NEC3 Contracts are becoming increasingly popular. In this article, we highlight 10 things you need to know about NEC3 Contracts.

1. Designs Must be Fit for Purpose

The NEC3 Engineering & Construction Contract states that “The Contractor Provides the Works in accordance with the Works Information”. This means the works must comply with any purposes specified in the Works Information i.e. the works must be fit for purpose. This design obligation is more onerous than a typical clause which requires the Contractor to carry out his design with reasonable skill, care and diligence. Unfortunately, a fitness for purpose obligation will also typically not be covered by professional indemnity insurance.

The fitness for purpose obligation can be excluded by selecting Option X15, which provides that the Contractor will not be liable for defects if he proves he used reasonable skill and care to ensure his design complied with the Works Information. This is more favourable to the Contractor, although it will almost always be necessary to obtain expert evidence to establish that reasonable skill and care was used. Contractors with design responsibility should therefore ensure Option X15 is always selected.

2. Programming is Key

The process of programming the works is emphasised much more in the NEC3 Engineering & Construction Contract than it is in most other standard forms of contract. The Contractor is required to submit a detailed programme to the Project Manager for acceptance at the start of the project and issue updated programmes at regular intervals to take into account changes in the progress of the works.

The programme is a key management tool. If the Contractor fails to provide a programme at the start of the project, 25% of the sums due under the contract can be withheld until a programme is submitted. If the Contractor fails to submit updated programmes, the Project Manager can assess compensation events based on his own view of the progress of the works, which is likely to result in compensation events being assessed much less generously than the Contractor would like. In addition, without an up to date programme, the Contractor will find it very difficult to demonstrate to an adjudicator what he considers his proper compensation event entitlement to be.

3. Disallowed Cost and Defects

The concept of Disallowed Cost, which applies to the target cost contracts (Options C and D), is a common source of dispute. One issue which causes a great deal of confusion is the cost of correcting Defects. The cost of correcting Defects after Completion is Disallowed Cost, but the cost of correcting Defects before Completion is generally allowed. Employers often find it difficult to understand why they are expected to pay for the Contractor to rectify Defects just because they have arisen prior to Completion. However, Employers do receive an indirect benefit from this provision.

When the Contractor is paid for rectifying a Defect, his Defined Cost increases, meaning the Contractor’s gain share may be reduced. The Contractor may even have to pay money back to the Employer if the target cost is exceeded. The Contractor is therefore incentivised not only to minimise Defects (thereby keeping Defined Cost down and hopefully ensuring a bigger gain share) but also to ensure there is a snag-free handover so he does not have to meet the cost of rectifying Defects post-Completion.

4. Importance of Early Warnings

Early warnings are a unique and very useful feature of all NEC3 Contracts, if used correctly. The importance of giving early warnings is emphasised in the compensation event process. If the Contractor does not give an early warning which he ought to have given and a compensation event then occurs, the event can be assessed as if the Contractor had given an early warning. This allows the Project Manager to use the benefit of hindsight to decline to award extra time and/or money to the Contractor which would not have been incurred if an early warning had been given, which is a powerful incentive for Contractors to stay on top of the early warning process.

5. Correction of Defects

The “defects date” and the “defect correction period” are easily confused. The “defects date” indicates how long the Contractor will be liable to rectify defects in the works. A typical “defects date” is 52 weeks after completion of the works. The “defect correction period” is the period in which the Contractor must rectify a defect which has been notified to him. The Employer can specify different “defect correction periods” for different types of defects, depending on their urgency.

6. No Provisional Sums

NEC3 Contracts do not provide for the use of provisional sums on the basis that if you cannot clearly define an aspect of the works, you should not include it in the contract because the Contractor will have no clear idea of what he is pricing for or what should be included in his programme. The correct approach under an NEC3 Contract is that unknown items of work should be managed via the early warning system/risk register and valued as compensation events, thereby passing all risk associated with unknown items onto the Employer.

If provisional sums are unavoidable (such as when it is necessary to secure an overall budget for a project), the Employer should put as much information about the unknown items in the Works Information as possible at the outset and update the Works Information as soon as the final requirements are known. This allows the Contractor to sensibly price and programme for the work that is known to be required. Any differences between the provisional work and actual work can then be valued as a compensation event.

7. Assessing the Cost of Compensation Events

The cost impact of a compensation event is assessed as the effect the event has on the actual Defined Cost of work already done and the forecast Defined Cost of work not yet done. The dividing line between work which is already done and work which is not yet done is the date the Project Manager instructed the Contractor to submit his quotation(s) for the compensation event.

When the Project Manager comes to review the quotation, the Contractor may have done the forecasted work and the Project Manager may know that the Contractor’s forecast Defined Cost was inaccurate. However, the Project Manager is required to rely on the Contractor’s forecast for work not yet done, even if the Contractor has actually done that work at a lower cost. This prevents the Project Manager from choosing between the forecasted Defined Cost and the actual Defined Cost, which would disadvantage the Contractor.

8. Notifications must be Separate

When a dispute arises, it is common for the parties to search through their records for evidence (such as an email or minutes of a meeting) which they can use to support an argument that they complied with the notification requirements of the contract.

NEC3 Contracts do not allow you to do this. Contractual notifications (such as early warnings, notifications of compensation events and notifications of the discovery of Defects) must be given in a separate document in order to be valid. The rationale is that this ensures good management and communication. However, it can also be an administrative burden, particularly for inexperienced NEC3 users.

9. Acceleration is Optional

Contractors are often wary of the acceleration clause in the NEC3 Engineering & Construction Contract. Understandably, few Contractors will wish to agree to speed up the completion of their works. However, the acceleration clause does not allow the Project Manager to insist that the Contractor accelerates. The acceleration clause is simply a mechanism for agreeing on how the Completion Date for the works might be brought forward. It is for the Contractor to decide whether he wishes to submit a quotation for acceleration, although he must give reasons for refusing to do so.

10. Adjudication is Compulsory

An unusual feature of NEC3 Contracts is that the parties cannot refer disputes to arbitration or court until the dispute has first been referred to adjudication. It is important to consider whether this provision requires amending. It may be unwise to agree to a dispute resolution provision which limits your discretion to deal with a dispute in the manner you deem most appropriate. For example, if the nature of the project is such that disputes may be extremely complex and therefore unsuitable for a ‘rough and ready’ adjudication, you may want to be able to commence legal action/arbitration proceedings straight away rather than going down the adjudication route first.