NEC and Risk

Why We Need Fair and Sustainable Risk Allocation

Projects should allocate risks to the party best placed to manage them. This judgement normally flows from an assessment of a project’s complexity and size. Complexity creates more risks, while size increases the financial impact of a risk being realised. In both cases suppliers normally demand a higher price for taking on higher levels of risk. However, in highly complex scenarios, pricing risks might not be feasible. Also, for larger projects, contractors and sub-contractors may lack the financial strength to accept their share of project risk.  In these circumstances it might be more beneficial for both sides to either share the risk or for the client to take on risk.

In a tight market or where a client has a dominant position in the sector, there may be a temptation for client to use their power to unfairly (and unsustainably) offload risk on to their suppliers. While this could lead to a short-term cost advantage for the client, it often results in long-term difficulties. Suppliers may adopt an aggressive stance to improve their position, leading to conflicts, strained relationships, and project setbacks.

Establishing a fair and sustainable risk allocation aligns the interests of clients and suppliers, fostering a co-operative environment across multiple contracts that cover the relationships with different suppliers servicing various project aspects from design to operations.

How does NEC help?

NEC provides diverse payment and delivery models tailored to match the complexity and scale of projects:

  • For straightforward work where a supplier can handle project risk: Clients can opt for a fixed price contract, ensuring cost certainty.
  • In complex or larger projects where both client and supplier agree to pool risk: Clients can use a Target Cost contract, sharing savings or overspends through a pain/gain mechanism.
  • When the client is best suited to manage risks: Clients use a Cost-Reimbursable Contract, in which suppliers receive their costs plus an agreed fee or a Management Contract, in which suppliers are paid a fee for managing the sub-contractors delivering the works.

These choices are further complemented by optional contract clauses allowing parties to address issues upfront, while also allowing contracts to reflect public policy priorities such as fair payment or local content provisions. The suite also supports framework contracts and design, build and operate options.

Early identification and timely resolution of problems

Risk allocation is not the same as risk management. It is essential that the parties to the project co-operate to ensure that problems are identified and dealt with as soon as they arise. A project should have a single view of live risks and how they will be dealt with. This shared view must extend to the implications of any action taken for the project budget, its delivery programme, and the quality of what will be delivered. 

NEC's Early Warning Process Explained

The foundation of the NEC contract is an obligation on all parties, “to act in a spirit of mutual trust and co-operation”. This obligation is brought to life by NEC’s unique early warning process. This is a risk management process that requires all parties to give each other early warning about matters potentially affecting project costs, completion delays, or operational work performance. 

A register of the early warning matters must be maintained, and regular early warning meetings are held to strategize and assign necessary actions to mitigate identified risks.

The contract requires updating the delivery program and budget forecasts to reflect the impact of agreed-upon actions, ensuring a single source of truth about the project's status.

The contract also includes a comprehensive list of compensation events, describing situations entitling the supplier to additional fees or time extensions. A clear process for logging these claims exists, aiming to resolve disputes swiftly without resorting to legal action. The contract outlines steps involving senior representatives, adjudicators, and potential tribunals for dispute resolution. 

Moreover, NEC offers the option of appointing a Disputes Avoidance Board, comprising members who periodically inspect the work in progress. This board identifies potential disputes early on, providing non-binding recommendations for fair resolutions benefiting both parties, aiming to prevent disputes from escalating.