Key Points
- An expense deemed as ‘Disallowed Cost’ in NEC cost-reimbursable contracts cannot be recovered by contractors.
- This represents a potential risk to contracting parties when contractors fail to prove that their expenses should not be disallowed.
- This article reviews the contractual definitions of disallowed cost and the importance of understanding the level of detail and records required to avoid disallowed costs.
Disallowed costs represent one of the biggest risks to contractors under the NEC4 Engineering and Construction Contract (ECC) cost-reimbursable options, namely Options C (target contract with activity schedule, D (target contract with bill of quantities), E (cost reimbursable contract) and F (management contract).
This article examines some of the risks associated with disallowed costs and highlights some of the key issues for consideration by the parties to an NEC4 ECC Options C, D or E.
Disallowed costs serve several purposes, including encouraging better contract management and preventing the recovery of non-defined costs by the contractor during the administration of the contract by the project manager.
Understanding disallowed cost
What counts as ‘Disallowed Cost’ is set out in clause 11.2(26) of NEC4 ECC under 10 bullet points. Each of these are discussed in the table below.
| Clause 11.2(26) bullets | Comments |
|---|---|
‘Disallowed Cost is cost which
|
It is important for the contractor to prove that expenses incurred in providing the works are supported by its records, otherwise they will be deemed as disallowed costs. The level of detail and substantiation expected should be agreed by the contractor and project manager from the outset. |
|
All payments made to a subcontractor or supplier should be strictly as stated in the contract, otherwise they will be disallowed. |
|
The client will naturally expect the contractor to follow all acceptance or procurement procedures set out in the scope before spending the client’s money. The acceptance or procurement procedure should be clearly set out in the contract to reduce the risk of disputes and/or disagreements between the contractor, project manager and client. Where the contractor has failed to follow an acceptance or procurement procedure, the assessment of such disallowed costs can be a difficult decision for the project manager. |
| – ‘give an early warning which the contract required it to give’ | If the contractor incurs extra costs which would not have been incurred if an early warning been given, then such extra costs are disallowed cost. It is important for the contractor to give early warnings as required by clause 15.1 if it becomes aware of any matter which could increase the total of the prices, delay completion, delay meeting a key date or impair the performance of the works in use. |
| – ‘give notification to the Project Manager of the preparation for and conduct of an adjudication or proceedings of a tribunal between the Contractor and a Subcontractor or supplier’ | The contractor must notify the project manager of any dispute with a subcontractor or supplier to enable the project manager and/or client to get involved in the resolution of the dispute. Legal costs incurred by the contractor which could have been prevented will be disallowed cost. |
‘and the cost of
|
Costs incurred by the contractor in correcting defects after completion are disallowed costs, unlike the costs of correcting defects before completion, which are reimbursed in Options C, D and E. |
|
The cost of correcting any defects caused by the contractor’s failure to comply with a constraint on how to provide the works as stated in the scope is disallowed cost. |
|
What is reasonable wastage of the contractor’s plant and materials is subjective and will be decided by the project manager. It is vital therefore that the contractor keeps good records to prove that all costs of plant and materials incurred are reasonable and should not be disallowed costs. |
|
The contractor has to demonstrate, from its records, that it has not allowed an excessive amount of resources after allowing for reasonable availability and utilisation. Otherwise, this too would be disallowed cost. |
|
This head of disallowed costs is understandable as no client would wish to pay for the cost of legal proceedings being taken against it. |
Impartiality of the project manger
As highlighted by Neil Earnshaw in Issue 137, the case of Costain Ltd & Ors v. Bechtel Ltd & Anor [2005] EWHC 1018 (TCC) set a strong precedent for NEC project managers to act impartially between the client and contractor when assessing disallowed costs.
The court held that, ‘it would be a most unusual basis for any building contract to postulate that every doubt shall be resolved in favour of the employer and every discretion shall be exercised against the contractor’.
The key lesson to take away from this case is that project managers must avoid acting solely in the client’s interest when certifying payments.
Conclusion
In summary, disallowed costs represent a significant risk to contractors and can result in a negative impact on the overall success of a project. As a result, it is fundamental that contractors have robust record-keeping procedures in place to assist in avoiding disallowed costs.
- Author
- Charles Edwards, New Temple Chambers
- Share this page
-
- Copy link
