COMPARING AND EVALUATING THE CONTRACTUAL PROVISIONS OF TWO ANALOGOUS CONSTRUCTION CONTRACTS FOR THE MANAGEMENT OF COST.

Tim McLernon1 and Sharon McClements1.

1 School of the Built Environment, University of Ulster, Jordanstown Campus, Newtownabbey, Co. Antrim, BT37 0QB, UK

ABSTRACT

The Royal Institution of Chartered Surveyors, on its website, defines cost management as being ‘concerned with delivering best value in building and infrastructure’. The contract used between the parties for the construction project has a significant influence on the management techniques and procedures used for post-contract cost control and management. Standard forms of construction contract dictate in detail, expressly and impliedly, the management techniques and procedures to be used for post-contract cost control and management. The aims of this study are to compare the cost management provisions of comparable JCT and NEC3 contracts and to evaluate the different contributions made by the two construction contracts to the management of cost of a construction project. This study will use a desk-based approach to analyse the respective provisions of the two contracts to be compared and evaluated. In so doing, the study will take account of case law that impacts on the legal matters associated with the management of cost on construction projects. The findings will offer a framework that may be used for the evaluation and comparison of the provisions for the management of cost amongst construction contracts and which may be used for practical evaluation and comparison of the same.Keywords: Evaluation, comparison, cost provisions, management, construction contracts.

INTRODUCTIONWhilst freedom to contract on whatever terms are most favourable to the contracting parties, the nature of construction lends itself to contractual arrangements that assure effective and efficient commercial administrative management. Standardisation of arrangements, whilst impinging on the concept of freedom of contract, continues to be an accepted method of contracting across the construction industry. Two consequences of using standardised arrangements are that procedures follow the standard patterns dictated by the contractual arrangement and terminology is owned by that contractual arrangement. Having different contractual arrangements may create some misunderstandings or misinterpretations associated with construction management practices. For example, the term ‘final account’ is commonly used across the UK construction industry to describe the final balance ascertained as being owed to, whilst ‘Variations’, has different connotations across the industry. The contract is the key management tool; construction managers should be fully familiar with the contractual language and procedures in order to manage effectively and to avoid disputes. Research conducted by EC Harris found the two top causes of dispute in UK construction projects to be: 1. Failure to properly administer the contract; and 2. Failure to understand and / or comply with its contractual obligations. Standard form contracts tend to mitigate disputes and misunderstandings although it could be argued that, in circumstances where one party, normally the Employer, dictates the use of a particular standard form contract, the contra proferentem rule would apply. This rule

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states, broadly, that where there is doubt about the meaning of a word or a phrase in a contract, the word or phrases will be construed against the person who put them forward. So, for example: Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd (1970) 1 B.L.R. 111 considered an issue involving unclear contract provisions for liquidated damages and extension of time. Having disposed of the issue, the Court gave an observation. Salmon LJ said (at page 121):

The liquidated damages and extension of time clauses in printed forms of contract must be construed strictly contra proferentem. If the employer wishes to recover liquidated damages for failure by the contractors to complete on time in spite of the fact that some of the delay is due to the employers' own fault or breach of contract, then the extension of time clause should provide, expressly or by necessary inference, for an extension on account of such fault or breach on the part of the employer. I am unable to spell any such provision out of clause 23 of the contract in the present case…The problem is solved by a suitable worded extension of time clause.

It should be said that authorities on construction law such as Keating (2013) and Hudson (2014) place doubt on this argument. The two tested, proven and most significantly promoted contractual arrangements used in the UK construction industry derive from the Joint Contracts Tribunal (JCT) suite of contracts, and the New Engineering Contract (NEC3) suite of contracts. THE STUDYThis paper compares and evaluates provisions affecting cost management in these two standard form contracts: the JCT Standard Building Contract With Quantities and the New Engineering Contract (NEC3) Engineering and Construction Contract, Option B: Priced contract with bill of quantities. The paper begins by examining the provisions in legislation relating to payment. It continues with an examination of the provisions of the two contracts that relate to payment and concludes with a commentary. The aims of this study are to theoretically compare, contrast and make commentary on the different contributions made by two selected, main-line construction contracts to the management of cost of a construction project in relation to payment with a view to opening a conversation on the contractual management of cost. This study used a desk-based approach to analyse the respective provisions of the two contracts to be compared and evaluated. In so doing, the study took account of decided case law and legislation that impacts on the legal matters associated with the management of cost on construction projects.

