NEC Contracts and Cash Flow Management

“I’m a Main Contractor Tendering for a project where the Contract will be an NEC Option A Contract.

We want to understand what the potential impacts of this Contract Type are in terms of Cash Flow and, the best management practices generally.”

That’s the scenario that we put forward to Jason Farnell, Adjudicator and CEDR Accredited Mediator.

We asked Jason the following questions:

1. What are the impacts in terms of cash flow management on this type of contract. Do we need to do anything specific in terms of Applications for Payment and what’s best practice?
2. In terms of our Supply Chain, do we need to include anything in their Subcontracts to be back to back?
3. With Compensation Events can we apply for actual costs rather than pro rating tender rates when assessing Variations or Delays?
4. With Early Warning Notices, at what point does an EWN become invalid to a Main Contractor when applying for extra costs?

Note that the comments are based on 2005 version of NEC 3.

1. What are the impacts in terms of cash flow management on this type of contract. Do we need to do anything specific in terms of Applications for Payment and what’s best practice?

Whilst it is for the Project Manager to assess the amount due to be paid at each assessment date, the Project Manager is required to consider any application for payment made by the Contractor on or before the assessment date. There is no prescribed form or content for such application but it would be sensible for the application to follow the valuation principles in the Contract of establishing the Price for the Works done to date. This is done by reference to groups of completed activities and activities which are complete but not in groups. Incomplete or partially complete activities are not included in the Price for the Works done to Date.

The Project Manager is at liberty to correct any wrong assessments (either up or down) in later certificates but such correction will still be subject to the above requirement.

The allocation of the Contractor’s tender price across the groups / activities set out within the Activity Schedule will clearly be influential in determining a cash flow strategy as will the type and nature of the activities themselves, bearing in mind that each activity is considered as a lump sum. The Activity Schedule will usually be provided within the tender documents but this may not preclude tender negotiations on the form and content of the Activity Schedule taking place.

Unless amended in Option Z the Certificates are issued within one week of each assessment date and payment is made within 3 weeks of the assessment date. Consideration should therefore be given to agreeing the time when the Contractor’s application is submitted and the acceptability or otherwise of the 3 week payment terms bearing in mind the Contractor’s supply chain requirements.

2. In terms of our Supply Chain, do we need to include anything in their Subcontracts to be back to back?

The NEC publishes forms of Subcontract to accompany the Main Contract options and it will usually be good practise to use the appropriate Subcontract form to ensure back to back obligations are established in principle. This would be particularly true for those Subcontractors undertaking significant sections of the permanent work.

Clearly the timing of Subcontract applications and payment terms need to be tailored to suit your cash flow strategy bearing in mind the terms which the Contractor is tied to under the Main Contract. To this end, consideration should be given to the activity schedules incorporated into the Subcontract documentation which, where possible, should mirror those in the Main Contract.

If Subcontractors demand to be paid on the basis of work done to date rather than for activities which are complete, then cash flow difficulties may be anticipated.

3. With Compensation Events can we apply for actual costs rather than pro rating tender rates when assessing Variations or Delays?

When valuing a compensation event it should be remembered that any costs associated with the time impact or disruptive effect of the event are to be included in its assessment. Unlike the JCT there are no express provisions in the NEC dealing with loss and expense. If disruption, for instance, is too uncertain to be forecast then the Contractor may state its assumptions about the event when making its assessment. This assumption can be corrected by the Project Manager if later found to be incorrect.

For example if it is considered that a variation to introduce additional manholes is likely to disrupt the progress of the groundworks in which they were located and cause access difficulties then it would be perfectly acceptable to state this assumption. Within the CE assessment allowances would then be included in respect of the anticipated additional costs (i.e. the loss and expense) to the groundworks caused by limitations on access and working areas etc. If the actual circumstances are subsequently proven to be more severe than those stated in the assumption, then a correction to the valuation can be made.

The assessment of Compensation Events are made wholly on the basis of changes in the Prices which are assessed on the basis of actual and forecast Defined Costs determined by the date that the Project Manager should have issued the instruction, plus fee. The Defined Cost is defined as the costs of the components in the Shorter Schedule of Cost Components irrespective of whether or not the work has been sublet excluding the cost of preparing the quotation.

The Contractor should therefore ensure that when pricing the Shorter Schedule of Cost Components it covers its anticipated actual costs.

The Contractor and Project Manager are however, also at liberty to agree to assess changes in the Prices (the Compensation Event assessment) using rates and lump sums. Such lump sums may be based on Subcontractor / Supplier quotations which will reflect actual cost.

The NEC is predicated upon a prospective, forward-thinking, approach and consequently the principle of the recovery of incurred costs is not a remedy, however, the Contractor is entitled to have included within the valuation risk allowances for cost and time which have a significant chance of occurring and are within its control.

4. With Early Warning Notices, at what point does an EWN become invalid to a Main Contractor when applying for extra costs?

Either the Contractor or Project Manager may give an Early Warning Notice as soon as becoming aware of such matters. No Early Warning Notice is required for a matter already subject to a Compensation Event (CE) and an Early Warning does not necessarily lead to a CE.

The Contractor should therefore be alert to any potential matter and raise an Early Warning Notice as there is no penalty for raising a warning in respect of a potential issue which ultimately does not arise or is avoided. There is no mechanism in the Contract which causes an Early Warning Notice to become invalid.

When assessing the valuation of a CE the Project Manager may notify the Contractor that they failed to give an Early Warning Notice. In these circumstances the Project Manager may then reduce the value of the CE by taking into account the consequences of actions which could have been taken had a timely Early Warning Notice been issued.

For example, if a potential CE being discussed required scaffolding access but the Contractor failed to give a warning notice that the removal of existing scaffolding was imminent, then the subsequent re-erection of the scaffold needed to execute the CE may be disallowed.

The time when it is considered that an Early Warning Notice should have been issued is at the Project Manager’s discretion, but it should be borne in mind that the Project Manger also has a duty to give Early Warning Notices and failure to do so can be to the Contractor’s advantage.

This piece was contributed by J P Farnell, FRICS, FCIArb, Adjudicator, CEDR Accredited Mediator March 2018

About Paul Heming

Paul was a Quantity Surveyor who gained 10 years experience of managing £200 million worth of flagship UK projects, including 20 Fenchurch Street and Battersea Power Station. In 2015, Paul founded C-Link with the intention of sharing his expertise of managing major projects with the SME market.