Page 1 The NEC3 Engineering and Construction Contract: A Comparative Analysis Part 1 - Energy and Natural Resources - United

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Home >UK >Employment and HR
Last Updated: 25 April 2013
Article byLaura Riddeck, Hayley Steel, Richard Ceeney, Vincent Rowan and Lynne Freeman
Reed Smith
United Kingdom: The NEC3 Engineering and Construction Contract: A
Comparative Analysis Part 1
0
The Engineeringand ConstructionContract(NEC3) and FIDIC Conditions of Contractfor
EPC/TurnkeyProjects (FIDIC Silver) arebothpopular standardforms of engineering and
constructioncontract, used ona varietyof projects bothintheUK and internationally.
However, theyhave fundamentally different approaches tothewayprojects shouldbe
managedand conducted.
Inthis, thefirst of a two-partseries assessingNEC3against themoreconventional FIDIC
Silver interms of its suitabilityfor substantial international constructionand engineering
projects, weexaminethecontrastingapproaches and philosophies of thetwo forms inrelation
tostructure, portability, risk and administration.
Introduction Inhis 1994 report entitled ConstructingtheTeam, Michael Lathamcommented
that "The client who wishes to accept little or no risk should take different routes for procuring
advice from the client who places importance on detailed, hands-on control." This comment
characterises thedifferenceinapproach betweena moretraditional formof contract (suchas
FIDIC Silver) and thenewNEC3form, whichembraces a morecollaborative approach.
FIDIC Silver is specificallydesignedas a turnkeycontract, whereanemployer hands full
responsibility over tothecontractor for all design, engineering and construction. This
approach expects theemployer to"waitfor thekeys" and tohave littleday-to-day
managementof theproject as workprogresses.
NEC3envisages theproject as a collaborative process, withanemphasis oncontract
administration. The parties areobliged to"actina spirit of mutual trust and co-operation", an
obligation whichis central tothephilosophy and concept of NEC3.
Of course, everyproject will be different, and everyemployer will have a different appetite for
risk. Whether anNEC3or FIDIC Silver standardformcontract is used for a large-scale
project, therewill inevitably be considerable scope for tailoringand amendmenttosuit the
project and theparties. That said, it is counterintuitive toselect a contract whichis draftedon
thebasis of a particular philosophy and thenseek toheavilyamendit suchthat it becomes far
removedfromits basis; thechoiceof base formis still important.
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Hands on or hands off? NEC3is oftenviewedwithsuspicion bythosewhoarenot familiar
withhowit works, even thoughtheformis nowinits thirdedition. It is, intentionally, a very
different contract, instructure, language and terminology, frommoretraditional forms suchas
FIDIC. It shies awayfromthetraditional language of constructioncontracts, suchas
"extensions of time" or "variations," and even avoids theuse of mandatorywordingsuchas
"shall" instead, verbs areused inthepresenttense. This takes somegettingused to, but is
deliberatelydone toreflecttheunderlyingcollaborative philosophy of theNEC3approach. It
is draftedtooperateina "commonsense" manner. The language is intendedtooperate
flexibly; as designresponsibility and pricingstructurearenot "nailed down" inthedraft it
should, theoretically, be adaptablefor anyproject whichmaymakeit moreportable
internationally.
Structurally, NEC3is made upof coreconditions, sixmain options (reflectingtheprice/
procurement strategy, analysedfurther inthesecond of this two-partseries) and various
secondaryoptions ("W," "X" and "Y" clauses). The parties cantailor their contract tofita
project byselectingwhichof theoptional clauses theywouldlike toincorporate.
Optional clauses include dispute resolutionprocedures, provisionfor bonds or parent
companyguarantees, limitations onliabilityand advance payment. The parties canalso
include further "Zclauses" if theywanttoamendanyof theNEC clauses or include additional
provisions. Manyof theprovisions intrinsic withinFIDIC appear as secondaryoptions in
NEC3(suchas performance securityand liquidated damages), and others aremissing
altogether. If adoptinga less traditional approach, anemployer will need tohave a good
understandingof howNEC3works so as toensure that nothingimportant is missed;
assumingthat the"usual" clauses arepresentwithinNEC3wouldbe a mistake.
