NEC Contracts Explained

NEC Contracts Explained

What is an NEC Contract?
Since the original NEC was designed and drafted by the late Dr Martin Barnes CBE in 1991, the Institution of Civil Engineers has developed a series of NEC standard contracts to stimulate good management of the relationship between the parties to a contract, and of the work included in the contract. 

NEC was designed to cater for a variety of commercial applications, for several types of work (including construction contracts) and has been drafted to be used in different jurisdictions.

A key aspect of all NEC Contracts is their intended clear and simple construction, whereby the principal NEC requirement to ‘act as stated in the contract’ may be easily accomplished with little or no confusion. In respect of the relationship between the parties, NEC requires that the parties are to act ‘in a spirit of mutual trust and co-operation'

This leaves no doubt that NEC envisages setting out a clear set of rules that the parties are to be bound by, and that by working together in a spirit of mutual trust and co-operation, the contract will be successful to the benefit of both parties.

In our experience, where contracting parties adhere to the provisions of an NEC Contract to the letter, the number of disputes that may arise are likely to be very limited or, indeed, non-existent.

However, a frequent criticism of NEC Contracts relates to a perceived absence of a ‘Plan B’ if the parties fail to strictly adhere to the requirements of the contract. It is imperative therefore for the parties to read and understand the NEC Contract fully so that there can be no misconception of what is required from the parties. 

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The different NEC contract forms
From its humble beginnings in the early 90’s, NEC has evolved into a 2nd, 3rd and now 4th Edition (NEC4 – the version primarily referred to in this article) that boasts several contract forms with applications covering Alliancing, Engineering and Construction, Professional Services, Term Service, Design Build & Operate, Supply, Dispute Resolution, and Framework contracts, with many of these having related Subcontract or Short forms.

Possibly the most familiar of these, is the Engineering and Construction Contract which is frequently used between Clients and Contractors in construction projects; with a corresponding Engineering and Construction Subcontract that is specifically designed to be operated alongside the main contract.

It should be noted that the preference of some contractors to use their own bespoke subcontract terms and conditions alongside NEC main contracts is not recommended. This often results in complex disputes arising where the main contract and subcontract terms are incompatible. Therefore, extreme caution should be taken when entering into such bespoke subcontracts.

The format of the NEC4 contract and its key provisions
The Engineering and Construction Contract contains several core clauses under 9 nr main sections relating to:

  1. General – further to the opening requirement to ‘act as stated in the contract … in a spirit of mutual trust and co-operation’ described above, this section deals with matters including definitions, interpretation and law, the need for good communications, the roles of the Project Manager and Supervisor, early warnings, Contractor’s proposals, requirements for instructions, corrupt acts, and acts of prevention. Please note that the provisions relating to the giving of ‘early warnings’ are essential in respect of the assessment of subsequent compensation events, where the failure to give early warning of such events (where applicable) can result in disallowed costs. 

  2. The Contractor’s main responsibilities – detailed NEC’s requirements in respect of the provision of the Works, Contractor’s design, design of Equipment, people (key persons), working with the Client and Others, Subcontracting and other responsibilities.

  3. Time – amongst other things, this section contains detailed requirements in respect of the programmes that are to be offered to the Project Manager for acceptance which, once accepted, have contractual status. Further, this section covers site access, instructions to stop or not start work, ‘Take over’ of the works (not to be confused with Completion), and ‘Acceleration’ whereby the Completion Date may be brought forward.

  4. Quality management – this section details NEC’s use of quality management systems (where the Contractor is required to use any such system as described in the Scope), tests and inspections, and how to deal with Defects (noting that, unless Defects are accepted … the ‘Contractor must correct all Defects which would prevent the Client from using the works or Others from carrying out their work …’ before Completion).

  5. Payment – details NEC’s payment provisions which are to be applied in conjunction with the provisions of secondary option Y(UK)2, where The Housing Grants, Construction and Regeneration Act 1996 (as amended), also known as the ‘Construction Act,’ applies. Assessment leading to payment is different for Main Options A to F (detailed below), and so particular attention is needed in respect of the additional payment clauses included under those Options. It should also be noted that NEC4 now includes a provision in respect of the ‘Final assessment.’

