UK: The New Engineering Contract: A Progress Report

Last Updated: 20 November 2006
Article by Philip Boulding QC MA LL.B (Cantab)

Introduction

1. The "New Engineering Contract" (NEC) has:

  • become increasingly popular,
  • particularly in the public sector,

since the first edition was published in 1993.

2. A second edition (NEC2) was published in 1995, when it was renamed the "Engineering and Construction Contract". Points:

  • NEC2 became the norm for many central government agencies, including the Environment Agency and NHS Estates ‘Procure 21’.
  • It is also well used by local authorities, and is becoming more common in the private sector.
  • It is used, for example, by BAA on all projects including Heathrow Terminal 5.

3. The third edition (NEC3) was launched in July 2005. Points:

  • NEC3 stands as a ‘Suite’ of construction contracts designed to meet the needs of a variety of projects.
  • Included in the Suite are three forms of Engineering and Construction Subcontract, a Professional Services Contract, a Team Service Contract and a Framework Contract.

4. The Office of Government Commerce:

  • Now recommends that public sector procurers use the NEC3 contracts on their construction projects
  • It has stated that NEC3 "now complies fully with the Achieving Excellence in Construction principles, using simple language and modern project management techniques."

5. In fact, the list of high profile projects using NEC3 is ever expanding. Points:

  • In April 2003 the Olympic Delivery Authority selected it for the London 2012 Olympic Games projects.
  • NEC3 is also reported to be used extensively overseas by clients including Eskom, Anglo Platinum (Mining), Transnet and ABSA Bank of South Africa.

6. Sir Michael Latham provided the following comments (for the NEC Users’ Group newsletter):

"In my 1994 report ‘Constructing the Team’ I said the first edition of the then New Engineering Contract met 11 of the 13 principles that characterised an effective, modern construction contract – far more than any other contract form then available.

Within a year the NEC 2nd edition came out and became the only contract to comply with all 13 principles. It is thus not surprising that the NEC 3rd edition remains at the forefront of best practice, becoming the first contract to meet all criteria of the UK Government’s Achieving Excellence in Construction initiative.
In addition to supporting the Office of Government Commerce’s recommendation that NEC3 be used by all public-sector construction procurers, I also commend its adoption by any private sector client wishing to procure their construction work on time, within budget and without litigation.

Looking to the future, in just seven years’ time the British construction industry has an unprecedented opportunity to prove its world-class status when it unveils £2.4 billion of state-of-the-art facilities for the 2012 Olympics. The procurement race is about to start – and I can think of no other contract form better-suited to winning it than NEC3."

7. Despite such eminent approval:

  • the use of "simple language" in the NEC has not met with universal approval, and
  • on the whole the quality of its drafting is not often considered one of its greatest strengths.

An Overview Of The NEC/ECC Approach

8. There are three distinctive features of the NEC:

  1. The use of "simple language", and the present tense throughout;
  2. The emphasis on good project management by the Contractor and the Project Manager.
  3. The division of the contract into "Core Clauses" and "Options".

  • The Options allow for choice on such important matters as:
    • the basis on which the Contractor is to be paid,
    • and the dispute resolution procedure,
    • as well as a host of secondary options.

‘Simple Language’

9. The NEC has deliberately been drafted in non-legal language, and in the present tense throughout.

  • This is intended to make the contract easier to understand,
  • But frequently has the opposite effect.

10. It is not always clear whether it is intended to impose an obligation upon the Contractor or Project Manager. Points:

  • In conventional drafting (and in everyday language) obligations and optional activities are distinguished by the use of "must" or "shall" for the former and "may" for the latter.
  • NEC3 and its predecessors occasionally make use of these expressions, but more frequently is drafted as in the following example:

"A Partner may ask another Partner to provide information that is needs to carry out work in its own contract and the other party provides it."

