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NEC Defined Cost vs FIDIC Cost - Looking Ahead or Looking Back? The Differing Approaches

Introduction

Assessing cost in relation to compensation events and claims is often a key sticking point in the resolution of quantum disputes. The New Engineering Contract (“NEC”) and the International Federation of Consulting Engineers (“FIDIC”) forms of contract both have distinct approaches regarding the assessment of cost, which reflect the different principles and overall ethos of the contracts.

NEC intends for issues to be dealt with on a prospective basis, to get agreement as the project proceeds, proactively managing the effects of change and to enable effective and timely management as the work proceeds. FIDIC utilizes a more retrospective approach, reviewing what costs are reasonably incurred, or would have been reasonably incurred, generally after the fact.

Are these differences just in theory only, or is there a practical implication? How defined is ‘Defined Cost’? With much of the work being subcontracted in construction, how does the assessment of the NEC cost component impact the overall assessment? Is FIDIC’s approach regarding the definition of cost more straightforward than NEC’s as far as dispute resolution is concerned?

How Defined is ‘Defined Cost’?

NEC4¹ provides a term “Defined Cost”, which for Options A and B² is “the cost of the components in the Short Schedule of Cost Components (“SSCC”)”.³ The SSCC⁴ covers various components that are priced differently. People, Equipment, Manufacture and Fabrication and Design are generally priced based on predetermined rates in the Contract Data. Whereas Plant and Materials, Subcontractors, Charges and Insurance are based on payments, open market or competitively tendered prices (see figure 1 below):⁵

NEC Clause 52.1 states “Defined Cost includes only amounts calculated using rates and percentages stated in the Contract Data and other amounts at open market or competitively tendered prices.” ⁶

NEC Clause 63.1 is key and states “The change to the Prices is assessed as the effect of compensation events upon:

the actual Defined Cost of the work done by the dividing date,
the forecast Defined Cost of the work not done by the dividing date and
the resulting fee.” ⁷

The dividing date determines which element of the compensation event is assessed as the change to the Prices based on actual or forecast Defined Cost.

Other NEC clauses impact how quantum is assessed.⁸

An NEC article⁹ notes that “‘forecast’ is the single most important word making NEC contracts different from so called ‘traditional’ contracts.”

FIDIC defines cost as “all expenditure reasonably incurred (or to be incurred) by the Contractor, whether on or off the Site, including overhead and similar charges, but does not include profit.” ¹⁰

Disputes over cost are often reviewed and decided sometime after the cost due to the event has actually been incurred.

Time Goes By: The Impact of When Costs are Assessed

Clause 63.1 of the NEC guide states “ideally, the assessment will be the forecast of Defined Cost of work which is yet to be done, but it may, on occasions, include an element of incurred Defined cost for work which has been done” ¹¹ – highlighting that forecast should be more prevalent than incurred.

Where there is only forecast Defined Cost to be assessed, this is not straightforward as there may be no or little preceding project data on which to base the forecast, unless there has been similar work undertaken on the project. A Contractor is unlikely to advance a forecast it considers will be lower than what is eventually incurred. As well as a healthy allowance of resources generally, this may also include additional allowances for risk¹² as well as assumptions advised by the Project Manager.¹³ A Project Manager, where it considers the Contractor is inflating forecasted cost, can either ask the Contractor to resubmit a quotation, or to make its own assessment of forecasted cost.

When such issues are later assessed in a dispute resolution process, forecast costs may have become incurred by that point, with actual records now being available. The NEC Contract does not make a specific adjustment for such a circumstance, with main option Clause W2.3(7) stating “if the Adjudicator’s decision includes assessment of additional cost or delay caused to the Contractor, the assessment is made in the same way as a compensation event is assessed.” ¹⁴

However, in practice many dispute resolution decisions assessing previously forecast Defined Cost, are based on actual records subsequently available. The principal case regarding this is Northern Ireland Housing Executive v Healthy Buildings (Ireland) Limited ¹⁵ with the decision stating it would be “a strained and unnatural interpretation of the contract to rely on the use of the word ‘forecast’ in Clause 63 to prevent access to the best evidence” ¹⁶ and “why should I shut my eyes and grope in the dark when the material is available to show what work they actually did and how much it cost them?” ¹⁷

On a similar theme, Keating on NEC also notes that “common sense also suggests that it would be wrong to ignore any actual costs that have been incurred or avoided by the time of the quotation or later assessment by the Project Manager. This would not result in a reasonable assessment and would be inconsistent with general principles applied in assessing damages.” ¹⁸

In practice, whether a forecast made at the time can be reassessed using subsequently available information remains a live and key issue – it may be the case that both experts in a dispute will receive differing instructions and this can have a significant impact on the corresponding assessments made by the experts.

