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April 21, 2020

Sharing the pain: working on target cost contracts in joint ventures

Sharing the pain: working on target cost contracts in joint ventures

Key Points

  • ECC Option C joint-venture contractors need to ensure their joint-venture agreements on interim payments and pain/gain share are consistent with the contract.
  • In the event of inconsistency, the joint venture agreement needs to state whether or not it takes precedence over the contract terms.
  • Joint-venture agreements need to have effective dispute-resolution procedures.

A decision last September by the UK Technology and Construction Court considered the application of the pain/gain share mechanism in the NEC3 Engineering and Construction Contract (ECC) Option C (target cost with activity schedule). It also highlighted key considerations where contracting parties include a construction joint venture.

In ECC Option C, financial risks are shared between the parties in agreed proportions. It is most typically used where the scope of work is not yet fully defined or on projects where greater financial risks are anticipated. In the course of carrying out the works the contractor is paid for its defined costs incurred in carrying out the works, plus a fee to cover overheads and profits. But at the outset the parties agree a target cost and, on completion of the works, any savings or overrun are allocated between them in accordance with a pre-determined pain/gain share mechanism.

It is also common for contractors to enter into joint venture agreements for carrying out specific large-scale or high-risk projects. This arrangement allows contractors to share specialist knowledge and also financial risks.

Interim payments dispute

Doosan Enpure and Interserve Construction entered into a joint-venture agreement (JVA) in 2016 to carry out upgrade works at the Horsley water treatment plant for Northumbrian Water under an NEC3 ECC Option C.

A dispute arose between the parties regarding interim payments to which Doosan was entitled under the JVA. Doosan argued payments should be made on an actual-cost basis, while Interserve maintained payments should reflect the anticipated pain share likely to result upon completion of the works. Payments to Doosan were suspended and proceedings were commenced between the parties in June 2019 to determine entitlement to sums held in the jointventure’s bank account.

The court found in favour of Doosan, holding that interim payments were to be made without adjustment, and that adjustments for pain/gain share would only take effect at the conclusion of the project.

Comparison of terms

In reaching its decision the court considered the terms of the NEC contract alongside those of the JVA. Clause 53.3 of the NEC3 ECC Option C (clause 54.3 in NEC4) outlines the following process in relation to assessment of the pain/gain share: ‘The Project Manager makes a preliminary assessment of the Contractor’s share at completion of the whole of the works using his forecasts of the final Price For Work Done To Date and the final total of the Prices. This share is included in the amount due following Completion of the whole of the works.’

Meanwhile clause 8.6 of the JVA stated that: ‘The parties shall receive interim payments from the JV in reimbursement of the Works Part Costs incurred by each party as shown on the parties’ Interim Cost Statements. Works Part Costs shall be reimbursed in accordance with the principles set out in schedule 4.’ Schedule 4 stated that costs would be paid, ‘net of internal changes, delay damages and other adjustments’.

Interserve had argued that Doosan was only entitled to receive interim payments in accordance with schedule 4. The court noted that while schedule 4 contained reference to the NEC pain/gain share mechanism, it made no specific reference to interim payments.

Need for consistency

In interpreting the terms of the JVA, the court gave careful consideration to the NEC contract terms, noting these were relevant because many defined terms were carried over to the JVA. This highlights the importance of ensuring that the terms of any JVA are consistent with the provisions of the related construction contract, and that the JVA sets out which agreement is to take precedence over the other in the event of an inconsistency.

In this case the only clauses within the JVA which dealt directly with the situation where defined costs were on course to exceed the agreed target cost provided that a joint venture committee could in such circumstances be requested to, ‘suspend or reduce the level of interim payments to the other party’. However, such a decision of the committee had to be unanimous, requiring the consent of both Doosan and Interserve and therefore allowed Interserve effectively to block interim payments to Doosan.

The case highlights that the relationship between a JVA and related construction contract together with the effectiveness of the JVA dispute-resolution clauses need to be carefully considered to prevent internal disputes in target cost contracts.

Written by Katie McDougall, CMS


POSTED BY NEC Contracts
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