The
New Engineering Contract was launched in 1991. It has outshone long-established
civil engineering works contracts to become the top standard for major
construction projects in the United Kingdom. It was developed as a
multidisciplinary contract to assist good management practice. It bears
simplicity, clarity and flexibility. NEC3 is the third edition that was
launched in 2005.

Compensation
events are NEC3 terminology for variations, loss and expense and extensions of
time; a single assessment that deals with the entire effect of an event on time
and money. Whilst the name suggests this always results in something
more for the Contractor (a compensation), this is not always the case (Evans,
Steven, 2013).
Compensation events create circumstances where either the scope of the contract
or other happenings requires the contractor to do additional work that they
were not originally contracted to do. As a result, the contractor incurs costs
and /or time not originally forecast through the implementation of a Project
Manager’s Instruction.

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1.      CRITICAL
OPINIONS AND THEORIES RELATING TO COMPENSATION EVENTS

                   
i.           
Recovery of
defined cost

Defined cost includes only amounts
calculated using rates and percentages stipulated in the contract data and
other amounts at current market or competitively tendered prices with
deductions for all discounts, rebates and taxes which will be recovered. All
other Contractor’s costs not included in the defined cost are assumed to be
included in the fee. The fee is the sum of the amounts that are calculated by
applying the subcontracted fee percentage to the defined cost of subcontracted
work and the direct fee percentage to the defined cost of other work.

In a contract, the contractor is
reimbursed the actual costs they incur in carrying out the works plus an
additional fee to cover the contractor’s costs, overheads and profits. These
two components entail a cost of a cost reimbursable contract. The actual costs
are calculated on the Contractor’s accounts and records, rather than a
pre-determined rate or price. On the contrary, all costs cannot be accurately
determined on a project specific basis, some are incurred due to the
Contractor’s inefficiency, and some are unrecoverable under the contract. It is
from this argument that the costs that can be recovered by the contractor are
called defined costs while the costs that cannot be recovered are described as
the disallowed cost. In a broader sense, defined cost is made up of the
payments due to subcontractors and the cost of components for other works like
equipment, people, etc, minus the disallowed cost.

Charges arising from compensation
events form one of the defined cost component criteria. The others include
people directly employed to carry out the works; equipment provided and used by
the contractor; plant and materials intended for use and included in the works;
manufacture and design of items needed for the works; design costs, and
insurance.

                 
ii.           
Costs of defects
and the philosophy of Target cost contracts

Target
costs are generally associated with cost-reimbursable contracts. They
introduce a mechanism enabling the contractor, and sometimes the consultant
team, to share in the benefits of cost savings, but also to bear some
of the client’s cost when there are cost overruns.
Contracting the contractor and the consultant team on
a target cost basis can be an effective way of ensuring good
collaboration.

The target
cost is set early in the project, and then cost savings or
over-runs are shared based on an agreed formula. The aim is to provide a
financial incentive encouraging cost control, rather than to penalize.
Bonus and penalty payments are usually capped to prevent over-zealous or
adversarial behaviour.

Target
costs might be set for the overall project, or for specific elements of the
works. Agreeing the target cost requires that the client has
sufficient knowledge and experience to be able to accurately estimate the
likely cost of the works and to negotiate effectively with the contractor
and sometimes the consultant team.

Examples
of target cost contracts include the New Engineering Contract (NEC)
Engineering and Construction Contracts Option C: Target contract with activity
schedule and Option D: Target contract with bill of
quantities (Anon., 2016).

               
iii.           
Early warning

Early warning procedures are
contained in clause 16 of the NEC3. The contractor is expected to give the
project manager warning of relevant matters. A relevant matter is anything that
could increase the total cost, delay the completion date or distort the
performance of the finished works. The contractor and project manager are then
required to attend a meeting specifically for the early warning issue if one or
the other party request it. The purpose of such a meeting is to ensure
cooperation and discussion on how to avoid or solve the challenge at hand in
the most efficient manner. It is important to note other parties might be
invited to the early warning meeting (Goud, 2007). The main
distinction between an early warning system and a compensation event is early
warning deals with events that have not yet occurred but have high chance of
taking place while compensation events are for circumstances that have already
happened.

Both the Contractor and Project
Manager have a responsibility of issuing early warnings as soon as either
becomes aware of any matter that could delay the project or key deadlines,
increase overall costs or compromise quality.

A contractor may receive compensation
for addressing issues raised through early warning. If the contractor fails to
give a required early warning and a compensation event then occurs, the clause
gives the Project Manager the opportunity to assess the compensation event as
if the Contractor had given an early warning. This enables the Project Manager
to consider the mitigation measures that could otherwise have been taken, as it
may be possible that an early warning could have allowed actions to be taken
which would have reduced costs and/or saved time. The Project Manager is
effectively allowed the benefit of hindsight when carrying out their assessment
of delay and extra cost, reducing the Contractor’s entitlement(compensation) (Lenehan,
2014).

               
iv.           
Risk Management
Theory

NEC simplifies management of risk.
The full list of compensation events is set out clearly and the facility exists
to add more options if necessary. Each risk now takes cost and time effects
into consideration. Of higher importance is that cost and time are valued and
adjusted collectively instead of being treated in isolation (McGowan,
1992).

