NEC3 A Practical Guide to Compensation Events

Chris Holden
LLB FRICS FBEng MCIArb

www.kerrigans.net

Introduction
The intention of this presentation is to provide a practical approach to dealing with compensation events in terms of not only what the contractual provisions require the parties to do, but also how the parties should proceed.

Introduction
The philosophy of the NEC is that the Contractor should not lose out, nor indeed should he benefit from a windfall, as a result of an event which the contract puts at the Employers risk, ie: compensation events.

Introduction
The approach adopted by the NEC in relation to a contractors entitlement to relief, in terms of both additional time and monetary relief is therefore quite different from that of earlier standard forms such as the ICE, GC Works 1, JCT and FIDIC forms.

Introduction
The NEC does not contemplate contractors claims, in the traditional (often advanced retrospectively) sense, for extensions of time, additional cost, or loss and/or expense. Under the NEC such matters are dealt with by both parties proactively following the procedures set forth in the contract for the notification and assessment of compensation events.

Introduction
Clause 10.1 provides: The Employer, the Contractor, the Project Manager and the Supervisor shall act as stated in this contract and in a spirit of mutual trust and co-operation.

Introduction
Clause 63.4 provides:
The rights of the Employer and the Contractor to changes to the Prices, the Completion Date and the Key Dates are their only rights in respect of a compensation event.

Breaches of contract by the Employer are compensation events (60.1). The intended effect of Clause 63.4 is to exclude the parties common law rights.

Introduction
Accordingly, since the Contractors only rights lie through the Contract, in order to maintain his rights and obtain the relief to which he may be entitled, it is essential that the Contractor complies with the provisions of the Contract in relation to the notification of events which may constitute compensation events. No timely notice, no financial relief and no extension of time for completion, culpable delay and exposure to delay damages.

Communications
Clause 13.1 provides inter alia: Each instruction, certificate, submission, proposal, record, acceptance, notification, reply and other communication which this contract requires is communicated in a form which can be read, copied and recorded. i.e. in writing Clause 13.7 provides: A notification which this contract requires is communicated separately from other communications.

Notices of compensation events must be given in writing and must be separate from other communications.

Communications
Minutes in meetings of meetings will not constitute valid notification, nor will it be sufficient to include a notification within a communication addressing other, unrelated matters. Email would be compliant but it is recommended that whilst email may be used to forward notifications, the notification should not be in the form of email itself. In the interest of uniformity, use of standard forms (see example 1) is recommended. This will lead to greater clarity and certainty in complying with the provisions of the contract.

Early Warnings
Clause 16.1 provides inter alia:
The Contractor and the Project Manager give and early warning by notifying the other as soon as either becomes aware of any matter which could:
Increase the total of the Prices Delay Completion Delay meeting a Key Date Impair the performance of the works in use

The Contractor may give an early warning by notifying the Project Manager of any other matter which could increase his total cost. The obligation is not confined to notifying matters which are/or may be compensation events. Use of a two-way standard form is recommended (see example 2).

Early Warnings
Clause 61.5 provides:
If the Project Manager decides that the Contractor did not give an early warning of the event which an experienced contractor could have given, he notifies this decision to the Contractor when he instructs him to submit quotations.

Clause 63.5 provides:

If the Project Manager has notified the Contractor of his decision that the Contractor did not give an early warning of a compensation which an experience contractor could have given, the event is assessed as if the Contractor had given early warning.

Early Warnings
Clause 63.5 is often misinterpreted as having the effect of letting the Contractor off the hook for failing to give early warning. In fact, the intention of the provision is to ensure that the Contractor does not benefit from his own breach in failing to give early warning, in circumstances where early warning would have had a mitigating affect on the effects of the compensation event.

Notifying Compensation Events

Early warning notifications do not constitute notifications of compensation events. The two require separate notifications. Both the Project Manager and the Contractor are under an obligation to notify. (61.1 and 61.3 respectively) The use of two-way standard forms is recommended (see example 3).

Notifying Compensation Events

Clause 61.1 provides inter alia:
For compensation events which arise from the Project Manager or the Supervisor giving an instruction or changing an earlier decision, the Project Manager notifies the Contractor of the compensation event at the time of given the instruction or changing the earlier decision. He also in instructs the Contractor to submit quotations,.