11. It is ironic that one of the few instances that "shall" is used is in relation to a somewhat vague obligation:

"The Employer, the Contractor, the Project Manager and the Supervisor shall act as stated in this contract and in a spirit of mutual trust and cooperation"

12. The precise obligations and sanctions imposed for non-compliance are also often unclear.

  • For example, NEC3 provides (in common with its predecessor) at clause 27.3 that:

"The Contractor obtains approval from Others for his design where necessary."

13. The following are not apparent, at least from this clause alone:

  1. what criteria are to be applied to decide whether approval is necessary;
  2. what criteria are to be applied in deciding whether to give approval:
    • whether it is not to be unreasonably withheld, or
    • whether it is a matter entirely within the discretion of Others;

  3. what sanctions or consequences follow from a failure to seek approval, or a refusal of it.

14. Again, this is a drafting issue that occurs frequently. Points:

  • In some cases the answers to these questions can be deduced from the other provisions of the contract,
  • But despite the use of simple and clear language in what has been written, what is unsaid and what the contract means may be far from clear or simple to ascertain.

Project Management

15. One of the NEC’s perceived strengths is the emphasis on project management and partnership.

16. The general approach of the NEC forms of contract, which is to encourage the early identification and resolution of problems, has been retained in the latest edition. Points:

  • The contract is designed to encourage the proactive resolution of difficulties and "partnership,"
  • This is a concept which is reflected in hard cash in the "Target Cost" payment options, which are also the most frequently used.
  • Many of the changes in NEC3 are intended to increase that strength.

17. The role of Project Manager is of specific interest,

  • not only because of the importance of the role itself, but
  • because it became the focus of one of the few reported decisions on the NEC form of contract: Costain v Bechtel [2005] EWHC 1018.

I will consider that role specifically along with Jackson J’s judgment once I have completed my initial overview of NEC3, and considered the changes incorporated since NEC2.

Option and forms of the NEC contract

18. The NEC2 included several different contracts as have been mentioned above:

  • the Engineering and Construction Contract,
  • the Engineering and Construction Subcontract,
  • the Engineering and Construction Short Contract,
  • the Engineering and Construction Short Sub-contract,
  • the professional Services Contract, and
  • the Adjudicator’s contract.

19. NEC 3 adds a Term Service Contract and Framework Contract.

20. Thankfully NEC3 also includes a Procurement and Contract Strategies document to assist those faced with such a wide choice.

21. The contracts consist of nine ‘core clauses’.

  • The parties then select their preferred pricing option (options A-F).
  • These are known as the ‘main option clauses’:

Option A: Priced contract with activity schedule.

Option B: Priced contract with bill of quantities.

Option C: Target contract with activity schedule.

Option D: Target contract with bill of quantities.

Option E: Cost reimbursable contract.

Option F: Management contract.

22. Where appropriate, the contract is completed by the selection of one or more of the 17 ‘secondary option clauses’:

Option X1: Price adjustment for inflation.

Option X2: Changed in the law.

Option X3: Multiple currencies.

Option X4: Parent company guarantee.

Option X5: Sectional completion.

Option X6: Bonus for early completion.

Option X7: Delay damages.

Option X12: Partnering.

Option X13: Performance Bond.

Option X14: Advanced payment to Contractor.

Option X15: Limitation of Contractor’s liability for his design to reasonable skill and care.

Option X16: Retention.

Option X17: Low performance damages.

Option X18: Limitation of liability.

Option X20 Key Performance Indicators.

Option Z: Additional conditions of contract.

23. Despite the length of the list one should not be overawed:

  • Many of these options add only a short paragraph, and
  • For Options A to F the contract is published as a separate booklet.
  • The true test of acceptance of the NEC form is the extent to which the parties incorporate their own bespoke amendments with Option Z.