Forecast: The Undefined Element of Defined Costs

Defined Cost is defined as a contract term and the SSCC sets out the parameters for the type of costs that can be assessed (and how they are assessed) in a compensation event. This is relatively detailed and prescriptive compared to the definition of cost in FIDIC.¹⁹ However, being defined and detailed does not necessarily result in accuracy, particularly in relation to forecast.

Forecast should be more prevalent than incurred²⁰ yet how a forecast should be carried out is not defined.²¹ The NEC guide states “on the rare occasions when some or all of the work arising from a compensation event has already been done, Defined Cost should be readily assessable from records. Forecasting future Defined Cost is less straightforward. Estimates of resources are required as well as productivity rates for Equipment and labour.” ²²

Depending how far a project has progressed at the time of providing a quotation for a compensation event, it may be that the estimation of the resources can be made by reference to similar work already being carried out on the project, with adjustments for issues such as gang sizes and expected differences in productivity. It is likely a Contractor will have its own records of resources and productivity from other projects with similarities that can also be utilised with adjustments. There may also be allowances for non-productive overtime and the costs of employing new resources.

Clause 61.6²³ provides that if the effects of a compensation event are too uncertain to be forecast reasonably, the Project Manager states assumptions in the instruction to the Contractor to submit quotations, and if such assumptions are later found to have been wrong a correction is notified. Though this can help with effectively ring-fencing the most uncertain elements to be forecast, in reality the Contractor will likely be making its own assumptions in a forecast, separate from any specific assumptions directed under Clause 61.6.

Additionally the Contractor may make risk allowances in accordance with Clause 63.8.²⁴ The NEC Guide says that risk allowances should be made in the same way that the Contractor allowed for risks when pricing its tender.²⁵ Notwithstanding this, risk allowances can often be subjective.

Taking all the above into account, particularly on complicated compensation events, a forecast may have considerable uncertainty within it and a Contractor is unlikely to under-pitch a forecast. From a pure cost point of view, accuracy is generally better served by looking at what actually transpires, although a Contractor’s ledger that records actual cost is not the same as Defined Cost or the SSCC. However, this retrospective approach is against the prospective approach of the NEC Contract.

An NEC article puts it this way: “The forecast will not be right but, when implemented, it is a reasonable deal in the circumstances. Each compensation is subject to such a deal. The agreed forecast is not revisited: the contractor or consultant will win on some and lose on others... The clear intent, which characterises NEC, is to get these events agreed (‘implemented’ in the language of the contract) as the works proceed.” ²⁶

Whilst the above reflects the NEC ethos during the currency of the project, when matters regarding a forecast end up in a dispute resolution process an assessment is being made in a different circumstance. The issue of forecast Defined Cost is often reviewed through a different lens, where accuracy after the event may be more sought by a decision maker than what a prospective approach provides.

Subcontractors

Subcontractors is often a Contractor’s largest component, with NEC4 introducing ”Payments to Subcontractors for work which is subcontracted” as a cost component which did not exist in NEC3 for Options A and B.²⁷

Whilst on the face of it, this component appears to be simple, it is not straightforward in reality. Firstly, payments only really apply to costs that are incurred and a payment will not have occurred in relation to a forecast.²⁸ There will therefore need to be a forecast of the Subcontractor’s own Defined Cost, which may be sought by the Contractor as a quotation from the Subcontractor under the provisions of the NEC Subcontract.²⁹ However, it may be the case that a Subcontractor has been appointed on different terms to NEC, which would then need to be submitted to the Project Manager for acceptance.³⁰

The NEC Subcontract SSCC³¹ is very similar to the SSCC under the NEC Main Contract. Therefore what is put in the Contract Data for rates, under the Subcontract SSCC, can be important as this will flow through to the Contractor’s quotation.

Adding further layers of complexity, the Subcontractor may well have subsubcontracted elements of the work further. The NEC Subcontract SSCC includes a component for this, “Payments to Subsubcontractors for work which is subsubcontracted”.³² This subcontracted subcontract is not an NEC subsubcontract, so the basis as to how forecasts flow through to the subcontract quotation, and thereafter the Contractor quotation, may vary widely.

On large and complicated compensation events, a number of Subcontractors can be impacted. For a Contractor, managing the process of quotations and assessing these within the prescribed timescales of both the NEC main contract and subcontract can be resource and time intensive. If there are many compensation events on a project, issues around this can compound with timescales not being achieved and compensation events not being agreed.

FIDIC Versus NEC: Which Definition of Cost is More Straightforward?

Various FIDIC clauses give the Contractor the right to make a claim using Cost, Sub-Clause 2.1³⁴ provides that if the Employer does not give possession of the site within times as required by the Contractor, subject to Sub-Clause 20.1³⁵ and 20.2,³⁶ the Contractor shall give notice and be entitled to payment of Cost.

