk. In such a highly improbable scenario, the contractor would only recover its actual defined cost arising from the event in accordance with the share ranges and share percentages set out within the contract data part one.

Possible termination

As discussed by Shiels and Groom previously, another possible outcome in these uncertain times could be termination. The two most likely reasons would be under clauses 91.6 or 91.7, namely the project manager instructing the contractor to stop work and not start again within 13 weeks, not due to a default by either party (reason R20), or an event occurs that stops the contractor completing the works for more than 13 weeks (R21). Both of these scenarios are clearly possibilities in the current circumstances. In both instances the contractor would be reimbursed the costs it had incurred to date, plus the cost of removing its equipment from site.

Obviously here the client would have to weigh up the costs of a very long suspension, which would include the initial compensation event(s) costs arising from Covid-19 in the first instance, compared to terminating to bring these costs to an end and possibly completing the works at a later date. It may be more cost effective to suspend the works by mutual agreement, as it would be a very rare occurrence for the client to be able to terminate and mobilise a replacement contractor for less than permitting the original contractor to complete the works. It should be noted that under reasons R20 and R21, the client cannot recover its additional costs incurred to complete the works from the original contractor.

Conclusion

It is clear that dealing with the effects of Covid-19 may constitute a compensation event on a number of grounds, all of which entitle and the contractor to additional costs and time. However, if early warning notices have not been served at the outset, this could impact upon the contractor’s overall entitlements and may ultimately lead to disputes between the parties.

The very uncertain overall effects of  any compensation event arising from the unprecedented circumstances present exactly the scenario contemplated by clause 61.6, where the project manager may state assumptions to be taken notice of within the contractor’s quotation.

Finally, a very careful and considered commercial judgement would need to be taken by any client considering terminating the contract due to an extended suspension of the works.

Reference

Covid-19 risks and NEC4 ECC contracts – a legal perspective, Louise Shiels and Andrew Groom, Brodies

Covid-19 Guidance Document, Peter Higgins, NEC4 Contract Board Chair

Written by Alan Williamson, NEC Consultant

 

 


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