Note: the requirement to instruct the submission of quotations is mandatory (as to which see 10.1).

Notifying Compensation Events

Clause 61.3 provides inter alia:
The Contractor notifies the Project Manager of

an event which has happened or which he expects to happen as a compensation event if

the Contractor believes that the event is a compensation event and The Project Manager has not notified the event to the Contractor..

Note: Clause 60.1 sets forth a list of events which are compensation events (60.1(1) to (19)). As far as Main Options A, C, E and F are concerned, the list is exhaustive. However, Main Options B and D carry two additional compensation events relating to changes in quantities stated in the Bill of Quantities (as to which see Main Option Clauses 60.4 and 60.5).

Notifying Compensation Events

Clause 61.3 further provides:
.If the Contractor does not notify a compensation event within eight weeks of becoming aware of the event, he is not entitled to a change in the Prices, the Completion Date or a Key Date unless the Project Manager should have notified the event to the Contractor but did not. Note: This provision is a condition precedent and must be complied with. The only proviso being in circumstances of the Project Managers failure.

Notifying Compensation Events

Failure to give Notice Conditions Precedent
Multiplex Constructions (UK) Ltd v Honeywell Control Systems Ltd (No.2) [2007] EWHC 447 (TCC) appears to support the Opinion of the Inner House of the Court of Session in City Inns v Shepherd
failure to comply with a condition precedent deprived the Contractor of the right to claim and extension of time.

there is no reason to suggest why the same principle would not deprive the Contractor of the right to claim any other form of relief

Notifying Compensation Events

Failure to give Notice Conditions Precedent
Steria Limited v Sigma Wireless Communications Limited [2008] BLR 79
By virtue of Condition 6, if circumstances arose for which Sigma was responsible, Steria was entitled to extensions of time provided Steria gave written notice within a reasonable period. The wording of Condition 6 was clear and there was no need for the inclusion of any expressed statement that unless written notice had been given within a reasonable time, Steria would not be entitled to an extension of time. Thus the Judge was saying that there does not need to be an express warning as to the consequences of non-compliance for the provision to operate as a condition precedent.

Notifying Compensation Events

Failure to give Notice Conditions Precedent
In the Scottish case of Education 4 Ayrshire Ltd v South Ayrshire Council [2009] CSOH 146 The Court dismissed the Contractors claim for both extension of time and monetary compensation on account of the Contractors failure to comply with the exacting requirements of a notice provision. This was despite the fact that the Contractors notice was given within the time period stated in the Contract.

Notifying Compensation Events

It is recommended not to wait for PM to notify, but to notify any event as soon as becoming aware, thereby avoiding the need for any claim to be founded upon reliance on a breach (ie. failure by the PM to notify). This approach is, in any event, consistent with the terms of Clause 61.3. Given the terms of 61.3 (condition precedent) it is recommended that notification should be given even in circumstances where there may be doubt as to whether an event qualifies as a compensation event or not. That matter can be debated later. Use of a two-way standard form is recommended (see example 4).

Notifying Compensation Events

Clause 61.4 provides: If the Project Manager decides that an event notified by the Contractor
arises from a fault of the Contractor, has not happened and is not expected to happen, has no effect upon Defined Cost, Completion or meeting a Key Date or is not one of the compensation events stated in this contract

he notifies the Contractor of his decision that the Prices, the Completion Date and the Key Dates are not to be changed. Note: the above four reasons are the only reasons upon which the PM can base his decision that there will be no changes.

Notifying Compensation Events

Clause 61.4 further provides:
If the Project Manager decides otherwise, he notifies the Contractor accordingly and instructs him to submit quotations
Note: it is mandatory for the PM to both notify his decision and instruct the submission of quotations (see Clause 10.1).

Notifying Compensation Events

Clause 61.4 further provides: If the Project Manager does not notify his decision to the Contractor within either
one week of the Contractors notification or a longer period to which the Contractor has agreed,

the Contractor may notify the Project Manager to this effect. A failure by the Project Manager to reply within two weeks of this notification is treated as acceptance by the Project Manager that the event is a compensation event and an instruction to submit quotations.
Note: This provision is clearly contingent upon the giving of

the reminder notice. It is only from the date of the reminder that the 2 week period can be calculated.

