Contract Overview The NEC is now in its 3 rd edition as has been with us for over 20 years There is considerable debate over how it works and how it will be interpreted by the Courts as there remain very few cases on it This is a highly sophisticated form of contract with complex ideas and methodologies As with most standard forms you see a wide variety of amendments
Contract Overview Just looking at the main form ECC You can have disallowance in the subcontract and even the professional services contract but that is less common Why? Disallowance is only relevant to those Main Options based on cost recovery (C, D and E)
Basic Principles of Disallowance Disallowance is intended as a means of ensuring that there is no overpayment for sums which are not properly due It forms part of the calculation of the Amount Due which therefore becomes part of the payment notice As part of the calculation of the Amount Due it is for the Project Manager to ascertain It is not part of a payless notice Disallowance should be specific identifiable sums for specific identifiable reasons
Disallowance in Context The cash options contracts are intended to be low risk for the contractor They are intended to give keener prices and more transparency on costs However, disallowance used incorrectly can cause significant cash flow problems for a contractor A low risk contract can very quickly become high risk because there is no margin or supply network for a contractor to hide behind
Section Two Contractual Framework for Disallowance
Definition of Disallowed Costs Costs which the Project Manager decides A changed decision is a Compensation Event (60.1(8)) There are 8 basic reasons for disallowance, some used much more frequently than others Grouped today into five categories Accounts and records Sums which shouldnt have been paid Correcting defects Failure to follow procedure or give early warning Things not used to provide the works Clause 11.2(25)
is not justified by the Contractors accounts and records There should be a statement from the Employer somewhere on what accounts and records are expected, probably in Works Information Very rarely set out explicitly and in detail Should be agreed at an operational level as early as possible to make interim payments functional Accounts and Records
should not have been paid to a Subcontractor or supplier in accordance with his contract This would include any designer and is intended to prevent gratuitous payments Care needed when finalising and settling an account to make sure the settlement is in accordance with the contract If delay damages could have been levied then a disallowance may arise if they were not taken A Project Manager should not need to re-assess the subcontract payments but he could This can cause problems where the Project Manager does not have access to the terms of the Subcontract Sums which should not have been paid
correcting Defects after Completion and correcting Defects caused by the Contractor not complying with a constraint on how he is to Provide the Works stated in the Works Information Intended to encourage early identification and correction of defects It is the cost of that is relevant so there has to be a cost actually incurred, an assessment of possible cost is not appropriate to the disallowance although it can be under 45.1 in assessing the defect This clause is often amended as Employers do not like the idea of paying for the correction of any defective work which shifts the risk balance Correcting Defects
was incurred because the Contractor did not follow an acceptance or procurement procedure stated in the Works Information or give an early warning which the contract required him to give The first part of this test is wide and would include all interim and final testing and commissioning There is cross over with the defect provisions Works Information would include any from the Contractor and process it may have given at tender The second part focuses on early warnings and needs to be read in conjunction with 16.1 for when early warning should be given and 61.5 which allows compensation events to be valued at a lower level Early Warning and Procedure Failures
Not Used to Provide the Works Plant and Materials not used to Provide the Works…resources not used to Provide the Works Plant and Materials are permanent not temporary items Provide the Works is very broadly defined To do all the work necessary to complete the works in accordance with this contract and all incidental work, services and actions which this contract requires There is an allowance for wastage and reasonable utilisation, in the Project Managers assessment
Section Three Practical Issues in Disallowed Costs
Disallowed Cost [DC] Practical Management DC Review at Tender Managing DC at Contract Commencement Managing DC during the Contract Common Issues Cost risk under the Contract
DC Review at Tender Contractor Paid PWDD PWDD = Defined Cost + Fee Defined Cost = Actual Cost - DC DC allowance in the Fee DC allowance % in Fee?
Managing DC At Contract Commencement Agreed Protocol DC Register – Unique Reference PM Notice PM Particulars PM / C Review Meeting Actions Agree / Disagree Allowable Cost / DC
Managing DC During the Contract Risk Register Driven by Early Warnings Add 3 columns with a tick mark (pencil) CE DC P/G
Managing DC During the Contact Accounts & Records Orders & Invoices Matching Labour & Plant Allocation Sheets Material Delivery Notes Plant on / off Hire Notes Major Material Reconciliations Staff Timesheets & Expenses
Managing DC During the Contract Subcontractors 3 Quotes? Subcontract Order CEs – The Works & Domestic Issues DCs – Back to Back Provisions Agreement if different Option
Managing DC During the Contract Defects Raising and closing out NCRs (Before Completion) Where Defects are DC – Timely and Proper Agreed Resource based records to be signed off by PM.
Common Issues Timely DCs When should DC be crystallised? When the cost is incurred? Anytime before the final assessment of the Contractors Share? Assessed monthly by PM? Assessed Quarterly by external audit team?
Common Issues Timely DCs If the DC is levied several months after incurred – what are the implications? Subcontractor account settled Cost could have been reduced Has the Contractors position be prejudiced by the late DC?
Common Issues Timely DCs If DC is levied several months after incurred – what does the contract say? Can it be an allowable cost one month and then DC a later month? Clause 50.5 allows the PM to correct any wrongly assessed amount due in a later payment certificate.
Common Issues Timely DCs What is the Contractors Remedy? The Party alleging the certificate is wrong bears the burden of proof. Clause 51.3 allows interest to be paid on the correcting amount. Persuade or adjudicate Tribunal
Common Issues DC and Pain Gain Relationship Standard contract states P/G impacted on certificate at completion. That could expose Employer to recover a debt. Amended contracts impact P/G when PWDD exceeds the Prices
Common Issues DC and Pain Gain Relationship Experience / history has shown that interim assessments of DC higher when P/G assessed at completion to offset debt risk. Impact on certificate is significantly different – with 50:50 P/G its 50p in the £1 but with DC £1 for £1.
Common Issues Specific v General PM must identify specific items of cost and identify how they fall within the definition of Disallowed Cost. PM cannot take a view as to the overall level of Defined Cost or take a view as to the economy or efficiency that should have been achieved.
Common Issues DC or Pain/Gain Risk Share Matters of efficiency and economy are the subject of the pain/gain risk share. Procurement losses are the subject of the pain/gain risk share. Misunderstanding between lump sum fixed price contracts and pain/gain risk sharing contracts.
Cost risk under the Contract Contractor is paid Defined Cost regardless of the level of Defined Cost. Exception is Disallowed Cost These are specific items of cost defined in the Contract They are not related to the level of Defined Cost The PM decides disallowed cost in interim payments Pain/Gain (Contractors Share) is a separate and distinct mechanism which is related to the level of PWDD (Defined Cost + Fee) compared to the Target (Prices). The risk is shared It is a calculation after Completion (Standard)