the nec3 engineering and construction contract_ a comparative analysis – part 1 - energy and...

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

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Last Updated: 25 April 2013Article by Laura Riddeck, Hayley Steel, Richard Ceeney, Vincent Rowan and Lynne FreemanReed Smith

United Kingdom: The NEC3 Engineering and Construction Contract: AComparative Analysis – Part 1

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

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

Introduction In his 1994 report entitled Constructing the Team, Michael Latham commentedthat "The client who wishes to accept little or no risk should take different routes for procuringadvice from the client who places importance on detailed, hands-on control." This commentcharacterises the difference in approach between a more traditional form of contract (such asFIDIC 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 fullresponsibility over to the contractor for all design, engineering and construction. Thisapproach expects the employer to "wait for the keys" and to have little day-to-daymanagement of the project as work progresses.

NEC3 envisages the project as a collaborative process, with an emphasis on contractadministration. The parties are obliged to "act in a spirit of mutual trust and co-operation", anobligation 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 forrisk. Whether an NEC3 or FIDIC Silver standard form contract is used for a large-scaleproject, there will inevitably be considerable scope for tailoring and amendment to suit theproject and the parties. That said, it is counterintuitive to select a contract which is drafted onthe basis of a particular philosophy and then seek to heavily amend it such that it becomes farremoved 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 familiarwith how it works, even though the form is now in its third edition. It is, intentionally, a verydifferent contract, in structure, language and terminology, from more traditional forms such asFIDIC. 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 isdeliberately done to reflect the underlying collaborative philosophy of the NEC3 approach. Itis drafted to operate in a "common sense" manner. The language is intended to operateflexibly; as design responsibility and pricing structure are not "nailed down" in the draft itshould, theoretically, be adaptable for any project which may make it more portableinternationally.

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 varioussecondary options ("W," "X" and "Y" clauses). The parties can tailor their contract to fit aproject by selecting which of the optional clauses they would like to incorporate.

Optional clauses include dispute resolution procedures, provision for bonds or parentcompany guarantees, limitations on liability and advance payment. The parties can alsoinclude further "Z clauses" if they want to amend any of the NEC clauses or include additionalprovisions. Many of the provisions intrinsic within FIDIC appear as secondary options inNEC3 (such as performance security and liquidated damages), and others are missingaltogether. If adopting a less traditional approach, an employer will need to have a goodunderstanding 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 andwhere 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 theparties will tailor this to their project through the use of "Particular Conditions." The contract ispart of the FIDIC "rainbow" of contracts, a well-established family of standard forms designedfor 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 contractorsare likely to be familiar with this as it is used as the basis for a variety of projects around theworld.

There is also a well-established body of case law interpreting traditional contracts such asFIDIC Silver and its forerunners. Its principles are therefore well-understood. There issignificantly 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 toembrace its approach, as well as a project manager who is experienced in following it; butthose 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, foruse in international projects, needs to be portable and easily adaptable for a variety ofjurisdictions. FIDIC is designed for international use and is the most common internationalstandard form, available in a number of languages.



NEC3 has widespread use in the UK, aided by the backing that it has received from the UKOffice of Government Commerce for public sector projects – recent high-profile examplesinclude 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 internationalprojects and markets.

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

However, these concerns by no means prevent NEC3's operation in other jurisdictions. Withamendment, 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 isalways a crucial area for consideration and/or negotiation in any construction project. Bothstandard forms allow for more time and money in certain circumstances, but reflect afundamentally different approach.

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

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

Looking at a few examples:

NEC3 lists several "compensation events" that entitle a contractor to both time andmoney. In particular, this includes any events which prevent the contractor fromcompleting the works and which an experienced contractor would have seen asunreasonable to price for. This is intended to capture force majeure events but ispotentially broader. FIDIC Silver's approach to force majeure events is moreprescriptive, with an entire chapter dedicated to force majeure, a more detailed definitionof 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 thenormal requirements of a turnkey contract. FIDIC Silver expressly imposes a fitness forpurpose obligation on the contractor. NEC3, on the other hand, is silent as to designstandards and obligations. While the English courts may imply a fitness for purpose orreasonable skill and care obligation, this may not be the case in other jurisdictions. InFIDIC Silver, the contractor is generally responsible for errors in the Employer'sRequirements, with some exceptions; in NEC3, this is an employer's risk, and thecontractor will be entitled to further time and money for instructions correcting anyerrors.



