The NEC3 Engineering and Construction Contract: A Comparative Analysis – Part 1

The Engineering and Construction Contract (NEC3) and FIDIC Conditions of Contract for EPC/Turnkey Projects (FIDIC Silver) are both popular standard forms of engineering and construction contract, used on a variety of projects both in the UK and internationally. However, they have fundamentally different approaches to the way projects should be managed and conducted.

In this, the first of a two-part series assessing NEC3 against the more conventional FIDIC Silver in terms of its suitability for substantial international construction and engineering projects, we examine the contrasting approaches and philosophies of the two forms in relation to structure, portability, risk and administration.

Introduction

In his 1994 report entitled Constructing the Team, Michael Latham commented 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 the difference in approach between a more traditional form of contract (such as FIDIC Silver) and the new NEC3 form, which embraces a more collaborative approach.

FIDIC Silver is specifically designed as a turnkey contract, where an employer hands full responsibility over to the contractor for all design, engineering and construction. This approach expects the employer to "wait for the keys" and to have little day-to-day management of the project as work progresses.

NEC3 envisages the project as a collaborative process, with an emphasis on contract administration. The parties are obliged to "act in a spirit of mutual trust and co-operation", an obligation which is central to the philosophy and concept of NEC3.

Of course, every project will be different, and every employer will have a different appetite for risk. Whether an NEC3 or FIDIC Silver standard form contract is used for a large-scale project, there will inevitably be considerable scope for tailoring and amendment to suit the project and the parties. That said, it is counterintuitive to select a contract which is drafted on the basis of a particular philosophy and then seek to heavily amend it such that it becomes far removed from its basis; the choice of base form is still important.

Hands on or hands off?

NEC3 is often viewed with suspicion by those who are not familiar with how it works, even though the form is now in its third edition. It is, intentionally, a very different contract, in structure, language and terminology, from more traditional forms such as FIDIC. It shies away from the traditional language of construction contracts, such as "extensions of time" or "variations," and even avoids the use of mandatory wording such as "shall" – instead, verbs are used in the present tense. This takes some getting used to, but is deliberately done to reflect the underlying collaborative philosophy of the NEC3 approach. It is drafted to operate in a "common sense" manner. The language is intended to operate flexibly; as design responsibility and pricing structure are not "nailed down" in the draft it should, theoretically, be adaptable for any project which may make it more portable internationally.

Structurally, NEC3 is made up of core conditions, six main options (reflecting the price/procurement strategy, analysed further in the second of this two-part series) and various secondary options ("W," "X" and "Y" clauses). The parties can tailor their contract to fit a project by selecting which of the optional clauses they would like to incorporate.

Optional clauses include dispute resolution procedures, provision for bonds or parent company guarantees, limitations on liability and advance payment. The parties can also include further "Z clauses" if they want to amend any of the NEC clauses or include additional provisions. Many of the provisions intrinsic within FIDIC appear as secondary options in NEC3 (such as performance security and liquidated damages), and others are missing altogether. If adopting a less traditional approach, an employer will need to have a good understanding of how NEC3 works so as to ensure that nothing important is missed; assuming that the "usual" clauses are present within NEC3 would be a mistake.

The structure reflects NEC3’s primary purpose as a management tool. It is often said that a "good" contract will never be taken out of a cupboard unless and until something goes wrong; this is wholly untrue of NEC3, which is intended to utilise involved project management and where the intent is that the contract remains an active tool throughout the life of a project.

FIDIC Silver is more traditional in nature. It sets out a series of "General Conditions" and the parties will tailor this to their project through the use of "Particular Conditions." The contract is part of the FIDIC "rainbow" of contracts, a well-established family of standard forms designed for use in a variety of projects and approaches, including design and build, employer-design, dredging, and smaller projects. The forms all follow a similar format; international contractors are likely to be familiar with this as it is used as the basis for a variety of projects around the world.

There is also a well-established body of case law interpreting traditional contracts such as FIDIC Silver and its forerunners. Its principles are therefore well-understood. There is significantly less case law looking at NEC3 or its predecessors.
Familiarity, however, does not automatically mean that the form is superior or more user-friendly; "different" is not the same as "bad." NEC3 does require an employer willing to embrace its approach, as well as a project manager who is experienced in following it; but those who are experienced at using it will often be found singing its praises.

Don’t leave home without it

A standard form of engineering and construction contract, for use in international projects, needs to be portable and easily adaptable for a variety of jurisdictions. FIDIC is designed for international use and is the most common international standard form, available in a number of languages.