Notifying Compensation Events

It is therefore recommended that such notification by way of reminder should be given. Use of a standard form is recommended (see example 5). Failure by the PM to notify his decision (as to whether the event falls within one or more of the four reasons why there will be no changes to the Prices, Completion Date and Key Dates or to instruct the submission of quotations) within a further 2 weeks following the reminder, the event is treated as accepted by the PM as a compensation event and an instruction to submit quotations.

Notifying Compensation Events

Assumptions
Clause 61.6 provides:
If the Project Manager decides that the effects of a compensation event are too uncertain to be forecast reasonably, he states assumptions about the event in his instruction to the Contractor to submit quotations. Assessment of the event is based on these assumptions. If any of them is later found to have been wrong, the Project Manager notifies a correction.

Notifying Compensation Events

Assumptions
Clause 65.2 provides: The assessment of a compensation event is not revised if a forecast upon which it is based is shown by later recorded information to have been wrong. On the face of it Clause 65.2 would seem to be in conflict with Clause 61.6. However, the notification by the PM of a correction under 61.6 constitutes a compensation event under Clause 60.1 (17). The effect is that a compensation event/quotation based originally on incorrect assumptions is not reassessed, but a new compensation event is assessed in accordance with the provisions under Clause 63.

Notifying Compensation Events

Clause 61.7 provides: A compensation event is not notified after the defects date. The defects date is stated in Contract Data Part One. This provision lends support to the proposition that the NEC does not allow retrospective claims of the type mentioned at the start of this presentation.

Quotations and Assessments

Clause 62.2 provides inter alia: Quotations for compensation events comprise proposed changes to the Prices and any delay to the Completion Date and Key Dates assessed by the Contractor.. Thus, the Contractors quotation must deal with the relief sought in terms of both time and money. If a quotation does not deal with all the relief sought and is accepted (or treated as accepted) by the PM, the Contractor will have lost his right to that part of the relief not dealt with by the quotation.

Quotations and Assessments

Clause 62.2 further provides: The Contractor submits details of his assessment with each quotation In complying with this part of the provision, the Contractors quotation must be detailed in the manner prescribed by Clauses 63.1 and 63.3 (as to which see below).

Quotations and Assessments

Clause 63.1 provides:
The changes to the Prices are assessed as the effect of the compensation event upon
the actual Defined Cost of the work already done, the forecast Defined Cost of the work not yet done and the resulting Fee.

The date when the Project Manager instructed or should have instructed the Contractor to submit quotations divides the work already done from the work not yet done.
Note: The actual physical progress of the work at the time the assessment/quotation is done is not the criteria for deciding work done or not done. The line in the sand is the date of the instruction or, if that instruction is late, the date it ought to have been given.

Quotations and Assessments

This method of assessment forms the basis of a quotation. Value does not enter into the matter, assessment is cost (i.e. Defined Cost) based. The term work used alone is not confined simple to the work required by the compensation event. The Defined Cost of any work affected by the compensation event is taken into account in a quotation/assessment. Due to the early warning provisions, the NEC contemplates most compensation event assessments will be on a forecast basis, resulting in accepted quotations, rather than a retrospective basis. (This is clear from clause 63.6 which provides that assessments include risk allowances for cost and time for matters at the risk of the Contractor which have a significant chance of occurring).

Quotations and Assessments

Assessments are made on the basis of Defined Cost. It is important to note that the definition of Defined Cost varies between the Main Options. Under Options C, D, E & F Defined Cost is defined as:
the amount of payments due to Subcontractors for work which is subcontracted. And the cost of the components in the Schedule of Cost Components for other work.

Quotations and Assessments

Under Options A and B, Defined Cost is defines as:
the cost of the components in the Shorter Schedule of Cost Components whether work is subcontracted or not excluding the cost of preparing quotations for compensation events

The implication of the different definition is that the Contractor is not entitled to recover amounts charged by subcontractors (ie. the subcontractors invoice amount) in quotations/assessments of compensation events.