  6. Compensation Events – these are events which, if not arising due to the Contractor’s fault, allow the Contractor to be compensated for any consequent change to the Prices, Completion and/or Key Dates. This section of the contract provides the main list of compensation events, and details NEC’s requirements in respect of notification, quotations, assessment, proposed instructions, and implementation of compensation events. Further provisions are included under the Main Option clauses (detailed below), and other compensation events may be found elsewhere in the NEC Contract, such as in the Contract Data. Caution: many NEC contracts are amended to remove compensation events (such as Clause 60.1(19), that relates to prevention) and so it is imperative that the Contractor fully review any contract amendments (typically in the ‘Z clauses’ – see below).

  7. Title – this relates to the NEC provision whereby the Client may secure ownership of large / expensive items of Equipment, Plant or Materials that are being manufactured or stored off site (i.e., outside of the Working Areas); which is particularly important under Main Options C, D & E where the Client must pay the Contractor for these when the Contractor pays its supplier.

  8. Liabilities and insurance – risks and contractual liabilities are imposed on the parties throughout the NEC Contract. However, this section is included to deal specifically with liabilities for death, and losses and damages caused by or in connection with the works (by the Parties/Others) – and details the necessary insurances that are required.

  9. Termination – the concluding section of the core clauses detail the Parties’ rights to terminate the contract, reasons for termination, the relevant procedures, and the making of any payment on termination. 

In addition to the core clauses, additional clauses are added in respect of Main Options:

  • Option A: priced contract with activity schedule – based on lump sum prices included in the activity schedule. The Prices are the lump sum prices for the activities on the activity schedule, which may later be changed in accordance with the contract (say, due to the effects of a compensation event). Note that the Activity Schedule is to be closely reflected by corresponding activities on the Accepted Programme. Payment is made in respect of completed activities.

  • Option B: priced contract with bill of quantities – based on a Bill of Quantities, with specified quantities provided by the Client (that should reflect the drawings, specifications, etc., in the Scope), with rates provided by the Contractor to derive the tendered total of the Prices. The Prices are lump sums and amounts obtained by multiplying the rates by the quantities for the items in the Bill of Quantities. The Price for the Work Done to Date is the total of the quantity of completed work by reference to the Bill of Quantities, and a proportion of any lump sums contained therein.

  • Option C: target contract with activity schedule – again, based on an Activity Schedule. Under Option C, the ‘Target’ price is the tendered total of the Prices (as Contract Data, and by reference to the lump sum prices for activities on the Activity Schedule, unless later changed in accordance with the contract, e.g., adjusted for the effects of compensation events). This is then compared with the Price for the Work Done to Date which is by reference to Defined Cost (amounts paid to Subcontractors … and as per the Schedule of Cost Components, less Disallowed Cost) and is the total Defined Cost which the Project Manager forecasts will have been paid by the Contractor before the next assessment date plus the Fee. The difference between the ‘Target’ and Price for the Work Done to Date is then apportioned according to the share ranges and share percentages shown in the Contract Data. The Project Manager makes a final assessment of the Contractor’s share (the pain/gain share) using the final Price for the Work Done to Date and the final total of the Prices. Payment is based on Defined Cost, plus Fee.

  • Option D: target contract with bill of quantities – similar to Option C, with the ‘Target’ price relating to the Bill of Quantities (unless later changed, e.g., ref. compensation events), and the Price for the Work Done to Date relating to Defined Cost. As above, the pain/gain share is assessed by the Project Manager.

  • Option E: cost reimbursable contract – the Prices are based on Defined Cost plus the Fee, and the Price for the Work Done to Date is the total Defined Cost which the Project Manager forecasts will have been paid by the Contractor before the next assessment date plus the Fee.

  • Option F: management contract – as Option E, the Prices are based on Defined Cost plus the Fee, and the Price for the Work Done to Date is the total Defined Cost which the Project Manager forecasts will have been paid by the Contractor before the next assessment date plus the Fee. However, the Defined Cost is ascertained by reference to amounts paid to Subcontractors and the prices for work done by the Contractor itself (i.e., the Schedule of Cost Components, which is used with Options C, D & E, does not apply to Option F).
In addition to these Main Options, there are:

  • Dispute Resolution Options W1, W2 & W3 (notably, Option W2 is to be used in the UK where the Construction Act applies).

  • Secondary Options X1 to X22, that deal with (when applicable): Price adjustments for inflation, changes in the law, multiple currencies, ultimate holding company guarantees, sectional completions, the bonus for early Completion, delay damages, undertakings to the Client or Others, transfer of rights, information modelling, termination by the Client, Multiparty collaboration, performance bonds, advanced payments to the Contractor, Contractor’s design, retention, low performance damages, limitation of liability, KPIs, whole life cost, and early Contractor involvement, then

  • Secondary Options Y(UK)1 – project bank account, Y(UK)2 – ref. the ‘Construction Act’, and Y(UK)3 – The Contract (Rights of Third Parties) Act 1999.