Principal Changes In The New Edition

24. New elements in NEC3 are:

  1. the addition of the Term Contract and the Framework Contract:
    • The Framework Contract uses just two additional pages to transform any other NEC contract into a framework contract;

  2. Option X18: Limitation of liability:
    • On large projects contractors often seek to negotiate limits on their potential liability and so it is preferable that a standard clause is available.
    • The clause and the blank spaces in the contract data pages (if filled in) provide limits of liability that can be set for different types of loss and damage.
    • That allows the user to have separate limits for indirect and consequential loss, liability from single events and design liability.
    • Space is also provided for a further limit covering the contractors total liability, but
    • It should be noted that that this sum excludes any liability for delay damages, or for performance damages or for loss or damage to the Employer’s property to the extent that the Contractor is liable under the contract terms in any event.
    • Space is also provided for a long stop liability date to be entered.

  3. Option X20 Key Performance Indicators:
    • The intention of the Option is to provide another financial incentive to a contractor.
    • In an incentive schedule Key Performance Indicators are agreed.
    • The Contractor’s performance is measured against what are intended to be clear targets.
    • If a target is achieved (or bettered) then the Contractor reaps a financial reward.
    • There is no penalty for under achieving.
    • Whether competitive tenderers will change the profit margins in their tenders in the hope that they can make up that money through the incentive scheme remains to be seen.

25. In addition, several changes have been introduced to the new edition of the NEC3 Engineering and Construction Contract (ECC) these include:

  1. The revision of the clauses which deal with the notification and procedure for dealing with Compensation Events;
  2. The introduction of a Risk Register, in clause 16.3:
    • This is kept up to date during the project by the Project Manager;
    • This is intended to become to central risk management tool.

  3. The provision for Key Dates
    • intended to be used for milestones that the Contractor is obliged to meet.

Compensation Events

26. The Compensation Event procedure is fundamental to the operation of the NEC contract

  • This is because all changes to the Contractor’s entitlement to additional money and to time for completion are through this procedure.

27. Clause 61.3 of NEC2 provided that the "the Contractor notifies an event which has happened or which he expects to happen to the Project Manager as a compensation event if" amongst other things "it is less than two weeks since he became aware of the event".

28. It was not at all clear what happened if the Contractor missed the 2 week period, and

  • this provision was frequently subject to bespoke amendment by employers
  • in particular, so as to provide that notification within time was a condition precedent to the Contractor’s entitlement.

29. In NEC3, clause 61.3 is amended to include the following:

"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 Prices, the Completion Date or a Key Date unless the Project Manager should have notified the event to the Contractor but did not."

30. This is obviously a compromise between the interests of contractors and employers,

  • But it may not be satisfactory to either party.
  • The Project Manager should have notified the event if it was an instruction or a change to an earlier decision, but when else?

31. Quotations for Compensation Events are retained, but

  • now the contract has more teeth in the event that the Project Manager falls behind in his administration and fails to notify whether he accepts or rejects a quotation.
  • After delay, notification from the contractor and a further delay there is deemed acceptance of the contractor’s quotation.

Introduction of the Risk Register

32. There has been, and remains, a scheme for the early identification of risks. Points:

  • The so called "early warning" system.
  • It is still the case that failure by the contractor to gave an early warning does not result in any penalty or change in the contractor’s entitlement for a compensation event if a foreseeable, but unforeseen, risk become reality.
  • (Clauses 61.5 and 63.5 result in a mere slap on the wrist.)

33. The risk register itself is

  • "a register of the risks that are listed in the Contract Data and the risks that the Project Manager or the Contractor has notified as an early warning matter. It includes a description of the risk and a description of the actions which are to be taken or avoided to reduce the risk".
  • It is maintained and amended (after agreement) by the Project Manager.

34. This is a document which is at the heart of the project management of the project. Points:

  • The expectation of draftsmen is that if risks are identified early enough it will often be possible to prevent risks from becoming reality.
  • Either the Project Manager or the Contractor can instruct the other to attend a risk reduction meeting.
  • It should be noted that the contract now states expressly that if a decision (on how to reduce risk) needs a change in the Work Information then the Project Manager instructs the change.

