Contractual risk due to Covid-19: Managing your entitlement under NEC4
We have been involved in a number of disputes under the various NEC forms of contract during the pandemic and it is a matter of fact that the NEC does not expressly deal with the effects of Covid-19. This immediately causes confusion with those administering the contract and I have personally witnessed a number of novel attempts, by contractors and subcontractors alike, in establishing their entitlement to additional time and money. Whilst some of these have been successful and others have failed, the fact that the contract does not provide a clear and concise mechanism for dealing with Covid-19 continues to cause uncertainty.
In this article I intend to set out the pertinent issues to be considered in relation to the NEC4 Engineering and Construction Contract.
Clause 19 - Prevention
When the pandemic first hit, this was the first port of call for many contractors in trying to establish their entitlement to recover time and money under the NEC form. Whilst in some circumstances this clause has provided a successful route to proving entitlement, in other circumstances it has not.
It is important to note that the clause only relates to events which “stop” the completion of the whole works or stop the completion of the whole works by the planned completion date. It does not therefore relate to issues which only require additional labour resources, increased health and safety obligations, or impose non-critical delays.
The event must also be one that neither party could have prevented, and one that an experienced contractor could not have allowed for when entering into contract. Consequently, and taking the second point as the most pertinent, it will be very difficult for a contractor to establish any entitlement under this clause for a contract which was entered into after the outbreak of the pandemic.
Therefore, on the basis that a project is critically delayed by a Covid-19 event and the contract was entered into before the onset of the pandemic, this clause could give rise to a compensation event under clause 60.1(19). However, for all contracts entered into following the start of the pandemic, and going forward from now, this clause will give little relief from the impact of Covid-19.
Option X2 is a secondary option clause under the NEC4 form. It is not a default contractual provision and is only incorporated into the contract by express provision. Therefore, and notwithstanding Covid-19, we would always advise that, as a contractor, you should insist on the inclusion of this option when negotiating the terms of contract.
The option states that any change in the law is a compensation event if it occurs after the contract date. Accordingly, as with clause 19 set out above, it is unlikely that this clause will give relief from the impact of Covid-19 going forward and unfortunately, in my opinion, the same can also be said for the majority of contracts entered into pre-pandemic.
The UK construction industry has led the way in adapting working practices and health and safety measures to ensure that sites can remain open and maintain progress. This has, in part, been due to Government action being in the form of guidance, rather than mandatory changes to the law. The Government has constantly reiterated the point that, within the UK, construction sites have not been required to close and, so long as the guidance is followed, continuing work on construction sites complies with the Chief Medical Officer's advice. Consequently, the guidance issued to date will not, in most cases, trigger the NEC4 change in law provision.
Clause 15 - Early Warning
Both the contractor and project manager have an obligation to notify the other as soon as they become aware of an event which could increase the total of the prices, delay completion, delay a key date, impair the performance of the works, or increase the contractor’s total cost.
In relation to Covid-19, the early warning mechanism provides the basis for anticipating associated risk and enables the parties to meet and deal with such issues in an attempt to mitigate the impact of the event. This should be recognised by all involved as the contractual starting point of any Covid-19 claim. For example, if a specific material is in short supply due to a restriction in international deliveries caused by the pandemic, then this issue should be raised by the contractor within a notice of early warning. The parties then have the ability to assess the likelihood of the issue impacting on the project, look at alternative solutions, or attempt to amend the schedule to take account of the impending delay.
A notice of early warning should not be confused with a compensation event notice and is only provided in anticipation of an issue. A notice of early warning does not give rise to any entitlement regarding time and/or money.
It is also important to remember that if the parties fail to provide a notice of early warning, then the result could have a negative impact for both the contractor and client. The client could see an increase in cost or time implications and, on the flip side, the contractor could lose an entitlement which it would otherwise have had. As stated in clause 63.7, if the contractor fails to give early warning of an event which an experienced contractor could have given, the compensation event is assessed as if the contractor had given the early warning. This could be a significant decrease in the ‘Defined Cost’ and/or the impact on planned completion.