Quotations and Assessments

This is a significant consideration when entering the fee percentages in Contract Data Part Two and when negotiating and finalising subcontracts. If the Contractors subcontracted fee percentage in Contract Data Part Two of the Main Contract is a significantly lower percentage than that of the subcontractor in Subcontract Data Part Two in the Subcontract, the Main Contractor will lose out in terms of the amount recovered for a compensation event under the Main Contract compared with the amount paid out under the Subcontract.

Quotations and Assessments

Clause 62.2 further provides: If the programme for remaining work is altered by the compensation event, the Contractor includes the alterations to the Accepted Programme in his quotation. Note: Alterations to the Accepted Programme are not confined to those affecting the critical path, but include non-critical activity delay.

Quotations and Assessments

Clause 63.3 provides inter alia: A delay to the Completion Date is assessed as the length of time that, due to the compensation event, planned Completion is later than planned Completion as shown on the Accepted Programme. Note: NEC contemplates the Contractor may plan to complete the works earlier than the contractual Completion Date, hence the reference to planned completion.

Quotations and Assessments

Thus, by virtue of Clause 63.3 any delay to planned Completion will result in an equivalent delay to Completion Date. Any float between planned Completion and the contractual Completion Date is owned entirely by the Contractor. Activity float before planned Completion is available to either party to mitigate delay.

Quotations and Assessments

Only by establishing a delay to planned Completion caused by a compensation event, revising the programme to reflect that position, submitting the revised programme to the PM for acceptance and receiving the PMs acceptance of the revised programme can the Contractor gain an extension of time. Failure on the part of the Contractor to submit revised programmes for acceptance and to get acceptance will result in the Contractor being in culpable delay and exposure to delay damages.

Quotations and Assessments

It is submitted that the correct approach is as follows:
1) Take the Accepted Programme current at the time the compensation event arises and bring it up to date to reflect reality in terms of progress at the time the PM instructed or ought to have instructed the submission of quotations. (This meets with the requirements of clause 32.1) 2) Impact the effect of the event on the Accepted Programme as updated in accordance with (1). If the effect is a delay to planned Completion as shown on the updated Accepted Programme, submit the revised and impacted programme for acceptance by the PM, as part of the quotation for the compensation event submitted for his acceptance.

Quotations and Assessments

Clause 62.3 provides:
The Contractor submits quotations within three weeks of being instructed to do so by the Project Manager. The Project Manager replies within two weeks of the submission. His reply is an instruction to submit a revised quotation, an acceptance of a quotation, a notification that a proposed instruction will not be give or a proposed changed decision will not be made or a notification that he will be making his own assessment.

Quotations and Assessments

Quotations are to be submitted within 3 weeks of the PM instructing submission. The PM must reply within 2 weeks of the submission. It is recommended that, in circumstances where the PM has not instructed submission, wherever possible, quotations should be submitted within 3 weeks of the date when the PM ought to have instructed submission. Note: time for submission and reply can be extended by agreement (see 62.5) but be sure the PM notifies the extension as required by 62.5 (ie. get written confirmation, otherwise there may be implications in relation to 62.6 (see below))

Quotations and Assessments

Clause 62.6 provides If the PM does not reply to a quotation within the
time allowed, the Contractor may notify Project Manager to this effect. If the Contractor submitted more than one quotation for the compensation event, he states in his notification which quotation he proposes is to be accepted. If the Project Manager does not reply to the notification within two weeks, and unless the quotation is for a proposed instruction or a proposed changed decision, the Contractors notification is treated as acceptance of the quotation by the Project Manager.

Quotations and Assessments

If the PM does not reply to a quotation within the allowed time (2 weeks unless agreed otherwise) the Contractor may notify the PM to that effect. It is recommended that such a notification by way of reminder should be given. Use of a standard form is recommended (see example 6). If the PM fails to reply within a further 2 weeks after the reminder, the notification is treated as acceptance by the PM of the Contractors quotation. This provision is clearly contingent on the giving of the reminder notice. It is only from the date of the reminder that the 2 week period can be calculated. Note: the reminder notification must make it clear which quotation is proposed to be accepted.

Quotations and Assessments

Clause 63.2 provides:
If the effect of a compensation event is to reduce the total Defined Cost, the Prices are not reduced except as stated in this Contract.