35. It does seem that the risk register and early warning system may be skewed in the Contractor’s favour.

  • For example the Contractor may give an early warning of maters which could increase his total cost.
  • It can then require the Project Manager to attend a meeting where the Project Manager is required to cooperate in seeking a solution to that will bring advantage to all affected (here the Contractor).
  • It is possible that a decision will be taken that requires a change to the work.
  • Is this a matter for which compensation should be payable?

Key Dates

36. Provision is made for key dates (milestones) by which the work is to have reached a particular state by a particular date. Points:

  • This is sensible.
  • There can be Other contractors of the Employer whose work has to be coordinated with the progress of work by the Contractor.
  • Clause 30.3 states:

"The Contractor does the work so that the Condition stated for each Key Date is met by the Key Date"

37. However, the contract also provides for the circumstances in which the Contractor does not.

  • This is found in clause 25.3.
  • Employers needs to take considerable care in respect of this clause.
  • The consequence of the Contractor’s failure are circumscribed. The only recovery the Employer can claim for is:

    • additional cost in carrying out work on the same project;
    • additional cost in paying an additional amount to Others in carrying out work on the same project.

  • Further, the assessment of loss is to be made within four weeks of the missed date, not the loss being incurred.

38. There is no possibility of recovery of further consequential loss suffered by the employer if the project as a whole runs late because one other contractor is prevented from starting when a key date is missed by the Contractor.

  • Completion of the Work by a particular date may, on some projects, be of less financial significance to the employer than the Contractor achieving a key date.
  • It is possible that Option Z (incorporating bespoke amendments) will come into its own here.

Role Of The Project Manager

39. As I indicated above, one of the few occasions when the construction of the NEC form has been tested in the Courts was in Costain v. Bechtel [2005] EWHC 1018.

40. Before I turn to that case, it would be useful to take a quick look at the Project Manager’s role as provided by the contract.

41. The Project Manager is appointed, and potentially replaced by the Employer. Points:

  • He plays a central role under the NEC.
  • Under NEC3 the PM is possibly even more significant that earlier editions.
  • The Employer has a relatively minor role, the Project Manager runs the show.
  • He issues instructions.
  • He maintains the risk register.
  • He reviews Contractor’s designs.
  • He monitor’s progress, approves programmes, and seeks quotations for acceleration.
  • He assesses compensation events for changes to the completion date or additional money.
  • He assesses the amounts due for payment.

42. These duties must be completed within specified timescales. Points:

  • A failure to respond results in a ‘deemed’ acceptance of the contractor’s notification/ quotation.
  • This provision is aimed at project managers who are not performing their duties diligently under the contract or
  • One who sit on the fence, for example, in making a determination as to a compensation event or the basis of the contractor’s assessment in a quotation.

43. The effect would be that the employer is fixed with the contractor’s interpretation of events or costs.

  • This may result in greater cost or time to the project which will be borne by the employer even where an event may not constitute a compensation event in the first place.
  • The Project Manager is thereby encouraged to perform his services diligently by the contract.

44. A cynic may think that:

  • This position provides the contractor with an incentive to overburden the Project Manager with requests in the hope to gain an advantage through the contract by exaggerating his claims.
  • If that were to be the case, the relationship between Project Manager and contractor could become increasingly strained.

45. In any event, it would appear that the role of the Project Manager under an NEC contract may be more complex and onerous than under an alternative form.

46. An example of this is found in Bechtel v Costain. Points:

  • There, Bechtel was the lead player in a consortium appointed as Project Managers for the Channel Tunnel High-Speed Rail Link Project.
  • Costain was part the consortium of appointed contractors.
  • The Employer was not a party to the action.

47. Care needs to be taken with the case because:

  • Of the limited legal hurdle required for the application that came to court.
  • However the case illustrates that even in a contract where the parties are required to "act in a spirit of mutual trust and co-operation" disputes may arise when the financial bottom line is under threat.