The structurereflects NEC3's primarypurpose as a managementtool. It is oftensaidthat a
"good" contract will never be takenout of a cupboardunless and until somethinggoes wrong;
this is whollyuntrueof NEC3, whichis intendedtoutilise involved project managementand
wheretheintent is that thecontract remains anactive tool throughoutthelifeof a project.
FIDIC Silver is moretraditional innature. It sets out a series of "General Conditions" and the
parties will tailor this totheir project throughtheuse of "Particular Conditions." The contract is
partof theFIDIC "rainbow" of contracts, a well-establishedfamilyof standardforms designed
for use ina varietyof projects and approaches, includingdesignand build, employer-design,
dredging, and smaller projects. The forms all followa similar format; international contractors
arelikely tobe familiar withthis as it is used as thebasis for a varietyof projects aroundthe
world.
There is alsoa well-establishedbody of case lawinterpretingtraditional contracts suchas
FIDIC Silver and its forerunners. Its principles aretherefore well-understood. There is
significantly less case lawlooking atNEC3or its predecessors.
Familiarity, however, does not automaticallymeanthat theformis superior or moreuser-
friendly; "different" is not thesameas "bad." NEC3does require anemployer willingto
embraceits approach, as well as a project manager whois experiencedinfollowingit; but
thosewhoareexperiencedatusingit will oftenbe foundsinging its praises.
Don' t leave home without it A standardformof engineering and constructioncontract, for
use ininternational projects, needs tobe portable and easilyadaptablefor a varietyof
jurisdictions. FIDIC is designedfor international use and is themost commoninternational
standardform, availableina number of languages.
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NEC3has widespreaduse intheUK, aidedbythebackingthat it has received fromtheUK
Office of Government Commercefor public sector projects recenthigh-profile examples
include constructionof Terminal 5atHeathrowAirport and the2012 Olympic Stadium.
However, it is intendedtobe fullyportable and is nowbeingseen ina number of international
projects and markets.
Is NEC3trulyportable? It is certainly draftedin"plainEnglish" rather thanlegalese, whichin
theorycouldhelpits use inother jurisdictions, althoughthat is not tosaythat project
managers have not comeunstuckwhentryingtoapplythose"plainEnglish" terms. It maybe
fair tosay, however, that it was draftedfromanEnglish perspective (includingspecific
optional provisions for compliance withEnglish statutes, and terminationprovisions which
refer tovarious UK-specific insolvency events whichwouldneed adjustment tosuit other
jurisdictions). It is alsotruetosaythat a "commonsense" approach might alsodiffer fromone
jurisdiction toanother; one risk of usingNEC3inother jurisdictions is that it mayend upinthe
hands of anarbitrator or judgeunfamiliar withtheform.
However, theseconcerns byno means preventNEC3's operation inother jurisdictions. With
amendment, it is most adaptabletoother commonlaw/English speakingcountries but can,
withcare, be used inother jurisdictions.
Who pays if things change? A contractor's entitlement toadditional timeand/or moneyis
always a crucial area for considerationand/or negotiationinanyconstructionproject. Both
standardforms allowfor moretimeand moneyincertaincircumstances, but reflecta
fundamentally different approach.
NEC3's approach could(albeit as a gross generalisation) be summarisedas beingthat
employers shouldpayfor risks as and whentheyoccur, rather thanpayinga higher price to
pass theserisks tothecontractor upfront. The consequenceof this is that (onthefaceof the
contractual provisions) theemployer bears morerisk thanit wouldunder moretraditional
forms.
FIDIC Silver has a different philosophy: as a turnkeycontract, it aims topass, as far as
possible, full responsibility tothecontractor and thesituations whichentitle thecontractor to
claimmoretimeand/or moneyaremorelimited. This approach is oftenpreferred(and indeed
maybe dictated) byfinanciers. Manyemployers and contractors will alsoprefer this more
conventional approach as it provides greater certaintyabout wheretherisk portfolio is
distributed.