Quotations and Assessments

Under Options A and B, Clause 63.10 provides:
If the effect of a compensation event is to reduce the total Defined Cost and the event is a change to the Works Information or a correction of an assumption stated by the Project Manager for assessing an earlier compensation event, the Prices are reduced.

Quotations and Assessments

Under Options C and D, Clause 63.11 provides:
If the effect of a compensation event is to reduce the total
Defined Cost and the event is a change to the Works Information, other than a change to the Works Information provided by the Employer which the Contractor proposed and the Project Manager has accepted or a correction of an assumption stated by the Project Manager for assessing an earlier compensation event, the Prices are reduced.

The additional wording in the first bullet point is to do with value engineering

Quotations and Assessments

Clause 63.6 provides:
Assessment of the effect of a compensation event includes risk allowances for cost and time for matters which have a significant chance of occurring and are at the Contractors risk under this contract.

Contractors will need to identify precisely what such risks are. Merely adding an arbitrary sum or percentage will not be acceptable.

Quotations and Assessments

Clause 17.1 provides:
The Project Manager or the Contractor notifies the other as soon as either becomes aware of an ambiguity or inconsistency in or between the documents which are part of this contract. The Project Manager gives an instruction resolving the ambiguity or inconsistency.

An instruction resolving an ambiguity or inconsistency may or may not constitute a compensation event.

Clause 63.8 provides:

A compensation event which is an instruction to change the Works Information in order to resolve an ambiguity or inconsistency is assessed as if the Prices, the Completion Date and the Key Dates were for the interpretation most favourable to the Party which did not provide the Works Information.

Quotations and Assessments

Clauses 63.13, 63.14 and 63.15 (depending upon which Main Option applies) all provide that the PM and Contractor can agree to use rates and lump sums to assess a compensation event instead of Defined Cost. It is not recommended that an agreement of the type contemplated by those clauses be reached on a blanket basis for compensation events, but if appropriate, on an individual by individual compensation event basis.

Quotations and Assessments

The inherent problems with such agreements, particularly in relation to high cost compensation events, are: (1) whether or not the individuals reaching such agreements have actual, or even ostensible authority to commit their respective employers to such agreements (these things are often done at site), and (2) the scope for failure to actually agree what rates or lump sums are appropriate, thus dragging out the intension of NEC to expedite early settlement in relation to what are effectively claim items, culminating in reverting to the Defined Cost basis after a considerable time has elapsed. However, in certain circumstances, such agreements may overcome some difficulties in establishing Defined Cost.

Project Managers Assessments

Clause 64.1 provides:
The Project Manager assesses a compensation event
if the Contractor has not submitted a quotation and details of his assessment within the time allowed, if the Project Manager decides that the Contractor has not assessed the compensation event correctly in a quotation and he does not instruct the Contractor to submit a revised quotation, if, when the Contractor submits quotations for a compensation event, he has not submitted a programme or alterations to a programme which this contract requires him to submit or if, when the Contractor submits quotations for a compensation event, the Project Manager has not accepted the Contractors latest programme for one of the reasons stated in this contract.

Project Managers Assessments

Under clause 64.1 there are only four circumstances in which it is open to the PM to make his own assessment of the effect of a compensation event. The Contractor must submit details with his quotation and submit his quotation within the time allowed (three weeks). Note: The PM is not obliged to call for any revised quotations. Note: Clause 32 sets forth the contract requirements for submission of programmes. Note: Clause 31.3 sets out the four reasons for which the PM can refuse to accept a programme.

Project Managers Assessments

It is not open to the PM to make his own assessments prior to or instead of instructing the submission of quotations. Under clauses 61.1 and 61.4 it is mandatory that the PM instructs submission of quotations. That is clear from the wording of Clause 10.1 which states:
The Employer, the Contractor, the Project Manager and the Supervisor shall act as stated in this contract

Project Managers Assessments

It is not open to the PM to reject programmes for reasons other than stated in clause 31.3. It is recommended that PM is pressed to accept programmes or give the reason for not accepting, within the 2 weeks allowed. Allowing the process of programme submission and acceptance to slip can have disastrous consequences under NEC. It is the only process whereby time can be extended. There are none of the traditional mechanisms available.

