The use of the NEC3 contract is becoming more widespread. For example, it is being used to construct the innovative Halley 6 Research Station, which is being constructed on a moving ice shelf in Antarctica. It is also the contract that has been chosen by the Olympic Development Agency (“ODA”), the single body that has been created to ensure the delivery of the 2012 Games and beyond. In particular, the ODA is responsible for the planning, designing and building of the venues, facilities and accommodation, and the development of the infrastructure to support these. The ODA released its draft Procurement Policy for consultation on 11 July 2006. This policy outlines the ODA’s requirement that the 2012 Games are delivered on time and budget, in a way that benefits the community and environment, in keeping with the spirit of London’s Olympic Bid.
Nicholas Gould gave a talk to the SCL Conference held in Singapore in February 2007 entitled “NEC3: The Construction Contract of the Future?”. In an extract from that talk, a full copy of which can be found on our website, Nicholas talks about the NEC3 early warning procedure.
The early warning procedure, at core clause 16, provides that:
- the contractor is to give the project manager a warning of relevant matters;
- a relevant matter is anything which could increase the total cost or delay the completion date or impair the performance of the finished work;
- the contractor and project manager are then required to attend an early warning meeting if one party so requests. Others might be invited to that meeting; and
- the purpose of the early warning meeting is to work together to discuss how the problem can be avoided or reduced. Discussion will focus on what action is to be taken next, and to identify who is to take that action.
It could be said that this is a partnering-based approach to the resolution of issues before they form entrenched disputes. Cooperation between the parties at an early stage provides an opportunity for the parties to discuss and resolve the matter in the most efficient manner. This is a departure from the usual approach of the contractor serving formal notices. A contractor may receive compensation for addressing issues raised by way of the early warning system. On the other hand, if a contractor fails to give an early warning of an event that subsequently arises, and that he was aware of, then any financial compensation is assessed as if he had given an early warning. If, therefore, a timely early warning would have provided an opportunity for the employer to identify a more efficient manner of resolving the issue, then the contractor will only be paid for that economic method of dealing with the event.
Risk register
The risk register which appears at clause 16.3 is new. The risk register will initially contain risks identified by the employer and contractor, but the risk register will develop as the project proceeds. It works hand in hand with the early warning process and in conjunction with the proactive project management approach of the contract. There are three main objectives of the risk register:
- to identify the risks associated with the project;
- to set out how those risks might be managed; and
- to identify the time and cost associated with managing those risks.
It may be possible to precisely and specifically identify risks that can be added to the register, or in other instances the risk register may simply contain some generic risks. The process of identification allows the parties to consider how those risks might be managed before turning their attention to the time and cost implications. If Option A or B (priced contracts) applies, then the employer will only bear the costs in terms of time and money if a risk is covered by a compensation event. Otherwise, the contractor bears all other risks. The approach is similar for Options C and D (target cost contracts) in that the employer will bear the risk if the event is one listed in clause 80.1. If not, the employer will in any event initially bear the risk, but the risk will then be shared through the risk share mechanism set out in clause 53.
There is however the further impact of clause 11.2(25) dealing with “disallowed cost”.[1] If an element of cost is a disallowed cost, then the risk will be the contractor’s in any event. Finally, the employer bears almost all of the risk under Options E and F (cost reimbursable contracts). This is unless the risk is covered by the definition in clause 11.2(25) or 11.2(26) again relating to disallowed costs. Nonetheless, the important aspect of the risk register is not just the early identification, but also the ability to then appraise and re-appraise as well as proactively manage risks before they occur. The overall effect of a well-run risk register is a greater assessment of the overall financial outcome of the project and a greater ability to manage the time for completion.
Compensation events
Core clause 60 deals with compensation events. If a compensation event occurs, which entitles the contractor to time and/or money, then these will be dealt with on an individual basis. If the compensation event arises from a request of the project manager, then the contractor is asked to provide a quote, which should also include any revisions to the programme. The project manager can request that the price or programme is revised, but only after he has explained his reasons for the request.
The general scheme of clause 60 is to define those events which are compensation events. Notice provisions are required at clause 61. The project manager may request a quotation in respect of a compensation event. The contractor should submit its quotation within three weeks of a request by the project manager. The project manager then replies within two weeks, either accepting the quote, instructing a revised quote, notifying the contractor that the proposed instruction will not be given, or notifying the contractor that the project manager will make his own assessment.
Compensation events are assessed under clause 63. A compensation event is assessed by reference to the “actual Defined Cost of the work already done, the forecast Defined Cost of the work not yet done and the resulting Fee”. Clause 52 deals with defined cost, which is the “contractor’s cost which is not included in the Defined Cost and treated as included in the Fee”. The defined cost comprises the rate and percentages that are set out in the contract data less any discounts, but subject to an additional fee.