Compensation events form one of three
pillars on which unexpected risk allocations are made. The other two include
risk allocation by insurance and by termination. While the term ‘unexpected’ is
not with reference to any class of compensation events occurring but rather the
likelihood of an individual compensation event taking place in the facts of a
given case. NEC drafters recognized this totally with the statement, for
example, with regard to the first compensation event that there may be reasons
for hanging the works information (McInnis, 2001)

                 
v.           
Time Risk
Allowance and Float

All construction contracts have
start and end dates because a degree of certainty is required by both parties(client
and contractor). As a consequence of this, construction disputes invariably involve
issues to do with time. Extension of time claims self-evidently involve time, as
do claims for liquidated damages. Similarly, prolongation costs claims, loss
and expense claims and disruption claims are all fundamentally time related. Therefore,
the effective management of time is crucial to construction and is at the heart
of many construction contracts. The first step is to identify any risks that
are likely to delay or disrupt the works. Once these risks have been
identified, it is essential that the design allows for the work sequences
likely to be disrupted and delayed by foreseeable events to be separated into
parallel, rather than sequential paths, so that they can be dealt with
accordingly. A Time Model could be used for the project, to measure the project
against the progress and should be something that can be improved upon as time
changes. A practical achievable strategy for dealing with intervening events
during the design, procurement and construction process must be in place at all
times. It is essential to monitor progress and update the programme; this should
cater for any changes, whether scheduled or due to unforeseen circumstances to
enable the project stay on track (Kennedys Law LLP, 2013).

 

2.      POTENTIAL
APPROPRIATE RESEARCH METHODS

Techniques used to analyze delay are
discussed below. They can either be prospective or retrospective. Prospective
techniques predict the likely impact of the delay on the progress of the works.
Retrospective methods demonstrate the actual impact of the delay on the project.
The latter can only be used after the works have been completed or after the
impact of the delay event has stopped. Prospective analysis can be used both
before and after the delay effect has occurred.

i.                   
As-planned v
As-built

This is a retrospective method
that involves a simple comparison of the contractor’s planned programme and how
it purposed to implement the work plan with the actual events. This is done by
drawing bars and/or lines on the planned programme to show when the activities
actually started and finished. The argument put forward when using this
technique is that the difference between the two programmes affirms entitlement
to an extension of time. This technique requires the contractor’s planned
programme and good as-built records to show when work was done. Since it is a
simple graphical comparison, the main advantage is there is no need to have a
properly logic linked programme or to use planning software. Other advantages it
offers are that it is quick and simple to prepare and it is easily understood.

ii.                 
Impacted
As-planned

This is a prospective form of
analysis. It is the most commonly technique contractors use in claims for
extensions of time. It involves inserting activities and/or constraints to
represent periods of excusable delay into the contractor’s planned programme.
The periods of delay are logic linked to activities in the programme to
determine the impact on progress and completion. The argument used with this
method is that the entitlement to an extension of time is the difference
between the As-Planned programme and the Impacted As-Planned programme. Impacted
As-planned technique heavily depends on having a good baseline programme that
accurately reflects the intended plan and steps to be followed during
construction. It does not require as-built records but where possible it is
good practice to cross check the results against as-built turning points. It is
highly preferred by contractors because it is relatively quick and simple to
perform, easily understood and often gives results highly to the contractor’s
favour. For very simple claims for extensions of time, this approach works well.
However, where the circumstances are more complex, such as where there are
multiple causes of delay with wide ranging impact, this technique may fail because
it takes no account of the progress of the works, contractor’s own delays and adjustments
in levels of resource (Larkin, 2008).

3.      PERSONAL
FINDINGS

The NEC3 contract is easy to use and
understand as a result of simple language and as a tool for contract
management. The idea that risks are managed pro-actively and identified as part
of the contract, rather than battled out afterwards makes a lot of sense and
appeals to stakeholders in the execution of projects.

However, it carries many hidden
traps. The simple language used to draft it creates ambiguity, particularly as
much as the rest of law and the legal system operate in a different style.
Another trap is timing. The contract defines precise time limits for
communication and responses by both parties, especially when dealing with the
assessment of compensation events. Prescribed time periods instruct contractors
when to notify compensation events and project managers have to reply promptly
to notifications and quotations. Failure to reply within the allocated time
carries express sanctions within the NEC. Such provisions are drafted to enable
parties agree the cost and time effect of compensation events in a prompt and
effective manner.

