Comparison of risk allocation in NEC4 ECC and FIDIC Yellow Book

Key Points

• Risk allocation in contracts should be governed by which party can best foresee and control the risk event and which can best bear the consequence of its occurrence.
• The NEC4 ECC approach to allocating risk of unforeseen ground conditions, force majeure, change in law and delay is compared to that in the FIDIC 2017 Yellow Book.
• Differences between indemnity and insurance clauses in each contract are also discussed.

All construction and engineering projects entail risk, particularly in terms of quality, time and cost. One of the most important functions of a construction contract is to allocate responsibility for these risks between the parties.

Unlike bespoke contract forms prepared by or on behalf of the parties, standard form contracts drafted by institutions, such as the NEC4 Engineering and Construction Contract (ECC), usually aim for a fair and balanced allocation of risk. They do this partly in response to market demands. Contracts with risk allocation perceived as unfair by some contractors are likely to result in higher tender prices, whereas contracts which are seen as giving too little protection to the employer do not find favour with many clients.

Risk allocation should also be governed by the answer to the question of which party can best foresee and control the risk event and which can best bear the consequence of its occurrence. What is appropriate in terms of risk allocation will vary as between different types of procurement (e.g. traditional employer design; design and build; engineering, procurement and construction (EPC)) as well as between domestic and international contracts, due to different attitudes towards risk in different markets and sectors.

The purpose of this article is to consider the approach to the allocation of particular risks under the NEC4 ECC and to compare it against another popular standard form of construction and engineering contract used internationally for design and build procurement, the FIDIC Conditions of Contract for Plant and Design-Build 2nd edition, commonly known as the 2017 Yellow Book.

Unforeseen ground conditions

NEC4 ECC allows time and cost relief in case of certain physical conditions encountered on site. The contractor is assumed to have taken into account site information provided to it, any publicly available information, information that may be obtainable through a visual inspection of the site and any other information which an experienced contractor could reasonably be expected to have or obtain.

NEC4 ECC uses an objective test namely that the ‘physical conditions’ have to be something that an experienced contractor would have judged at the contract date to have had such a small chance of occurring that it would have been unreasonable to have allowed for them. The meaning of this phrase was considered in the case of Atkins Ltd v. Secretary of State for Transport [2013] EWHC 139 (TCC). Atkins’ claim that a higher number of potholes than was expected constituted a compensation event was dismissed by the judge on the grounds that even though it would be difficult in practical terms to determine how many potholes would constitute an excessive number, the real question was whether the likelihood of occurrence of potholes was so small that it would have been unreasonable to have allowed for them at the contract date.

In the 2017 Yellow Book, the contractor is entitled to relief in case of unforeseeable physical conditions. ‘Unforeseeable’ is defined as ‘not reasonably foreseeable by an experienced contractor by the Base Date’ (i.e. by 28 days before the latest date for submission of the tender). The contractor is responsible for interpreting all site-related data made available to it and is deemed to have satisfied itself as to sufficiency of the accepted contract amount in the light of such data.

Force majeure

In the course of a construction project, performance of the parties’ obligations can be delayed, impaired or altogether prevented by events outside the parties’ control. Standardform contracts typically deal with this risk explicitly rather than relying on the relevant regime (if any) under the governing law of the contract.

In contrast to some other well-known standard form contracts, NEC4 ECC does not provide for a separate force majeure regime. However, the effect of the provisions referred to below is similar to what one finds in other standard form contracts. Clause 60.1(19) allows the contractor both time and cost relief by way of a compensation event if it can demonstrate that the event is something neither party could prevent, an experienced contractor would have judged the event to have such a small chance of occurring that it would have been unreasonable to have allowed for it, and the event is not covered under any of the other compensation events under the contract.

The 2017 Yellow Book has replaced the force majeure provisions in the 1999 edition with a new clause entitled ‘Exceptional Events’. The definition of these is similar (though not identical) to force majeure in the 1999 edition. Like NEC4 ECC, an exceptional event in the 2017 Yellow Book needs to satisfy certain conditions to qualify for relief. It needs to be an event or circumstance which is: beyond the affected party’s control; the affected party could not reasonably have provided against before entering into the contract; having arisen, such party could not reasonably have avoided or overcome; and is not substantially attributable to the other party. In such a case the contractor would be entitled to an extension of time and/or (in limited circumstances) additional payment.