THE LEGISLATIONThe Housing Grants, Construction and Regeneration Act 1996 (HGCRA), commonly referred to as the Construction Act includes provisions to ensure that contractual payments in construction contracts are made promptly and on time throughout the supply chain. These provisions were amended by Part 8 of the Local Democracy, Economic Development and Construction Act 2009. The Act (2009) deals with making periodic payments, making the date a payment becomes due dependent upon the giving of a notice by the payer of the sum the payer proposes to pay. It also amends the original provisions of the HGCRA that provided that a contractor had a right to stop working when the contractor has not been paid. These revised provisions are designed to ensure that payments are made promptly and on time throughout the supply chain.

THE JCT STANDARD BUILDING CONTRACT (SBC 2011)

This title actually refers to three different contracts that can be used by an Employer (client) and a Contractor, each designed for a traditional procurement route and lump sum pricing. This study will use one of these, viz., the JCT Standard Building Contract With Quantities (SBC/Q 2011) for the comparison and evaluation.

Terms and provisions for the management of cost.Article 2 of SBC/Q2011 sets out the contract sum, normally the accepted tender, with the provision that “[T]he Employer shall pay the Contractor at the times and in the manner specified in the Conditions the VAT-exclusive sum of (the Contract Sum, £x) or such other sum as shall become payable under this contract. The Bill of Quantities is the basis on which the accepted tender, which is the Contract Sum, was computed and is the key cost management tool. This Contract Sum may be adjusted in accordance with express provisions of the contract as provided in Clause 4.2; the items included in adjustments are expressly laid out in Clause 4.3. In order to assist cash flow and good cost management, Clause 4.4 provides that as soon as the amount of an adjustment is ascertained, in whole or in part, the ascertained amount shall be taken into account in the next Interim Certificate. Clause 4.5 provides a rigorous timeframe and process for the final adjustment of the Contract Sum with the aim of preventing delays in final payment and resulting disputes. The consequence of the final adjustment of the Contract Sum is that the finally paid amount culminating in the Final Certificate is never the same as the Contract Sum. The major adjustments to the Contract Sum are by way of Variations, Fluctuations and Loss and Expense claims. The term ‘Variation’, with an uppercase ‘V’ has a particular contractual meaning which includes the alteration or modification of the design, quality or quantity of the Works … (Clause 5.1.1). It also means the imposition by the Employer of any obligations or restrictions in regard to: … access to the site or use of any specific parts of the site, limitations of working space, limitations of working hours, or the execution or completion of the work in any specific order. This contract is a fluctuating price contract which means that the Contract Sum represents costs at the time of pricing and the effects of inflation and deflation on rates and prices are accounted for by adjusting the Contract Sum accordingly. There are three options for fluctuations: options A, B, and C. Options B and C both provide for price fluctuations in labour and materials cost and tax fluctuations but differ in the method of calculation. Option A, however, provides only for contribution, levy and tax fluctuations; a relatively minor cost. Consequently a contract incorporating Option A is, arguably, a firm price contract. Clause 4.23 states that if in the execution of this contract the Contractor incurs or is likely to incur direct loss and/or expense for which he would not be reimbursed by a payment under any other provisions in these conditions due to deferment of giving possession of the site … or because the regular progress of the Works or any part of them has been or is likely to be materially affected by any of five Relevant Matters which are specified in Clause 4.24, the Contractor may make an application to be paid that loss and expense. A strict timeframe and procedures for making the application are laid out. Complying with these provisions by the Contractor is probably condition precedent to the Contractor’s claim being valid. Strict adherence by all parties to the procedures and timeframes is vital for effective cost management. Clause 2.9.1 obliges the Contractor to provide the CA with his master programme. However, clause 2.9.3 provides that this programme shall not impose any obligation beyond those imposed by the Contract Documents. The programme in the SBC/Q11 therefore has less impact on managing costs than that of the ECCB.