Sub-Clause 20.1³⁷ and 20.2³⁸ set out the notice period for a claim and that the Contractor “shall keep such contemporary records as may be necessary to substantiate any claim.” ³⁹ Detailed interim claims are to be provided with the Contractor sending “a final claim within 28 days after the end of the effects resulting from the event or circumstance” ⁴⁰ i.e. the final claim is made on a retrospective basis, which is different from NEC.

At this point the quantum of the claim will likely be fully incurred by a Contractor. As such the “or to be incurred” under FIDIC Cost⁴¹ should not arise. This makes the process of assessment arguably clearer and more accurate. Notwithstanding this, there is still often disagreement between parties and experts on the specific amount of a cost incurred relating to a Contractor’s claim. However, the documents for assessing the claim, for example reviewing a Contractor’s ledger and other relevant records, should be readily available and known.

Conclusion

The ethos of NEC is to avoid disputes in the first place by getting issues agreed as the works proceed,⁴² and if this is achieved it will be beneficial for the parties. However, there are many instances where this is not the case, with NEC disputes ending up in a dispute resolution process. To assess compensation events with prospective or forecast elements takes a different mindset to the arguably simpler position of purely retrospective cost under FIDIC.

Footnotes:

1: NEC4 Engineering and Construction Contract (ECC).

2: This article focusses on Options A and B and so does not consider the Schedule of Cost Components in other options.

3: NEC4 Options A and B, Clause 11.2 (23).

4: NEC4 Options A and B, SSCC.

5: NEC, ‘Understanding defined cost in NEC3 ECC and its simplification in NEC4 ECC’, November 2021.

6: NEC4 Options A and B, Clause 52.1.

7: NEC4 Options A and B, Clause 63.1.

8: Clause 61.6, 63.2, 63.7, 63.8 and 63.9 amongst others.

9: NEC, ‘Understanding the critical ‘F-words’ that make NEC contracts different’, March 2020. — see summary.

10: FIDIC Red Book First Edition 1999 and Second Edition 2017, Sub-Clause 1.1.4.3 used as an example but also applicable to other FIDIC forms.

11: NEC4, Managing an Engineering and Construction Contract, Volume 4, Clause 63.1.

12: NEC4 Options A and B, Clause 63.8.

13: NEC4 Options A and B, Clause 61.6.

14: NEC4 Options A and B, Option Clause W2.7. There is no reference to an assessment date in the contract other than in relation to payment under clauses 50 and 51, which is not applicable in relation to the assessment of the effects of a compensation event which is based on a dividing date.

15: [2017] NIQB 43.

16: Ibid, para 50.

17: Ibid, para 54.

18: Keating on NEC, 63.1 – 7-170.

19: FIDIC Red Book First Edition 1999 and Second Edition 2017, Sub-Clause 1.1.4.3.

20: NEC4, Managing an Engineering and Construction Contract, Volume 4, Clause 63.1.

21: Keating on NEC, 63.1 – 7-170.

22: NEC 4, Managing an Engineering and Construction Contract, Volume 4, Clause 63.1.

23: NEC4 Options A and B, Clause 61.6.

24: NEC4 Options A and B, Clause 63.8.

25: NEC4, Managing an Engineering and Construction Contract, Volume 4, Clause 63.8.

26: NEC, ‘Understanding the critical ‘F-words’ that make NEC contracts different’, March 2020.

27: NEC4 Options A and B, SSCC, Clause 41.

28: Apart from maybe some advance payment.

29: NEC4 Subcontract, Core Clause 6.

30: NEC4 Options A and B, Clause 26.3.

31: NEC4 Subcontract, Short Schedule of Cost Components.

32: NEC4 Subcontract, Short Schedule of Cost Components Clause 41.

33: FIDIC Red Book First Edition 1999 and Second Edition 2017, Sub-Clause 1.1.4.3 used as an example but also applicable to other FIDIC forms.

34: FIDIC Red Book First Edition 1999 and Second Edition 2017 Sub-Clause 2.1.

35: For FIDIC Red Book First Edition 1999.

36: For FIDIC Red Book Second Edition 2017.

37: For FIDIC Red Book First Edition 1999.

38: For FIDIC Red Book Second Edition 2017.

39: FIDIC Red Book First Edition 1999, Sub-Clause 20.1. FIDIC Red Book Second Edition 2017 Sub-Clause 20.2.3.

40: FIDIC Red Book First Edition 1999, Sub-Clause 20.1. FIDIC Red Book Second Edition 2017 Sub-Clause 20.2.6 (d), which uses the words “a fully final claim.”

41: FIDIC Red Book First Edition 1999 and Second Edition 2017, Sub-Clause 1.1.4.3 used as an example but also applicable to other FIDIC forms.

42: NEC, ‘Understanding the critical ‘F-words’ that make NEC contracts different’, March 2022.” — see “doing a deal”.

Published

December 10, 2024

Key Contacts

Christopher Johnston

Managing Director