In keeping with the turnkey approach, FIDIC Silver provides that the contractor will takeresponsibility 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 Silveras providing a clear dividing line between the parties' respective positions. That said, othersmay prefer a more collaborative approach that seeks to manage risks rather than simplyallocate 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 optionalclauses, the employer can also incentivise the contractor – the target cost options, forexample, include shared savings mechanisms, and there are also optional clauses toincorporate key performance indicators and early completion bonuses. None of theseconcepts are found in FIDIC Silver.

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

NEC3's collaborative approach is also represented in its unusual approach to delay and/orcost entitlement. Rather than the usual retrospective approach represented in FIDIC andother 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 requiredto notify the anticipated effects of this event and, once agreed or determined, theseanticipated effects (in terms of time and/or cost) are crystallised irrespective of the actualeffects. In theory, this ensures that the time and cost awarded are reasonable but that theemployer is then protected against contractor inefficiency and excesses in dealing with theissue, with no requirement to retrospectively compare what should have happened againstthe actual approach taken.

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

Who makes the decisions? Insofar as the day-to-day administration of the contact isconcerned, FIDIC Silver places obligations on the employer and the contractor only. NEC3,however, places obligations on the employer, the contractor, the project manager and thesupervisor. NEC3 therefore clearly anticipates, and in fact heavily relies on parties other thanthe 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 onbehalf of, the employer, the project manager is required to act fairly and impartially. Heavyreliance is placed on the project manager in terms of making various decisions and issuingvarious key notices, including notifying compensation events. The party selected to act asproject 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 itworks.

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

FIDIC Silver is drafted on the basis that the employer will generally leave the contractor toprogress with the works, in accordance with the contract. FIDIC Silver does not envisage thatthe contract will be "administered" by any third party and works generally on the basis that theemployer accepts that the contractor will progress the works, address any issues as andwhen 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 tomonitor compliance with the contract. The rights (for example) for the employer to approve thecontractor's documents and inspect the work or plant are clearly intended to allow the input ofa technical advisor; it is simply that there is nothing in FIDIC Silver to fetter the employer'sdiscretion. In practice, an employer using FIDIC Silver (and its technical advisor) is likely tohave a high degree of involvement in the project.

Which contract works best? To recap, we have looked at a number of criteria in assessingNEC3 against the more conventional FIDIC Silver book. See below for a comparativesummary.

When assessing these contracts, it is not so much a case of better or worse, but a differencein approach, and the question of which contract will work best for a specific project and theparties involved. NEC3 relies on good management and is designed to flesh out problems asthe project progresses. FIDIC Silver is designed as a true turnkey contract, with the intentionthat the contractor will, for the most part, take responsibility for ongoing problems. However, inthe majority of international high-value projects conducted under FIDIC Silver, the employerwill 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 tomanage problems as they arise and avoid more formal dispute resolution procedures.

Inevitability, there are pros and cons to both approaches. A heavy emphasis on managementcomes with cost implications and may not suit every project owner, but it could have theadvantage of fixing problems earlier. How well the contracts work depends to a large extenton how they are used in practice. Will the parties using NEC3 really embrace the collaborativenature and adhere to the administrative procedures essential to its operation? Conversely, aturnkey 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 formsapply these approaches to some of the mechanisms which are likely to be of importance inhigh-value international infrastructure projects: pricing, programming and testing.

Comparative summary:

Criteria FIDIC Silver NEC3



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Clause structure Traditional: all provisionsset out as "generalconditions" with partiesspecifying detail oramendments within"particular conditions"

Made up of core clausesand a series of main andsecondary options

Portability Designed for internationaluse in range of jurisdictionsand languages

Drafted to be portable butonly in English languageand (arguably) from Englishperspective

Entitlement to more time andmoney

Tighter list of events Broader and including widecatch-alls

Design responsibility Fitness for purpose Silent as to designstandards

Errors in employer'srequirements

Generally a contractor risk(some exceptions)

Employer risk

Site conditions Contractor takesresponsibility for the siteincluding unforeseendifficulties

Unexpected physicalconditions are acompensation event

Role of third parties No structured role (thoughmay often be appointed inpractice)

Project manager heavilyinvolved in administration ofcontract

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.

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