Interim PaymentsThe provisions for payment follow and comply with the legislation. The first Due Date for interim payments is specified in the Contract Particulars and payments thereafter are on the same date each month or the nearest business day in that month up to either the date of practical completion or the specified date one month thereafter (Clause 4.9.1). If no Due Date is stated, the first due date is deemed to be one month after the date of possession. The Contract Administrator (CA) takes the dominant role in the payment procedure. Clause 4.10.1 obliges the CA not later than 5 days after each due date to issue an Interim Certificate stating the sum that he considers to be or have been due at the due date to the Contractor in respect of the interim payment. Interim valuations must be made by the Quantity Surveyor (QS) whenever the CA considers them necessary for ascertaining the amount to be stated as due in an Interim Certificate (Clause 4.10.2). The final date for payment of an interim payment shall be 14 days from its due date (Clause 4.12.2). If the Employer fails to pay the Contractor the sum payable in accordance with clause 4.12 … by the final date for payment and the failure continues for 7 days after the Contractor has given notice to the Employer with a copy to the CA of his intention to suspend the performance of his obligations under the contract … the Contractor may suspend performance … until payment is made in full (Clause 4.14.1). This contract recognises the practice of Contractors preparing the interim valuation and Clause 4.11.1 makes provision for the Contractor to make an application (an Interim Application) to the QS stating the sum that the Contractor considers will become due to him at the relevant due date. These provisions cover ‘normal’ procedures. Clause 4.11.2 makes provision for circumstances where an Interim Certificate is not issued in accordance with these procedures. Clause 4.12 makes extensive provision for ensuring that the Contractor receives the amount due within a strict timescale. Clause 4.13 ensures through its provisions that if less than the amount due is to be paid that a Pay Less Notice is issued appropriately. The procedures laid down in respect of interim payments are detailed with specific rights and duties assigned to the parties. It is probably the case that these procedures are conditions-precedent to the intended outcome and therefore it is vitally important that they are followed to ensure smooth cost management and the avoidance of disputes. The case of Sutcliffe v Thackrah [1974] AC 727 additionally established a liability in Tort, deciding that a Contract Administrator owes a duty of care to the Employer and the Contractor in the performance of all duties, particularly, certification. Retention continues to be a controversial topic in the construction industry. Retention is a contractual provision that allows the Employer to retain a percentage of the amount due to the Contractor in interim certificates. The purpose of retention is to provide a fund for the Employer to draw upon for the rectification of any defects. The default retention percentage is 3 percent unless a different rate is stated. The SBC/Q also allows for no retention. The retention is taken on interim payments up to the date of issue of the Practical Completion Certificate. At this point one half of any retention fund is released to the Contractor. The remaining half of the retention fund is released to the Contractor upon the issue of the Certificate of Making Good. Once more there is a strict contractual timeframe and process.

THE NEW ENGINEERING AND CONSTRUCTION CONTRACT (NEC3)The NBS National Construction and Law survey (2013) found that despite the dominance of the JCT suite of standard building contracts, the NEC3 is the second most used contract in the UK construction industry. The results from the survey identified an increase in the adoption of the NEC3, with usage increasing from 16%

(2011) to 22% (2012). The survey also found that users of the NEC used the contract mostly ‘for medium to large projects’. It now seems certain that the simple and collaborative management structure of the NEC3 has become successful. This paper proposes to examine the cost management provisions within this contract which has created new ways to manage costs in construction contracts. The two agreeing parties (Employer and Contractor), are facilitated in their contract duties by a project manager and supervisor. The project manager’s duties include ‘instructing, certifying, submitting, proposing, recording, accepting, notifying, and replying’, while the role of the supervisor resides in ‘testing and defects’ (NEC3). To enhance the parties’ ability to adhere to their duty to collaborate the NEC3 clauses are structured around three guiding principles of ‘(1) flexibility, (2) clarity and simplicity and (3) stimulus to good management’, (NEC3). In relation to the management of costs the guiding principles are enabled by six main pricing options. This study will use the NEC3 Engineering and Construction Contract (ECC) with Option B, Priced Contract with Bill of Quantities, using the abbreviation ECCB for the comparison and evaluation. The ECCB is a remeasurable contract and thus lacks cost certainty insofar as the ‘accuracy of billed quantities and the consequences of re-measure’ (Broome, 2012) is a financial risk largely borne by the employer.