4.      CHALLENGES
ORGANIZATIONS FACE IN DELIVERING A SUCCESSFUL PROJECT WHILE TRYING TO
ADMINISTER A CONTRACT IN RELATION TO COMPENSATION EVENTS

i.                   
Undefined goals

Goals that are not clearly defined
bring can cause harm to the project and teams handling it, especially when
upper management cannot collectively decide on or support such goals. Most
organizations have more opportunities and initiatives than they can ever hope
to implement. Many project managers are given more than enough projects that
they cannot realistically manage them to completion on time and on budget. Some
more experienced ones may push back and inform the senior management that they
cannot effectively complete the tasks but out of fear, mostly of losing their
jobs, most struggle with the huge load (West, n.d.). Amid all this work,
a project manager may incorrectly assess compensation events of any particular project(s).
The contractor would point out of the wrong assessment and the project manager would
be forced to reopen the compensation event and create a mechanism to pay the
contractor his entitlement or choose to face formal adjudication as specified
in the contract.

ii.                 
Scope Changes

Scope refers to the project
parameters. Scope changes occurs when the project management allows the scope
to extend beyond originally set goals. New features are added to product
designs already approved. Stakeholders and project team members may ask for
changes to a project. It takes a strong project manager to assess, decide on and
implement each request. Under clause 60.1, an instruction issued by the
employer which changes the scope automatically translates to a compensation event.

Scope changes can give rise to scope
creeps. Scope creep refers to adding features and functionality without
addressing the effects on time and available resources. It is a negative
occurrence that has to be avoided. Scope creep creates a large number of
compensation events. Good management would reduce occurrence of such.

iii.               
Gaps in
communication

This mostly occurs after a project
has taken off. One common issue would be lack of a centralized system to locate
and view project history since communication is mostly done through emails and
resides in individuals’ email boxes. This creates a problem in case a new
resource joins the project and cannot be directed to a reference point in a
centralized data location to enable them acquaint themselves with progress
made.

One common mistake project
managers do is giving an early warning and on a later date, say that this as
well comprised notification of a compensation event. Early warnings are
independent, distinct items and hence compensation events and early warnings
shouldn’t be notified within one communication. Another mistake can be seen in
making changes to works specifications where project managers give instructions
under clause 14.3. This is a compensation event in almost all situations and
requires project manager’s instructions for forwarding of quotations. From this
simple change, there are three separate communications needed to be done:
instruction under clause 14.3 changing works details; notification under clause
61.1 of the compensation event; and instruction under clause 61.1 for
quotations to be presented. It is rare to see this being followed up in
projects, possibly because it may take long to write three letters or fill in
three forms. This becomes a challenge especially when a system to notify all
parties of communications made does not exist. The bigger problem arises when
all communication is include within corporate communication models e.g
notifications contained in minutes, progress reports, etc. All these don’t meet
the standard for communication under clause 13.7 of the NEC3 ECC (Woodrow,
2015).

iv.               
Improper Risk
Management

Historically, using highway
construction projects in UK as an example, there have been disputes in agreeing
with final accounts in relation to the total costs and most importantly, in
assessing time in relation to change. Common occurrences pit the contractor
reaching the end of a project and in case of a shortfall between actual costs
incurred and the sum to be paid, a ‘delay and disruption’ claim is employed to
cover up the discrepancy. This circumstance usually leads to disagreements and
lengthy negotiation between employer and contractor till they come to a
settlement. Most of the times, this happens with no tangible contractual
justification for the final cost amount. The process incurs significant staff
costs from both parties and worst of all, means neither party has followed up
on real cost certainty throughout the project duration (Hambleton,
2016).
Since compensation events are risk events for which the contractor is entitled
to receive financial compensation if the event happens and to the extent the
contractor is affected financially, they should always be clearly and precisely
defined in detailed form to respond to their extraordinary nature. As in the
case of an Act of God, the contract should clearly report the procedures to
assess the risk occurrence, the conditions to determine the right of access to
the relief or compensation (which should only be available to the extent that
the impact could not have been prevented by due care and diligence by the
contractor), and other obligations related to information and communication (Anon., n.d.). Both the contractor
and project manager are required to give an early warning to the other as soon
as either becomes wary of any issue which could increase total costs or delay
deadlines. A risk reduction meeting would follow and the parties cooperate and
discuss ways to delay or decrease effects of the delay. Early warnings and risk
reduction meetings are designed to provide alternative ways of dealing with
compensation events. The contractor, upon request from the project manager, may
present quotations for other practicable means (Kennedys Law
LLP, 2013).

v.                 
Dependency
conflicts

Most projects are interrelated, sharing people, equipment
and resources. These dependencies mean that a single project delay creates a
significant ripple effect on related projects. Consequences of such throw into
disarray schedules, causing resource conflicts and even triggering expensive
contingencies. Such a challenge is man-made and does not warrant any
entitlement to time and money relief (Bennet, n.d.).