NEC3 has widespread use in the UK, aided by the backing that it has received from the UK Office of Government Commerce for public sector projects – recent high-profile examples include construction of Terminal 5 at Heathrow Airport and the 2012 Olympic Stadium. However, it is intended to be fully portable and is now being seen in a number of international projects and markets.

Is NEC3 truly portable? It is certainly drafted in "plain English" rather than legalese, which in theory could help its use in other jurisdictions, although that is not to say that project managers have not come unstuck when trying to apply those "plain English" terms. It may be fair to say, however, that it was drafted from an English perspective (including specific optional provisions for compliance with English statutes, and termination provisions which refer to various UK-specific insolvency events which would need adjustment to suit other jurisdictions). It is also true to say that a "common sense" approach might also differ from one jurisdiction to another; one risk of using NEC3 in other jurisdictions is that it may end up in the hands of an arbitrator or judge unfamiliar with the form.

However, these concerns by no means prevent NEC3’s operation in other jurisdictions. With amendment, it is most adaptable to other common law/English speaking countries but can, with care, be used in other jurisdictions.

Who pays if things change?

A contractor’s entitlement to additional time and/or money is always a crucial area for consideration and/or negotiation in any construction project. Both standard forms allow for more time and money in certain circumstances, but reflect a fundamentally different approach.

NEC3’s approach could (albeit as a gross generalisation) be summarised as being that employers should pay for risks as and when they occur, rather than paying a higher price to pass these risks to the contractor up front. The consequence of this is that (on the face of the contractual provisions) the employer bears more risk than it would under more traditional forms.

FIDIC Silver has a different philosophy: as a turnkey contract, it aims to pass, as far as possible, full responsibility to the contractor and the situations which entitle the contractor to claim more time and/or money are more limited. This approach is often preferred (and indeed may be dictated) by financiers. Many employers and contractors will also prefer this more conventional approach as it provides greater certainty about where the risk portfolio is distributed.

Looking at a few examples:

  • NEC3 lists several "compensation events" that entitle a contractor to both time and money. In particular, this includes any events which prevent the contractor from completing the works and which an experienced contractor would have seen as unreasonable to price for. This is intended to capture force majeure events but is potentially broader. FIDIC Silver’s approach to force majeure events is more prescriptive, with an entire chapter dedicated to force majeure, a more detailed definition of the events which constitute it, and a procedure setting out the consequences.
  • Design responsibility is given a much stronger emphasis in FIDIC Silver, in line with the normal requirements of a turnkey contract. FIDIC Silver expressly imposes a fitness for purpose obligation on the contractor. NEC3, on the other hand, is silent as to design standards and obligations. While the English courts may imply a fitness for purpose or reasonable skill and care obligation, this may not be the case in other jurisdictions. In FIDIC Silver, the contractor is generally responsible for errors in the Employer’s Requirements, with some exceptions; in NEC3, this is an employer’s risk, and the contractor will be entitled to further time and money for instructions correcting any errors.
  • In keeping with the turnkey approach, FIDIC Silver provides that the contractor will take responsibility for the site including any "unforeseen difficulties." The NEC3, however, allows unexpected physical conditions as a compensation event.

On the face of it, therefore, many employers would opt for the risk position under FIDIC Silver as providing a clear dividing line between the parties’ respective positions. That said, others may prefer a more collaborative approach that seeks to manage risks rather than simply allocate responsibility. The theme of risk management underpins NEC3’s approach to risk, and the employer is expected to take a proactive approach. Through the use of optional clauses, the employer can also incentivise the contractor – the target cost options, for example, include shared savings mechanisms, and there are also optional clauses to incorporate key performance indicators and early completion bonuses. None of these concepts are found in FIDIC Silver.

NEC3’s collaborative approach to risk is further represented by the "risk register" and "early warning" concepts that allow more "hands on" time and delay management. The risk register is intended to be a project management tool to manage those risks which arise over the course of a project. Risks should be notified by the contractor or project manager as an "early warning matter" and will then be added to the risk register. The parties are encouraged to have risk reduction meetings to review registered risks and decide on solutions. There is risk inherent in this process itself: if the project manager is not on top of the process of approving or rejecting contractor’s claims for compensation events and fails to respond, for example, this is treated as deemed acceptance.

NEC3’s collaborative approach is also represented in its unusual approach to delay and/or cost entitlement. Rather than the usual retrospective approach represented in FIDIC and other traditional contracts, under NEC3 an award is forward-looking, based upon a quotation-style approach: when an event occurs which is the employer’s risk, the contractor is required to notify the anticipated effects of this event and, once agreed or determined, these anticipated effects (in terms of time and/or cost) are crystallised irrespective of the actual effects. In theory, this ensures that the time and cost awarded are reasonable but that the employer is then protected against contractor inefficiency and excesses in dealing with the issue, with no requirement to retrospectively compare what should have happened against the actual approach taken.