Lookingata fewexamples:
NEC3lists several "compensation events" that entitle a contractor tobothtimeand
money. Inparticular, this includes anyevents whichpreventthecontractor from
completingtheworks and whichanexperiencedcontractor wouldhave seen as
unreasonable toprice for. This is intendedtocaptureforcemajeure events but is
potentiallybroader. FIDIC Silver's approach toforcemajeure events is more
prescriptive, withanentire chapter dedicatedtoforcemajeure, a moredetaileddefinition
of theevents whichconstituteit, and a procedure settingout theconsequences.
Designresponsibility is givena muchstronger emphasis inFIDIC Silver, inline withthe
normal requirements of a turnkeycontract. FIDIC Silver expresslyimposes a fitness for
purpose obligation onthecontractor. NEC3, ontheother hand, is silentas todesign
standards and obligations. While theEnglish courts mayimplya fitness for purpose or
reasonableskill and careobligation, this maynot be thecase inother jurisdictions. In
FIDIC Silver, thecontractor is generallyresponsible for errors intheEmployer's
Requirements, withsomeexceptions; inNEC3, this is anemployer's risk, and the
contractor will be entitled tofurther timeand moneyfor instructions correctingany
errors.
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Inkeepingwiththeturnkeyapproach, FIDIC Silver provides that thecontractor will take
responsibility for thesite includingany"unforeseendifficulties." The NEC3, however,
allows unexpectedphysical conditions as a compensation event.
Onthefaceof it, therefore, manyemployers wouldopt for therisk positionunder FIDIC Silver
as providinga clear dividingline betweentheparties' respective positions. That said, others
mayprefer a morecollaborative approach that seeks tomanage risks rather thansimply
allocateresponsibility. The themeof risk managementunderpins NEC3's approach torisk,
and theemployer is expectedtotakea proactive approach. Through theuse of optional
clauses, theemployer canalsoincentivise thecontractor thetarget costoptions, for
example, include sharedsavings mechanisms, and therearealsooptional clauses to
incorporate keyperformance indicators and early completionbonuses. Noneof these
concepts arefoundinFIDIC Silver.
NEC3's collaborative approach torisk is further representedbythe"risk register" and "early
warning" concepts that allowmore"hands on" timeand delaymanagement. The risk register
is intendedtobe a project managementtool tomanage thoserisks whicharise over the
course of a project. Risks shouldbe notified bythecontractor or project manager as an"early
warningmatter" and will thenbe addedtotherisk register. The parties areencouragedto
have risk reductionmeetings toreviewregisteredrisks and decideonsolutions. There is risk
inherent inthis process itself: if theproject manager is not ontopof theprocess of approving
or rejectingcontractor's claims for compensation events and fails torespond, for example, this
is treatedas deemedacceptance.
NEC3's collaborative approach is alsorepresentedinits unusual approach todelayand/or
costentitlement. Rather thantheusual retrospective approach representedinFIDIC and
other traditional contracts, under NEC3anawardis forward-looking, based upon a quotation-
style approach: whenanevent occurs whichis theemployer's risk, thecontractor is required
tonotifytheanticipatedeffects of this event and, once agreedor determined, these
anticipatedeffects (interms of timeand/or cost) arecrystallisedirrespective of theactual
effects. Intheory, this ensures that thetimeand costawardedarereasonablebut that the
employer is thenprotectedagainst contractor inefficiencyand excesses indealing withthe
issue, withno requirementtoretrospectivelycomparewhatshouldhave happenedagainst
theactual approach taken.
The FIDIC Silver approach is muchmoretraditional, withthecontractor expectedtomanage
risks as theproject develops and deliver a complete solutionontime. For employers and
contractors whoareused tothemoretraditional balance of risk inanEPC contract, theFIDIC
Silver approach is likely tobe moreattractive.
Who makes the decisions? Insofar as theday-to-dayadministration of thecontactis
concerned, FIDIC Silver places obligations ontheemployer and thecontractor only. NEC3,
however, places obligations ontheemployer, thecontractor, theproject manager and the
supervisor. NEC3therefore clearlyanticipates, and infact heavilyrelies onparties other than
theemployer and thecontractor toensure that thecontract is administered correctly.
The role of theproject manager is central toNEC3. Althoughselected by, and acting on
behalf of, theemployer, theproject manager is required toactfairlyand impartially. Heavy
reliance is placedontheproject manager interms of making various decisions and issuing
various keynotices, includingnotifying compensation events. The partyselected toactas
project manager will therefore undoubtedlyneed tobe veryinvolved intheproject ona daily
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basis and will alsoneed tohave a verydetailedknowledgeof theNEC3formand howit
works.
