| Date | 5 December 2007 |
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| Judgment | Compensation Events under the ECC form of contract, NEC 3rd Edition |
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| The Issue | Brief review of the underlying philosophy of Compensation Events, and their management and implementation |
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| Implication |
Although the NEC Compensation Event procedure is designed to motivate the parties to identify and resolve the time and cost consequences of scope changes and claim events at the time they occur, strong commercial management discipline is required to achieve those aims. |
print‘Compensation events’ are an important element of the commercial administration of a project awarded under the Engineering and Construction Contract (ECC), published as part of the third edition of the NEC suite of contracts in June 2005. The term applies collectively to changes made by the employer and to claim type issues, including breaches of contract by the employer. There are 19 compensation events listed in the core clauses to the ECC, but these may be augmented by further provisions in the option clauses and within the Contract Data appended to the contract. Taking into account the strict timescales that are imposed, all this provides plenty of work for the commercial staff employed by the parties. As a starting point it is important to note that there is no distinction made between events which give a remedy for extension of time and events which give a remedy for additional costs. All the compensation events listed in the core clauses of the contract at clause 60.1 (including items such as weather) will give a right to claim both extension of time and additional cost. Resolving the contractor’s entitlement to extension of time and additional cost is termed the ‘assessment of a compensation event’ and this is based on a forecast of the cost and time consequences of the event. The publishers of the NEC say that this stimulates good management since the contractor is motivated to manage the new situation efficiently. Risk is reduced, it is said, because assessing cost and time consequences is similar to the assessment of risk made by a contractor when pricing work at tender stage, but this can be done more accurately at the time the problem is identified. The reality may be slightly different as it can be extremely difficult to predict accurately the consequences of a compensation event. The risk involved is often much greater than at tender stage when the contractor has a clean sheet and can plan for efficient use of plant and resources. When one or more compensation events occur the consequences can be a dramatic loss in productivity and motivation of the workforce. Resources may be found to be inappropriate for the change in approach required. The cumulative effect of several compensation events may not become apparent until much later in the construction process. The tight timescales set out in the ECC make this all the more difficult, and the inevitable consequence of strict adherence to the demanding timescales imposed by the contract is the submission of “safe” quotations for compensation events. There are several different categories of compensation events. The procedure for dealing with them varies according to their category. Where the compensation events arise from an instruction of the PM or Supervisor or where the event changes an earlier decision, the PM is required to notify the contractor of the compensation event and instruct the contractor to submit a quotation. The contractor is required to comply with the instruction whilst at the same time preparing the quotation which must be given within 3 weeks of the instruction. Where the PM is considering issuing an instruction or changing a decision, but first requires to know what effect that would have on cost and programme, the contract allows the PM to instruct the contractor to submit a quotation before the proposed change is put into effect. A third category of compensation event is where the contractor notifies the PM that he considers that a compensation event has happened or is anticipated. The contractor loses his entitlement to extension of time and cost if he fails to notify within 8 weeks of becoming aware of such an event. As might be expected, this provision often causes considerable difficulty. Quotations for compensation events comprise the contractor’s proposed changes to his Prices (as defined in the contract) and any delay to the completion date assessed by the contractor. If the programme for remaining work is affected by the compensation event the contractor must include a revised programme with his quotation. The philosophy of the ECC is that the contractor should be paid those additional costs arising from the compensation event which are outside his control. Hence the assessment is made on the basis of Defined Cost (again, as defined in the contract), rather than contract rates. Where the work relating to the compensation event has already been carried out then the assessment will be on the basis of the Defined Costs that have been incurred. However, where the work is to be undertaken in the future, the contractor must forecast his Defined Costs. In doing so he will be expected to allow for, and therefore take the risk of, those costs increasing and future delaying factors which may have a chance of occurring as a consequence of the compensation event. Apart from where the PM has required the use of certain assumptions when asking for the quotation, the assessment of a compensation event cannot be revised at a later date. The guidance notes to the contract indicate that the reason for this strict procedure is to motivate the parties to decide the effects of each compensation event soon after it occurs. Unfortunately this may instead make it more difficult for the parties to reach agreement on the assessment and if the backlog of disputed compensation events is allowed to grow, the compensation event regime will become increasingly difficult to manage. Inevitably, for this and other reasons, properly resourced and experienced commercial management teams are a necessary feature of large projects awarded under the ECC.
CJ-0748
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