Therefore, as a contractor looking forward, it is imperative that the early warning mechanism under clause 15 is fully understood and an adequate process is put in place to enable the administration of this contractual obligation.
Clause 60 - Compensation Events
Whilst the NEC4 contract does not specifically deal with Covid-19, there are a number of potential clauses which could, in specific circumstances, give rise to a compensation event due to the effects of the pandemic. This entitlement shall be subject to the actions of the parties, and in particular the actions of the client/project manager in providing the works.
We identify the following events as the most pertinent:
- Clause 60.1 (2):
Scenario: If the client does not allow access to and use each part of the site by the later of its access dates and the date for access shown on the Accepted Programme.
Potential outcome: Should the site be closed for a period of time, or elements of the work are suspended due to Covid-19 issues then this could give rise to a compensation event.
- Clause 60.1 (4):
Scenario: The project manager gives an instruction to stop or not to start any work or to change a key date.
Potential outcome: This shall be dependent upon direct instruction from the project manager but will provide a clear entitlement should the works be stopped or suspended for a period of time due to a Covid-19 issue.
- Clause 60.1 (5):
Scenario: The client or others do not work within the times shown in the accepted programme, do not work within the conditions stated in the scope, or carry out work on site that is not stated in the scope.
Potential outcome: This can give rise to a compensation event if the project becomes disrupted due to the effects of Covid-19 and the accepted programme is impacted. Furthermore, the clause highlights the importance of providing adequate information within the contract. It is imperative that any agreement on working conditions is clearly established and included within the scope.
As always, the ability for the contractor to claim the impact of a compensation event is subject to the provision of a timely notice in accordance with clause 61.3. If a valid compensation event notice is not provided, assuming it is not an event arising from a project manager’s instruction, then the contractor loses its entitlement.
Whilst we all know and understand the severe consequences of not correctly administering the compensation event mechanism under the NEC4 contract, it never ceases to amaze me how many contractors fall at this hurdle. Therefore, and notwithstanding Covid-19, we would reiterate the importance of providing adequate resources to ensure that all contractual obligations are correctly managed. This can be a significant undertaking for an NEC project, so do not underestimate your obligations.
Whilst the contractor may be able to establish entitlement to a compensation event for Covid-19 under one of the aforementioned clauses, in my opinion this ability still remains open to differing interpretations and is by no means certain. The entitlement of the contractor will depend upon the specifics of each individual scenario, and it is entirely feasible that an entitlement to time and/or money will not be captured by the compensation event clauses listed.
As we know, ambiguity in contracts will often lead to dispute, and therefore it is important that a clear and concise approach is adopted wherever possible. We would therefore suggest that the contractor and the client expressly agree who takes on board the risks associated with the Covid-19 pandemic, then amend the contract to suit.
There are a number of ways that this can be executed within the NEC4 contract, however we would suggest the most prudent options as follows:
- The risk of Covid-19 can be added to the client liabilities under clause 80.1, which would then give rise to a compensation event under clause 60.1 (14).
- Alternatively, it is possible to include an additional compensation event within the Contract Data Part One, which will then be triggered in accordance with clause 60.1 (21).
Whichever way it is executed, the important factor shall be to ensure that the drafting is clear, it is unambiguous and that both parties fully understand their risk exposure and obligations under the contract.
Time and Money
As with all compensation events under NEC4, they are assessed in accordance with clause 63. The default position is that the contractor is entitled to both time and money for any event which constitutes a compensation event.
Within any Covid-19 related compensation event, there will most likely be a requirement for the contractor to forecast costs on the basis of the project manager’s assumptions (clause 61.6) or allow risk allowances for matters which have a significant chance of occurring (clause 63.8). Therefore, from the outset, the assessment of a Covid-19 compensation event may be fraught with uncertainties.
Time is assessed in accordance with clause 63.5 as the length of time that, due to the compensation event, planned completion is later than planned completion as shown on the accepted programme at the dividing date. Whilst in practice a number of anomalies can arise from the implementation of this clause, the entitlement of the parties is relatively clear.
With regard to money, the situation is not as straightforward, especially when dealing with the potential effects of a Covid-19 event, such as periods of suspension, site shutdowns, long delays or even people working from home.
