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March 27, 2020

Understanding the critical ‘F-words’ that make NEC contracts different

Understanding the critical ‘F-words’ that make NEC contracts different

Key Points

  • Critical ‘F-words’ in NEC contracts are ‘forecast’ and ‘fault’.
  • Parties must be prepared to agree forecasts of the cost and time effects of every change, and regularly agree forecasts of total cost in costreimbursable options.
  • It is important for parties to recognise and agree when a contractor is at fault.

Many presentations have been given on why the NEC is so different from other standard forms of contract. I have given quite a few myself over the last 25 years. But I have only recently focused on the criticality of just one word in the NEC contracts: ‘forecast’.

The word appears in all the main NEC4 and NEC3 contracts: the Engineering and Construction Contract (ECC), the Professional Service Contract (PSC), the Term Service Contract (TSC) and in the short versions of these contracts. For the purposes of this article I will refer to clauses in the NEC4 ECC.

In most traditional contracts, when there is an event for which the contractor can claim extra time or money, the process is to keep records, keep more records, possibly get those records agreed and then sort it out later when the effects of the event are over and can be assessed, and argued about, based on those records. Often the assessment of the claim is months, if not years, after the event. In the meantime, the client and supplier are guessing at the possible outturn cost and indeed the required completion date for the contract.

The key word that makes NEC so different from all other contracts is the ‘forecast’ in clause 63.1. The clause sets the rules for how to assess the cost effect of a compensation event – the NEC word for any event that might lead to the contractor getting more cost and/or time.

Forecasting effects of change

Clause 63.1 states (bullets omitted): ‘The change to the Prices is assessed as the effect of the compensation event upon the actual Defined Cost of the work done by the dividing date, the forecast Defined Cost of the work not done by the dividing date, and the resulting Fee. For a compensation event that arises from the Project Manager or the Supervisor giving an instruction or notification, issuing a certificate or changing an earlier decision, the dividing date is the date of that communication. For other compensation events, the dividing date is the date of the notification of the compensation event.’

In most compensation events the very clear ‘dividing date’ will be soon after the occurrence of the event. It is either the date of a project manager’s or supervisor’s action causing the event, or the date the contractor notifies an event. The clause 63.1 assessment rule is used in the contractor’s quotation for the event, in the project manager’s review and, if agreement cannot be reached, in an ultimate project manager’s assessment, as well as, if it comes to it, in an adjudicator’s assessment.

When it comes to time, the equivalent clause is 63.5, ‘A delay to the Completion Date is assessed as the length of time that, due to the compensation event, planned Completion is later than planned Completion as shown on the Accepted Programme current at the dividing date.’ Note the only change in NEC4 was the addition of ‘at the dividing date’, which makes this much clearer. While the word ‘forecast’ is missing here, the delay to planned completion to be assessed is based on the forwardlooking accepted programme and so, like cost, assessment of delay is very much a forecast.

Rather than just keep records, the contractor and project manager must look forwards rather than backwards and forecast the effect of the compensation event. And, as they are doing so, they are required to ignore what is actually happening and agree the forecast of the cost and delay, including allowances for risks with the contractor, as viewed at the dividing date.

Doing a deal

The forecast will not be right but, when implemented, it is a reasonable deal in the circumstances. Each compensation is subject to such a deal. The agreed forecast is not revisited: the contractor or consultant will win on some and lose on others.

The assessment process is very clearly defined and has clear timescales. The clear intent, which characterises NEC, is to get these events agreed (‘implemented’ in the language of the contract) as the works proceed. Clients will recognise the benefit of this to their business, but they must also recognise that this agreement of events at the time needs resources and so costs money.

A common misconception of NEC is based on the ‘administration burden’. However, a significant part of the additional burden compared with other contracts is the need professionally to agree the impact of compensation events during the project, that is to manage the contract professionally. In effect, the client, if using NEC, must invest in the resources to make NEC give it the benefits of incremental certainty.

To do so, the project manager must have (or have access to) a good understanding of the contractor’s real costs and the programme, negotiation skills and sufficient empowerment from the employer to make decisions. Under the contract there are few limits on the project manager’s actions but, in reality, the contract between client and project manager is likely (ought) to set out where the client wants to be at least consulted before the project manager makes a decision. In effect the project manager’s role is to do deals with the contractor for each compensation event, based on the rules in the contract.

Understanding fault

There is another important F-word that should be highlighted in every NEC user’s copy of the contract. NEC requires any compensation event that has happened to be notified, either by the project manager or the contractor. But, in clauses 61.2 and 61.4, if ‘the event arises from a fault of the Contractor’, the project manager does not instruct a quotation and there is no change to the prices or delay to the completion date.

An example is a project manager giving an instruction to stop work, leading directly to a compensation event. But if the reason for that instruction was a clear health and safety issue, that will be the ‘fault’ of the contractor and there will be no change to the prices or delay to the completion date. As such there will be no need to instruct a quotation for the event.

I have seen clients using extensive Z clauses defining what fault means here, but these are surely unnecessary. It is clear that if contractors are not working within the requirements of the law or the scope, they are at fault.

Forecasting total costs

Lastly, in the target and cost-reimbursable options of NEC, which for NEC4 ECC are Options C−F, clause 20.4 requires: ‘The Contractor prepares forecasts of the total Defined Cost for the whole of the works in consultation with the Project Manager and submits them to the Project Manager.’

Note that most contractors will include in that forecast the amount forecast each month rather than just the forecast at the end of the project. Some clients use an additional condition (Z clause) to make that an explicit requirement.

The forecasts are required at the interval stated in the contract data, typically monthly. For a client it is critical that this is done well, so that the client has ‘incremental certainty’ on the costs of the contractor, which are paid by the client.

In the case of target contracts, which for NEC4 ECC are Options C and D, this forecast, combined with proper management of the prices through forecasting and implementation of compensation events as described above, will give clients incremental certainty of the total they will pay after the contractor’s share.

Summary

In summary, ‘forecast’ is the single most important word making NEC contracts different from so called ‘traditional’ contracts. NEC users need to make sure they properly understand the meaning and significance of forecasting the cost and time effects of changes, and of forecasting total defined costs.

It is also important to be able to recognise when contractors are at fault.

Written by Richard Patterson, Mott MacDonald


POSTED BY NEC Contracts
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