Valuing variations in advance

The process for assessing compensation events under the NEC3 standard form looks to use contractor’s quotations as much as possible. The intention is for the project manager and contractor to agree the impacts and the adjustments to the prices and/or the completion date(s). Note that the responsibility for assessing compensation events always rests with the project manager and he or she achieves this either through accepting a contractor’s quotation or, when there is no acceptable quotation, by making his or her own assessment. Any failure to agree with the contractor does not remove the project manager’s responsibility to assess compensation events within the contractual timescales.

There is an opportunity to extend the time for submission of the contractor’s quotation or a project manager’s response through agreement (clause 13.5), however, this should only be used where there is a genuine reason for not being able to meet the applicable time period. Unnecessarily prolonging the compensation event assessment only serves to increase uncertainty which in turn provides an obstacle to the effective management of the contract.

The cost part of the assessment considers the impact of the compensation event on the contractor’s defined cost (clause 63.1). Once that is established the contractor’s fee is added using the fee percentages included in the contract data. The adjustment to the prices is therefore a combination of the forecast change in defined cost and contractor’s fee.

What constitutes defined cost varies between different main options and is specifically defined in clause 11.2 of each, through the use of a schedule of cost components or its shorter version. Both schedules list the items which make up defined cost. Everything else is deemed to be included within the contractor’s fee.

Under the lump sum based contracts, main options A and B, defined cost is the cost of components in the shorter schedule of cost components whether work is subcontracted or not excluding the cost of preparing quotations for compensation events (clause 11.2(22)).

Under the target and cost reimbursable contracts, main options C, D and E, defined cost is the amount due to subcontractors plus ‘the cost of components in the Schedule of Cost Components for other work less disallowed cost’ (clause 11.2(23)).

In order to properly understand these definitions one must know what is meant by 'cost components', ‘shorter schedule of cost components’, 'schedule of cost components' and 'disallowed cost'. For information about these terms see the section on NEC3.

All the main options allow for the use of rates and lump sums in assessing compensation events where the project manager and contractor both agree to their use. In options B and D this alternative approach is stated in clause 63.13 for options B and D and in clause 63.14 for all other main options.

The impact of compensation events on defined cost can be to reduce it as well as increase it and prices are reduced where appropriate. In contrast to this a completion date is only changed if, as a result of the compensation event, planned completion is later than shown on the accepted programme. It is only by the project manager instructing acceleration that contractual completion dates can be set earlier and acceleration is only possible through agreement using a contractor’s quotation (clause 36). Therefore, the compensation event assessment process cannot set earlier completion dates.

Because of the timescales involved in their assessment, compensation events may have an impact on either or both the defined cost of work already completed and work still to do. Clause 63.1 provides the mechanism for determining the date which separates actual from forecast defined cost.

As already stated it is the project manager’s responsibility to assess compensation events. This is generally achieved by either the project manager accepting a contractor’s quotation or where the project manager decides to make his or her own assessment. When in receipt of a quotation the project manager must provide a response that is either a confirmation of acceptance of the quotation, an instruction to submit a revised quotation or a notification that the project manager will be making his or her own assessment (clause 62.3). The project manager should always state the reasons for not accepting a quotation.

If the project manager does not respond to a quotation within 2 weeks of its submission, the contractor may notify the project manager of his or her failure to respond and should the project manager not respond within 2 weeks of that notification,  the contractor’s notification is treated as acceptance of the quotation by the project manager (clause 62.6).

Clause 64.1 sets out the circumstances where the project manager must make his or her own assessment, they include:

• the contractor failing to provide a quotation with details of his or her assessment in the time allowed;
• the project manager decides the contractor has not assessed the compensation event correctly and does not instruct the contractor to provide a revised quotation;
• the contractor fails to provide a programme or alterations to a programme with his or her quotation;  or
• where the project manager has not accepted the contractor’s latest programme for a reason stated in the contract.

Clause 64.2 states the project manager assesses a compensation event using his or her own assessment of the programme for the remaining work where:

• there is no accepted programme; or
• the contractor has not submitted a programme or alterations to a programme for acceptance.

The project manager makes his or her assessment in the same way the Contractor prepares his or her quotations.

The end of the compensation event assessment process is implementation, where the adjustments to prices and/or dates are formalised. Once a compensation event has been implemented it is not revisited. Correcting project manager’s assumptions used in any assessment generates a whole new separate compensation event and that follows its own process to implementation. If the contractor disagrees with an assessment made by the project manager he or she may raise it directly with the employer following the dispute process stated in the contract.

Administration of compensation events under NEC3

An often levelled criticism of NEC3 is the perceived high cost of administration relative to the value of works. That complaint has been explained in terms of large numbers of management staff required to fulfil the prescribed processes linked to programme, early warnings, notification and compensation events. The clear intention of including prescriptive processes and procedures is to impose good project management on those responsible for administering the NEC contract.

The categories of management staff actually required and their number will be determined by several factors, including the complexity of the works and/or services to be provided, the speed and time-frame in which they are to be provided, the level of change, the level of experience and capabilities of the individuals and the level of adherence to those prescribed processes/procedures.

The NEC processes and procedures are written into the conditions to ensure good practice is followed throughout the various management functions. If that good practice is followed the benefits can be many, including:

• a greater chance that employer’s requirements are fully realised, in terms of quality, time of completion and cost;
• the balance of commercial risk between employer and contractor is maintained as far as possible throughout;
• greater certainty of outcome commercially and in terms of the quality and timing of the completed works/services;
• that commercial outcome is determined soon after completion as the final account is effectively established progressively throughout the contract;
• agile project management throughout allowing good decisions to be made when obstacles to effective progress arise; and
• more efficient use of resources in providing the works/services.

Any actual additional management burden during the contract will be offset through the realisation of these benefits and it can be argued the benefits more than outweigh the cost. Leaving the process for establishing a final commercial outcome until later creates uncertainty, which can prolong the process for determining final accounts.