Clause 63.1 states that the change to the prices is assessed as the effect of the compensation event upon the actual Defined Cost of the work done, the forecast Defined Cost of the work not done and the resulting fee. Notwithstanding whether the assessment is made prospectively or retrospectively, the key issue is the definition of Defined Cost.
Under pricing options A and B, the definition of Defined Cost is included within clause 11.2 (23), which refers to the Shorter Schedule of Cost Components and, under C, D and E, the definition of Defined Cost is included within clause 11.2 (24), which refers to the Schedule of Cost Components (SSCS) .
The SSCS states that the Defined Cost of people, whether directly or indirectly employed, or whether or not the normal place of working is within the ‘Working Area’ (item 1), is “calculated by multiplying each of the People Rates by the total time appropriate to that rate spent within the Working Areas.” (item 11). As we all know, the Working Area will be defined within the contract data and will usually include the site and potentially any places of manufacture etc.
The Schedule of Cost Components (SCC) is a little more convoluted. The Defined Cost for people that are directly employed by the contractor and whose normal place of working is within the Working Area, or whose normal place of working is not within the Working Area, but who are working in the Working Area (item 1), is calculated upon the “wages, salaries and amounts paid by the Contractor for people paid according to the time worked on the contract.” (item 11). For people who are not directly employed by the contractor but are paid for by the contractor according to the time worked while they are within the Working Areas, Defined Cost is calculated based upon “Amounts paid by the Contractor” (item 14).
Therefore, and based upon the strict wording of the SSCS (pricing options A and B), only time spent working within the Working Area is included within the calculation of Defined Cost. With regard to the SCC (pricing options C, D and E), there is a greater chance that people may be recoverable outside of the Working Areas, however, in our opinion this remains unclear.
So, if you have members of staff working from home, they will not be working within the Working Area. This may well preclude their costs from the calculation of Defined Cost under options A and B, and possibly to an extent under C, D and E also. Furthermore, if your works are suspended or delayed, and you have staff and/or labour resources on hold awaiting their return to site, then such people are not within the Working Area and therefore, once again, their time may not be included within the calculation of Defined Cost.
Whilst some will argue that these costs are recoverable under the NEC4 contract, for me the contract remains ambiguous. As already noted herein, ambiguity often leads to dispute and without certainty on how the parties, and ultimately how a third party will interpret the contractual terms, an underlying risk continues to lurk.
It is therefore imperative that you are fully satisfied with your entitlement to recover costs under the contract and address any concerns prior to entering into contract, if possible. If you do envisage having staff working from home, that would usually be site-based, then ensure that your entitlement to recover such staff is included within the contract. Likewise, if periods of suspension are a potential risk on the project, then it is important to understand the entitlement to recover Defined Cost for staff and operatives who are not within the Working Area.
Wherever possible, we would suggest that these issues are discussed upfront, and the contract is duly amended to reflect the agreements reached.
The approach to Covid-19 will very much depend upon when the contract is entered into. For all contracts that were entered into prior to the pandemic, the entitlement of the contractor to claim time and money turns on the individual facts of the case. If the site was the subject of significant delay due to Covid-19, then there are contractual routes to follow in recovering an entitlement to both time and money.
With regard to contracts entered into post-pandemic, then a more cautious approach should be considered. The contractor will lose the ability to rely on the prevention clause, and the inclusion of Option X2 is unlikely to be of much assistance. Accordingly, the contractor has to be reliant upon the actions of the project manager or the failures of the client in managing any issues that arise.
For all contracts which have not yet been entered into, the power remains within your hands. As established herein, the NEC4 contract does not expressly deal with Covid-19. Consequently, and to ensure clarity on Covid-19 and its inherent risks, you must be proactive and instigate open discussions with all parties concerned, then include clear drafting within the contract to allocate such risks between the parties.
For an informal discussion on any existing issues, or for any assistance in drafting bespoke contract amendments going forward, please get in contact.
This insight was written by: Paul Ives - Head of Dispute Resolution for Gateley Vinden.
To contact Paul directly, please see below:
T: 01204 362888
M: 07921 934881