  • Z clauses (additional conditions of contract – see “Contract amendments” below).

  • The Schedule of Cost Components (and Short Schedule of Cost Components, which is only used in NEC4 for Option A & B compensation events) to be used in respect of Defined Cost and the assessment of compensation events, and

  • Contract Data (provided by the Client and Contractor).

  • The NEC Contract also includes for: Site Information (such as SI Reports), the Scope (which will include drawings, specifications, and the like), the Accepted Programme, documents in respect of certain Secondary Options (e.g., a Performance Bond), an Activity Schedule or Bill or Quantities … Note: it is essential to review all the Contract documents upon receipt, and certainly before the Contract Date, which is when the contract came into existence, to identify, verify and/or query what is included in your contract. Otherwise, you may be stuck with onerous amended contract clauses/provisions that provide little remedy.
Which NEC contract should I choose?
That is probably a very good question, the answer to which being somewhat subjective to the respective needs and wants of the Parties...

If a relatively straightforward contract is needed, it seems that Option A (with appropriate dispute resolution and secondary options being applied, etc.) is the way to go. This being on the basis that there should be few surprises, as the Contractor has already provided lump sums in respect of a defined set of activities, and once these are completed, the Contractor can be expected to be paid for them. 

Further, the mechanism for assessing compensation events under Option A is by reference to the simplified Shorter Schedule of Costs Components, and as these components are pre-defined (i.e., as Defined Cost), it ‘should’ be relatively simple to assess the impact of these events on the Prices (and Accepted Programme) – noting also that the Project Manager/Contractor may agree to use rates and lump sums instead to assess a compensation event.

Alternatively, Option C proves a very popular choice as it provides a performance incentive whereby the Contractor may make a ‘Gain’ in respect of the pain/gain share. This also provides an incentive to the Client/Project Manager to be cooperative during the project to ensure that project overrun or overspend does not occur – such that the parties then have to share in the “Pain” (i.e., both parties become culpable in respect of project losses).

Contract amendments
Option Z (the ‘Z clauses’) are included in NEC Contracts to incorporate additional conditions of contract, over and above those already included in the core clauses, main options, dispute resolution and secondary option clauses.

However, Z clauses are often used to incorporate substantial amendments to the standard NEC clauses, and these should all be reviewed ‘very carefully’ prior to entering into the Contract.

In practice, the ‘overuse’ of Z clauses often changes the ‘intention’ of the standard NEC Contract and are often included by Clients to transfer as much risk as possible to the Contractor. This should not be accepted. Indeed, we advise you to be wary of any proposed ‘NEC Contract’ which has extensive amendments, as these amendments will highly likely be incompatible with the original intention of the NEC. Such amendments will also provide further complications in respect of any Subcontract terms and conditions.

The standard NEC Contract and associated Subcontracts have been very carefully drafted to be compatible, and we cannot overemphasise enough the benefits of sticking to the standard and well-established forms. 

How we can help you
Procurement
It is critical to take appropriate advice before entering into any form of building contract. The implications of entering into a contract that does not properly document your intent, can lead to you taking on more risk and responsibility than you intended. This, in turn, can be catastrophic if an issue arises on the project. Many construction disputes can be mitigated by ensuring that the construction contracts are properly prepared and understood prior to commencement.

At Arbicon, we offer advice of procurement routes, contract drafting, clause amendments and regularly undertake risk reviews of contracts that you may have been asked to enter.

Disputes
If you are already in an NEC Contract and in dispute in respect of payments, delay, compensation events, termination issues or you are unsure of how to implement the high level of management input required, Arbicon can help you resolve all issues by negotiation or adjudication. 

NEC Training
Further, in respect of NEC4 contracts, Arbicon provides bespoke detailed and comprehensive training seminars covering topics such as NEC Payment Provisions, NEC Compensation Events, and NEC Accepted Programmes. Whilst focussing on standard NEC provisions, these can also be adapted to suit your particular contract and its amendments.

If you would like advice on an NEC contract, or have an NEC dispute, please use our contact form or call our offices below:

01733 233737 Peterborough

0207 406 1494 London

0121 262 4086 Birmingham  


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