Project Managers Assessments

Clause 64.2 provides:
The Project Manager assesses a compensation event using his own assessment of the programme for the remaining work if
there is not Accepted Programme or the Contractor has not submitted a programme or alterations to a programme for acceptance as required by this contract.

Project Managers Assessments

Clause 63.4 provides:
The Project Manager notifies the Contractor of his assessment of a compensation event and gives him details of it within the period allowed for the Contractors submission of his quotation for the same event. This period starts when the need for the Project Managers assessment becomes apparent.

The period is three weeks. The need for the PMs assessment arises when one or more of the conditions set out in clause 64.1 arises.

Project Managers Assessments

Clause 64.4 provides:
If the Project Manager does not assess a compensation event within the time allowed, the Contractor may notify the Project Manager to this effect. If the Contractor submitted more than one quotation for the compensation event, he states in his notification which quotation he proposes is to be accepted. If the Project Manager does not reply within two weeks of this notification the notification is treated as acceptance of the Contractors quotation by the Project Manager.

Project Managers Assessments

It is recommended that such notifications by way of reminder should be given. Note: If the Contractor has submitted more than one quotation, the reminder notification must make it clear which quotation is proposed to be accepted. Use of a standard form is recommended (see example 7). If the PM fails to reply within a further two weeks after the reminder, the notification is treated as acceptance by the PM of the Contractors quotation. This provision is clearly contingent on the giving of the reminder notice. It is only from the date of the reminder that the two week period can be calculated.

Implementation
Clause 65.1 provides:
Compensation events are implemented when:
the Project Manager notifies his acceptance of the Contactors quotation, the Project Manager notifies the Contractor of his own assessment or a Contractors quotation is treated as having been accepted by the Project Manager.

The quotation which will be treated as having been accepted will be that referred to in the reminder notification given pursuant to clause 62.6.

Implementation
Clause 65.1 provides:
Compensation events are implemented when:
the Project Manager notifies his acceptance of the Contactors quotation, the Project Manager notifies the Contractor of his own assessment or a Contractors quotation is treated as having been accepted by the Project Manager.

The quotation which will be treated as having been accepted will be that referred to in the reminder notification given pursuant to clause 62.6.

Implementation
Remember, under clauses 13.1 and 13.7 (communications, see above) all communications must be in writing and notifications are to be communicated separately from other communications. It is recommended that the PM is pressed to commit his notifications as to decisions and acceptances in the manner prescribed by clauses 13.1 and 13.7 and not to be allowed to leave matters in a state of uncertainty or ambiguity. This is a common cause of problems and disputes under NEC. For example, clause 32.1 requires the Contractor to show, on each revised programme, the effects only of implemented compensation events. This can lead to argument as to the actual integrity/accuracy of the revised programme which may affect acceptance.

Worked Example
The example is based on a compensation event under a Main Option A, Priced Contract with Activity Schedule. The same procedure would apply in the case of the other Main Options. For simplicity, the example does not include supporting documents in relation to Defined Cost or planned resources but it is assumed that such information would be provided in appendices to the quotation submission. Examples of programmes, notifications, covering letters and activity schedules are provided. Again, for simplicity, the programme periods do not take account of public holidays or other shutdown periods.

Worked Example
The Contract:
John Wayne Contractors has contracted with Running Water Ltd to construct a new oxidation ditch, settlement tank and associated ancillary works at an existing sewage treatment works known as Wild West STW. The main work comprises the placement of reinforced concrete bases and the construction of reinforced concrete walls to the oxidation ditch and settlement tank. The Conditions of Contract are the NEC Edition 3, Main Option A. The Employer is to free issue the steel bar reinforcement. The starting date is 4 May 2010. The Completion Date is 3 December 2010.

Worked Example
The Event:
The Project Manager has issued John Wayne Contractors with revised drawings and bar schedules, changing the design of the steel bar reinforcement to the oxidation ditch walls. The original design called for predominantly 20 mm diameter bars. The revised design calls for predominantly 16 mm diameter bars. The oxidation ditch is 15m long x 10m wide x 6m deep.