The FIDIC Silver approach is much more traditional, with the contractor expected to manage risks as the project develops and deliver a complete solution on time. For employers and contractors who are used to the more traditional balance of risk in an EPC contract, the FIDIC Silver approach is likely to be more attractive.

Who makes the decisions?

Insofar as the day-to-day administration of the contact is concerned, FIDIC Silver places obligations on the employer and the contractor only. NEC3, however, places obligations on the employer, the contractor, the project manager and the supervisor. NEC3 therefore clearly anticipates, and in fact heavily relies on parties other than the employer and the contractor to ensure that the contract is administered correctly.

The role of the project manager is central to NEC3. Although selected by, and acting on behalf of, the employer, the project manager is required to act fairly and impartially. Heavy reliance is placed on the project manager in terms of making various decisions and issuing various key notices, including notifying compensation events. The party selected to act as project manager will therefore undoubtedly need to be very involved in the project on a daily basis and will also need to have a very detailed knowledge of the NEC3 form and how it works.

This may, for some, put NEC3 at a disadvantage, due to its central reliance on a third party to correctly and diligently administer the contract – some employers may see this as a dilution of the employer’s control. The role of the project manager is not, however, unfettered, as both contractor and employer need to sign changes to the contract.

FIDIC Silver is drafted on the basis that the employer will generally leave the contractor to progress with the works, in accordance with the contract. FIDIC Silver does not envisage that the contract will be "administered" by any third party and works generally on the basis that the employer accepts that the contractor will progress the works, address any issues as and when these arise and hand over a fully functional product at the end of the works. That said, there is nothing to prevent the employer from engaging a technical advisor or engineer to monitor compliance with the contract. The rights (for example) for the employer to approve the contractor’s documents and inspect the work or plant are clearly intended to allow the input of a technical advisor; it is simply that there is nothing in FIDIC Silver to fetter the employer’s discretion. In practice, an employer using FIDIC Silver (and its technical advisor) is likely to have a high degree of involvement in the project.

Which contract works best?

To recap, we have looked at a number of criteria in assessing NEC3 against the more conventional FIDIC Silver book. See below for a comparative summary.

When assessing these contracts, it is not so much a case of better or worse, but a difference in approach, and the question of which contract will work best for a specific project and the parties involved. NEC3 relies on good management and is designed to flesh out problems as the project progresses. FIDIC Silver is designed as a true turnkey contract, with the intention that the contractor will, for the most part, take responsibility for ongoing problems. However, in the majority of international high-value projects conducted under FIDIC Silver, the employer will be actively involved throughout and will often take a collaborative approach. For example, FIDIC has a concept of the dispute adjudication board, which can be used by the parties to manage problems as they arise and avoid more formal dispute resolution procedures.

Inevitability, there are pros and cons to both approaches. A heavy emphasis on management comes with cost implications and may not suit every project owner, but it could have the advantage of fixing problems earlier. How well the contracts work depends to a large extent on how they are used in practice. Will the parties using NEC3 really embrace the collaborative nature and adhere to the administrative procedures essential to its operation? Conversely, a turnkey contract, in practice, never really results in a truly hands-off approach.

In the second of this two-part series, we will look in closer detail at how the standard forms apply these approaches to some of the mechanisms which are likely to be of importance in high-value international infrastructure projects: pricing, programming and testing.

Comparative summary:

Criteria

 

FIDIC Silver

 

NEC3

 

Clause structure

 

 

Traditional: all provisions set out as "general conditions" with parties specifying detail or amendments within "particular conditions"

 

 

Made up of core clauses and a series of main and secondary options

 

 

Portability

 

 

Designed for international use in range of jurisdictions and languages

 

 

Drafted to be portable but only in English language and (arguably) from English perspective

 

 

Entitlement to more time and money

 

 

Tighter list of events

 

 

Broader and including wide catch-alls

 

 

Design responsibility

 

 

Fitness for purpose

 

 

Silent as to design standards

 

 

Errors in employer’s requirements

 

 

Generally a contractor risk (some exceptions)

 

 

Employer risk

 

 

Site conditions

 

 

Contractor takes responsibility for the site including unforeseen difficulties

 

 

Unexpected physical conditions are a compensation event

 

 

Role of third parties

 

 

No structured role (though may often be appointed in practice)

 

 

Project manager heavily involved in administration of contract

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Topics:  Construction Contracts, Contract Drafting, EU, FIDIC Contracts, NEC3 Contracts

Published In: General Business Updates, Construction Updates, International Trade Updates, Labor & Employment Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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