NEC3 AND NEC4: ASSESSING COMPENSATION EVENTS

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1 NEC3 AND NEC4: ASSESSING COMPENSATION EVENTS IAN PARKINSON Senior Consultant, Manchester The NEC3 suite of contracts were first published in 2005, meaning that the industry has had 13 years getting to grips with this family of contracts and specifically the provisions relating to the assessment of compensation events. However, I still come across cases/examples where the Parties, when assessing compensation events, fail to follow the contract. This short article is drafted to detail some of the key points to consider when assessing compensation events. DEFINED COST The assessment of compensation events is based upon the event s effect on the Defined Cost. The principle behind this is that a contractor should not unfairly gain or lose as a result of the compensation event. This is different from other standard forms of contract, which use the rates and prices included in the contract as a basis for assessment, where a contractor can potentially make significant gains or a significant loss as a result of a change. However, I continue to see examples of contractor s using their rates to price compensation events rather than the Defined Cost. This can mean the contractor is taking on more risk than they should and subsequently they under recover their full entitlement. Clause 63.1 states: The changes to the Prices are assessed as the effect of the compensation event upon: - the actual Defined Cost of the work already done; the forecast Defined Cost of the work not yet done and; the resulting Fee. 1

2 So, the contractor is entitled to assess the impact of the compensation event on their Defined Cost. The most frequently used contract options to calculate Defined Cost are either the Schedule of Cost Components (SCC) or the Shorter Schedule of Cost Components (SSCC). The cost components in the schedules include people; equipment; plant and materials; charges; manufacture and fabrication; design and insurance. If a cost item is not listed in the schedules, then it is deemed included in the Fee. Under the NEC3, the cut-off point between whether the contractor uses actual or forecast cost to assess the impact, is the date when the Project Manager instructed, or should have instructed, the Contractor to submit quotations. When making their assessment, contractors need to ensure that they account for not only the direct cost of doing the work, but the prolongation and disruption including any inefficient use of labour and plant as a result of the event. I often see assessments where the direct costs are included, but the contractor has not accounted for the disruption caused by the event, thus affecting their level of recovery and ultimately. If a compensation event occurs and, as a result of the event, there are labour and plant (Equipment under NEC3) resources not fully utilised, then this needs to be included in the assessment. A contractor would not be entitled to submit a separate claim for delay and disruption under an NEC3 form of contract. TIME Clause 62.2 of the NEC3 contract states Quotations for compensation events comprise proposed changes to the Prices and any delay to the Completion Date and Key Dates assessed by the Contractor. This means, that contractor must ensure they include any time impact within their quotations. Failure to do so may result in them not being entitled to an extension of time under the contract. Obtaining an extension of time is a precursor to recovering time-relating costs on the project. Failure to assess and include the time impact of the compensation event, will result in the contractor being unable to recover the time-related costs and could also make them liable for damages. On previous projects, I have seen contractors failing to 2

3 include the time impact of the event within the quotation, resulting in under recovery of costs and potential liability for damages. It should not be assumed that the impact of time on the project can be assessed globally. There is no scope for global claims under the NEC3 contract. The contract is clear, in that each event is assessed individually and in sequence. It is also worth remembering that delays to the Completion Date, are assessed as the length of time that, due to the compensation event, actual planned Completion is later than the planned Completion as shown on the Accepted Programme i, under clause Therefore, the Contractor is entitled to additional time and cost if the compensation event delays the planned Completion date, not the contractual Completion Date. RISK Clause 63.6 entitles the Contractor to include within their assessment, risk allowances for cost and time to cover matters which have a significant chance of occurring and are at the Contractor s risk under the contract. This is probably one of the main areas where contractors are under recovering their full entitlement on NEC3 contracts. As we all know, when pricing any construction work, assumptions have to be made for unknown elements that may or may not affect the works. Under the NEC3 form of contract it would be naïve to assume that by including your own assumptions within the quotation as to how you have assessed the event, you are protected if those assumptions turn out to be incorrect. The only contract provision entitling the contractor to additional time and/or cost is the compensation event provisions in clause Clause 60.1(17) entitles the contractor to a compensation event if the project manager (the contractor under the subcontract) notifies a correction to an assumption which he had stated i Last Accepted Programme if NEC4 applies 3

4 within his compensation event. Therefore, it is important to obtain the assumption from the project manager in accordance with clause 61.6, thus giving the contractor peace of mind that they will be entitled to an additional compensation event if those assumptions turn out to be incorrect. If an assumption is not forthcoming from the project manager then the contractor would be well advised to include risk allowances for any unknown/undefined factors, which may affect the works. I often find that this then prompts the project manager to provide the relevant assumption(s). In order to clearly explain pricing risk under the NEC3 contract I will give an example below based on the risk of weather events affecting the works. In this scenario clause 60.1(13) has been deleted from the contract, meaning the contractor carries the risk for all delays resulting from weather events. A compensation event occurs (a change to the Works Information) and a significant amount of rainfall is forecast in the month that the event is to occur. When making the assessment, should the contractor assume that all days will be affected, resulting in significant downtime or just a few days affected with little or no downtime? Taking this scenario back to the contract, the risk must have a significant chance of occurring, otherwise it is not a valid allowance in accordance with clause Therefore, the contractor must make a reasonable assessment of the likelihood of the rainfall causing downtime and make their allowance based on that assessment. The next threshold is that the risk must be with the contractor s under the contract. In this scenario the clause entitling the contractor to a compensation event due to a weather event, 60.1(13), has been deleted, meaning that any time and cost impact caused by weather events is at the contractor s risk under the contract. If this clause had not been omitted then the calculation would be completely different. Assessing risk in compensation events is akin to the way in which a contractor would assess the risk inherent in pricing a tender. If they get it right, they will maximise their return on investment, however if they get it wrong, they could stand to lose a significant amount of money on the project. If contractors adhere to the provisions of the contract relating to the assessment of compensation events, they will ensure that they maximise their returns on a project, thus maximising the bottom line. If you are having problems on an NEC3 or NEC4 contract regarding the assessment of compensation events, or any other matter, please do not hesitate to contact your nearest DGA office. 4

5 MORE INFORMATION If you would like to find out more details about any of the subjects covered in this Ebriefing please contact DGA Group through the contact details below or at DGA GROUP HEADQUARTERS 25 Eastcheap BIRMINGHAM Tel: +44 (0) London MANCHESTER Tel: +44 (0) United Kingdom NOTTINGHAM Tel: +44 (0) EC3M 1DE LEEDS Tel: +44 (0) BRISTOL Tel: +44 (0) Tel: +44 (0) MAIDSTONE Tel: +44 (0) UNITED ARAB EMIRATES SINGAPORE CANADA Office Anson Road 160 Quarry Park Boulevard SE Park Lane Tower #19-02 Suite 300 Al A amal Street Twenty Anson Calgary Business Bay Singapore Alberta United Arab Emirates Singapore Canada T2C 3G3 Tel: Tel: Tel: +1(403) Tel: HONG KONG AFRICA Suite 2802 Building 2 Lippo Centre Tower 2 Country Club Estate 89 Queensway 21 Woodmead Admiralty Sandton Hong Kong South Africa 2054 Tel:

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