48. Also note:

  • The contractor was to be reimbursed on the basis of actual cost less disallowed costs.
  • The PM was to decide which costs were disallowed by applying the provisions of the payment clause.
  • After nearly four years a deduction of £1.4m had been made from costs of £264.2m.
  • There was then a sea change.
  • In the next month disallowed costs rose to £5.8m: a factor of four.
  • After a meeting of the project management team, rumours spread that Bechtel had been instructed by their manager to disallow legitimate costs.
  • It seems that the rumour was wrong, but that Bechtel had been instructed to "adopt a stricter attitude" and "aggressively disallow costs where [they] could" and to exercise their function under the contract in the interests of the Employer.
  • It seems, at the expense of impartiality.

49. Despite the limited scope of the decision the judge, Jackson J., expressed clear views that:

  • when his role required him to hold the balance between Employer and Contractor the PM was in the normal role of a certifier.
  • In those roles he was required to act impartially.
  • Only when this was not the case was the Project Manager entitled to act in the best interest of the Employer:

"contract C105 (and indeed the New Engineering Contract on which it is based) is more specific and contains more objective criteria than conventional construction contracts. Nevertheless, there are still many instances where the Project Manager has to exercise his own independent judgment, in order to determine whether the criteria are met and what precisely should be paid to the contractor or deducted from payments made to the contractor ...

I quite accept that in discharging many of its functions under the contract, the Project Manager acts solely in the interests of the employer. This is the case, for example, when the Project Manager is deciding which of two alternative quotations to accept. Nevertheless, I do not see how this circumstance detracts from the normal duty which any certifier has on those occasions when the Project Manager is holding a balance between employer and contractor".

50. It seems that litigation on the NEC contract has now reached the position that was reached on the RIBA / JCT series of contracts in 1974, Sutcliffe v Thackrah [1974] AC 727.

Conclusion: The Advantages And Disadvantages Of NEC3

51. I think that it would be useful to conclude with my own assessment of the advantages and disadvantages of the NEC form of contract.

  1. Firstly, while the language uses might be user-friendly to non-lawyers, the use of narrative, descriptive present tense causes concern to legal advisers who have to interpret its effect.
  2. While it is true that the NEC places a commendable emphasis on promoting good project management practice, it places the Project Manager in:
    • an extremely demanding role which demands an intense use of resources, and
    • a certain amount of uncertainty relating to areas where his duty of impartiality applies (Costain v Bechtel).

  3. Even the wide range of choice given by the Options can be criticised as being confusing to those unfamiliar to the NEC Suite.
  4. Although
    • NEC3 is considered the suitable choice for partnering and other collaborative arrangements,
    • the legal effect of the ‘spirit of mutual trust and cooperation’ provision remains uncertain.

  5. Finally, the risk register:
    • makes possible the early identification of risks,
    • but has led to concerns that it may be skewed in the contractor’s favour, obliging the Project Manager to cooperate to the contractor’s advantage.

52. For those:

  • familiar with the NEC
  • willing to accept the heavy administrative burden (and associated costs) that it is likely to result during the execution of a contract
  • NEC3 is a further step in the right direction for contracting.

53. It cannot be denied that:

  • few disputes where NEC has been used have reached the courts.
  • That is welcome.
  • Time will tell whether this continues to be the case as NEC3 becomes widely adopted.
  • It may be that the draftsmen’s have achieved a contract which distributes risk fairly and which replaces antagonism with cooperation.
  • Or it may be that there is a financial price paid by Employers using NEC to provide contractors with incentives and to achieve a reduction in disputes.
  • If such an analysis were available or possible it would certainly be interesting.

The articles and papers published by Keating Chambers are for the purpose of raising general awareness of issues and stimulating discussion. The contents must not be relied upon or applied in any given situation. There is no substitute for taking appropriate professional advice.

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