A delay to the completion date is assessed by reference to the planned completion shown on the accepted programme. The adjustment to the time for completion is, therefore, based upon assumptions, and may include for risks associated with the forecasting of any particular event. There is, however, no change to any adjustment to the time for completion if the assessment turns out to be wrong.[2]
NEC3 has adopted a more strict regime for contractors in respect of compensation events. Core clause 61.3 is set out in terms:
“The Contractor notifies the Project Manager of an event which has happened or which he expects to happen as a compensation event if the Contractor believes that the event is a compensation event and the Project Manager has not notified the event to the Contractor.”
If the contractor does not notify a compensation event within eight weeks of becoming aware of the event, he is not entitled to a change in the price, completion date or a key date unless the project manager should have notified the event to the contractor but did not. This clause must also be read in conjunction with clause 60.1(18) which states that a compensation event includes:
“A breach of contract by the Employer which is not one of the other compensation events in this contract.”
Clause 61.3, therefore, effectively operates as a bar to the contractor in respect of any time and financial consequences of any breach of contract if the contractor fails to notify.
The courts have for many years been hostile to such clauses. More recently, there has been an acceptance by the courts that such provisions might well be negotiated in commercial contracts between businessmen.[3] The House of Lords case of Bremer Handelsgesellschaft MBH v Vanden Avenne Izegem PVBA provides authority for the proposition that for a notice to amount to a condition precedent it must set out the time for service and make it clear that failure to serve will result in a loss of rights under the contract. This seems relatively straightforward. However, it may not be possible for an employer to rely upon Bremer where the employer has caused some delay. An employer may, therefore, be in some difficulty when attempting to rely upon Bremer in circumstances where it has caused the loss or a proportion of the loss.
The courts interpret strictly any clause that appears to be a condition precedent. The court will construe the term against the person seeking to rely upon it and also will require extremely clear words in order to find that any right or remedy has been excluded. However, an alternative approach to the drafting of such provisions was highlighted in the case of City Inn Ltd v Shepherd Construction Ltd. City Inn was the employer, and Shepherd was the contractor for a hotel at Temple Way, Bristol. The conditions incorporated the JCT Standard Form of Contract Private Edition With Quantities (1980 edition). The architect granted an extension of time of four weeks. An adjudicator then granted a further extension of five weeks.
City Inn argued that as the contractor failed to comply with clause 13.8.1 they were not entitled to any extension of time. Shepherd claimed that clause 13.8.5 was a penalty clause and was therefore unenforceable. They also argued that the clause only applied if on receipt of an instruction the contractor actually formed the opinion that there would be an adjustment to the contract sum and delay to the completion date.
Lord Justice Clerk, delivering the opinion of the court, held that the contractor was impliedly obliged to have applied his mind to the question and form a view as to the likely consequences of an architect’s instruction. It was not sufficient for the contractor quite simply not to bother to think about the position. The clause was not a penalty because the contractor had the option, if he wished to avoid liability for the delay, of applying his mind to the clause and then providing the employer with the details required by clause 13.8.1. As the contractor had failed to comply with the clause, he had deprived the employer of the opportunity to address the matter, if the employer considered that the cost and/or the delay, potentially caused by the instruction, were not acceptable.
One important distinction between the drafting of the provision in City Inn and the NEC3 is that the contractor in City Inn did not have to carry out an instruction unless he had submitted certain details to the architect. The NEC3 is a bar to the bringing of a claim simply for a failure to notify the project manager about a compensation event. A specific instruction might not have been given. The contractor might not be prompted to respond in the absence of a specific instruction.
Mr Justice Jackson, in the case of Multiplex Constructions (UK) Limited v Honeywell Control Systems Limited (No. 2) [2007] EWHC 447, agreed with the view taken in City Inn v Shepherd, that there are good reasons both for the employer requiring a contractor to give prompt notice of delay, and also for creating a sanction by way of condition precedent for any failure to give such notice. He said that:
“Contractual terms requiring a contractor to give prompt notice of delay serve a valuable purpose; such notice enables matters to be investigated while they are still current. Furthermore, such notice sometimes gives the employer the opportunity to withdraw instructions when the financial consequences become apparent.”
Time bars are becoming increasingly common. This judgment confirms that time bars are legally enforceable and that they do not set time at large. Consequently, all parties should always carefully check their contracts when entering into them in order to see whether there are any time bars in the extension of time or loss and expense clauses.
[1] Under NEC3, Option C “disallowed costs” are costs which the project manager decides are not “justified by the Contractor’s accounts and records”, should not have been paid to a subcontractor or supplier, and were incurred because the contractor did not follow acceptance or procurement procedures or give an early warning.
[2] Clause 65.2: “The assessment of a Compensation Event is not revised if a forecast upon which it is based is shown by later recorded information to have been wrong”.
[3] See for example Photo Production Ltd v Securicor Ltd [1980] AC 827.