Change in law

In NEC4 ECC, change in law is included but as a secondary option clause. If incorporated, it provides that any change in law shall be a compensation event entitling the contractor to time and money. Where the impact of a change in law is such that overall costs decrease, the contract price shall be reduced to reflect such a decrease.

Change in law relief is included as a default provision in 2017 Yellow Book and is relatively broad in scope. Any changes in the terms of any permits, permission, licence or approval (or requirement for these items to be obtained after the base date) entitles the contractor to time and money. Similar to NEC4 ECC, an adjustment to the contract price may be made to reflect any decrease in cost.

Delay

NEC4 ECC, again as a secondary option clause, provides for liquidated damages where the contractor fails to meet the time for completion. NEC4 ECC does not expressly refer to payment of such damages as the sole and exclusive remedy of the client for such delay. But it does expressly provide that if the completion date changes to a later date after the liquidated damages for delay have been paid, the client is to repay the overpayment of damages with interest.

If the client takes over a part of the works before the completion date, the delay liquidated damages are to be reduced pro rata to reflect the benefit to the client of the part of the works taken over as a proportion of the whole of the works from the date on which the relevant part is taken over.

The 2017 Yellow Book contains a delay liquidated damages clause and expressly provides that such damages shall be the only damages applicable to the contractor’s delay in completing the works by the time for completion. However, this does not apply in case of fraud, gross negligence, deliberate default or reckless misconduct by the contractor.

Indemnities

Under an indemnity, the indemnifier assumes a primary responsibility for the adverse event covered by the clause and undertakes to hold the indemnified party harmless against the consequences of that event. NEC4 ECC replaces indemnities with liabilities for costs, and expressly sets out the risks that the contractor and client assume.

The 2017 Yellow Book reworks the 1999 regime and includes a new care of the works and indemnities clause, making the contractor fully responsible for the works (subject to certain express exceptions) until the issue of the taking over certificate and from that point onwards for any loss or damage to the works caused by the contractor.

The 2017 Yellow Book and FIDIC EPC/Turnkey Contract 2nd edition (2017 Silver Book) feature a substantial strengthening of the contractor’s design obligations and liabilities using indemnity provisions, so that the contractor indemnifies the employer against all, ‘acts, errors or omissions’ in carrying out the contractor’s design obligations which results in the works, ‘not being fit for the purpose(s) for which they are intended’. The FIDIC Construction Contract 2nd edition (2017 Red Book) contains a similar provision in respect of any design carried out by the contractor.

Insurance

NEC4 ECC requires the contractor to take out certain insurances in the joint names of the parties in relation to loss of or damage to the works, loss of or damage to the contractor’s equipment, loss of or damage to property other than the works and liability for third party personal injury or death. The contractor must also obtain insurance with respect to personal injury or death of its employees. The client is required to obtain any other insurances which are stated in the contract.

In case of either party’s failure to obtain insurance, the other party may do so at such party’s cost and each insurance policy must include a waiver of subrogation rights against the parties (save for fraud), so that insurers can no longer take action which would undermine the agreed allocation of liabilities under the contract.

In the 2017 Yellow Book , the contractor must insure the works and goods against injury to persons and damage to property and injury to employees and must also provide, ‘all other insurances required by the Laws of the countries where (any part of) the Works are being carried out,’ and, ‘other insurances required by local practice (if any) shall be detailed in the Contract Data’. Importantly the requirement that the contractor’s indemnity in respect of breach of its fitness for purpose obligation to the employer in relation to design of the works needs to be covered by professional indemnity insurance if required by the contract data.

Summary

The FIDIC forms of contract have long been regarded as ‘international benchmarks’, but in terms of risk allocation the position varies significantly as between the different procurement methods and forms of FIDIC contracts.

NEC4 ECC stands out as being distinct from the other standard forms of contracts in regular use in the international marketplace. While the core clauses obviously adopt particular positions, the key feature of selecting from a large number of options and secondary option clauses means that it is more difficult to generalise about the balance struck between client and contractor.

This article has sought to highlight the differences in what is available. The key is party choice. Ultimately, the risk allocation under NEC4 ECC will be less that determined by institutional drafters and more by what the parties have agreed it to be without the need for sometimes extensive amendments.