This may, for some, put NEC3ata disadvantage, due toits central reliance ona thirdpartyto
correctlyand diligentlyadminister thecontract someemployers maysee this as a dilution of
theemployer's control. The role of theproject manager is not, however, unfettered, as both
contractor and employer need tosignchanges tothecontract.
FIDIC Silver is draftedonthebasis that theemployer will generallyleavethecontractor to
progress withtheworks, inaccordance withthecontract. FIDIC Silver does not envisage that
thecontract will be "administered" byanythirdpartyand works generallyonthebasis that the
employer accepts that thecontractor will progress theworks, address anyissues as and
whenthesearise and hand over a fullyfunctional productattheend of theworks. That said,
thereis nothingtopreventtheemployer fromengaginga technical advisor or engineer to
monitor compliance withthecontract. The rights (for example) for theemployer toapprove the
contractor's documents and inspect theworkor plant areclearlyintendedtoallowtheinput of
a technical advisor; it is simplythat thereis nothinginFIDIC Silver tofetter theemployer's
discretion. Inpractice, anemployer usingFIDIC Silver (and its technical advisor) is likely to
have a highdegree of involvement intheproject.
Which contract works best? To recap, wehave lookedata number of criteria inassessing
NEC3against themoreconventional FIDIC Silver book. Seebelow for a comparative
summary.
Whenassessingthesecontracts, it is not so mucha case of better or worse, but a difference
inapproach, and thequestionof whichcontract will workbest for a specific project and the
parties involved. NEC3relies ongood managementand is designedtofleshout problems as
theproject progresses. FIDIC Silver is designedas a trueturnkeycontract, withtheintention
that thecontractor will, for themost part, takeresponsibility for ongoingproblems. However, in
themajorityof international high-valueprojects conductedunder FIDIC Silver, theemployer
will be activelyinvolved throughoutand will oftentakea collaborative approach. For example,
FIDIC has a concept of thedispute adjudicationboard, whichcanbe used bytheparties to
manage problems as theyarise and avoidmoreformal dispute resolutionprocedures.
Inevitability, therearepros and cons tobothapproaches. A heavy emphasis onmanagement
comes withcostimplications and maynot suit everyproject owner, but it couldhave the
advantage of fixingproblems earlier. Howwell thecontracts workdepends toa large extent
onhowtheyareused inpractice. Will theparties usingNEC3reallyembracethecollaborative
natureand adhere totheadministrative procedures essential toits operation? Conversely, a
turnkeycontract, inpractice, never reallyresults ina trulyhands-off approach.
Inthesecond of this two-partseries, wewill lookincloser detail athowthestandardforms
applytheseapproaches tosomeof themechanisms whicharelikely tobe of importancein
high-valueinternational infrastructureprojects: pricing, programmingand testing.
Comparative summary:
Criteria FIDIC Silver NEC3
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Reed Smith
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More fromthis Firm
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Laura Riddeck Hayley Steel Richard Ceeney Vincent Rowan
Clause structure Traditional: all provisions
setout as "general
conditions" withparties
specifyingdetail or
amendments within
"particular conditions"
Made upof coreclauses
anda series of main and
secondaryoptions
Portability Designed for international
use inrange of jurisdictions
andlanguages
Draftedtobe portable but
onlyinEnglish language
and(arguably) fromEnglish
perspective
Entitlement tomoretimeand
money
Tighter list of events Broader andincludingwide
catch-alls
Designresponsibility Fitness for purpose Silent as todesign
standards
Errors inemployer's
requirements
Generallya contractor risk
(someexceptions)
Employer risk
Site conditions Contractor takes
responsibility for thesite
includingunforeseen
difficulties
Unexpectedphysical
conditions area
compensation event
Role of thirdparties Nostructuredrole (though
mayoftenbe appointedin
practice)
Project manager heavily
involvedinadministration of
contract
The content of this article is intended to provide a general guide to the subject matter.
Specialist advice should be sought about your specific circumstances.
Contributor
Authors
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