Terms and provisions for the management of cost.The management of costs in the ECCB is made up from a combination of core clauses, core clauses relevant for the selected main option and any applicable secondary clause options. The management of cost in the ECCB is provided by detailed procedures and defined timescales. The procedures are contained in the core clauses (50 - payment) and (60 – compensation events). The ECCB is further enhanced with secondary optional clauses that incentives the contractor for exceptional performance, facilitates advance mobilisation payments and includes provisions for project bank accounts but all of these optional clauses are at the employers discretion. In the contract data (part one) the Employer further provides key information pertaining to the management of costs in respect to; the currency of the contract, the assessment interval, the interest rate and the payment period.

PaymentThe payment period and procedures, (both interim and final), differ for each of the options. In the ECCB the relevant core clauses are clause 11.2(21) bill of quantities; clause 11.2(22); definition of defined cost; clause 11.2(28); definition of the price for work done to date; clause 11.2(31); definition of the prices. The ECCB states that interim payments relate to the quantities of completed work at bill of quantity rates and proportions of any lump sums; whilst the final amount is considered the remeasured value of the work in accordance with the bill of quantities. The defined costs (clause 11.2(28) relate to additional costs and are determined by ‘the cost of components in the shorter schedule of cost components, whether subcontracted or not; excluding the cost of preparing quotations for compensation event’. It is evident that the contractor’s recovery for payment is not dependent on the subcontractors request for payment but on the cost of the works as allocated in the cost component. Controversially there is no recovery for payment pertaining to the cost of preparing a quotation, often resulting from a change to the scope of the works. The cost of preparing a quotation is considered further in this paper, in managing additional costs. The payment (Clause. 50.2) includes as standard 'work done to date, plus other amounts due to the contract, less amount paid or to be retained’. This provision is

further enhanced in clause 11.2(28), that states that the work is to be ‘completed without defects’. Specifically core clause 50 and additional secondary optional clauses provide for a number of payment methods other than monthly valuation i.e. milestones, activity schedules or payment schedules, thus providing the employer and the contractor with flexible payment procedure for managing costs. Despite differences in payment processes of the six main options, core clause 50, provides common and fundamental payment characteristics which include that assessments of amounts due are made at not more than five week intervals (contract data), certification is within one week of each assessment date (clause 51.1) and as standard payment is due within three weeks of each assessment date, unless stated otherwise (clause 51.2)The responsibility for assessing amounts due resides with the project manager. The payment is assessed at each assessment date and the project manager is allowed one week to make his assessment (clause 51.1). Assessment dates, can be no later than 5 weeks intervals, are determined by the project manager and stated in the contract data. However the default payment assessment date in the contract is 3 weeks. The payment process is driven by the assessment date, (in this case the default 3 weeks). This payment process removes the liability of assessment for payment from the contractor who is under ‘no obligation’ to submit an application for payment. However Clause 50.4 allows the contractor the make an application for payment ‘on or before the assessment date’. Nevertheless it is the project manager who is responsible for considering the application and is further required to provide the contractor details of how the amount due has been assessed. Clause Y (UK) 2 Housing Grants, Construction and Regeneration (HGCR) Act 1996 is an optional clause that supplements the core payment provisions in the ECCB. Clause Y (UK) 2 introduces two additional standards, namely ‘date on which payment becomes due’ and ‘the final date for payment’. Payment can either be linked to the assessment date (Clause 51.2) or when payment becomes due, (clause Y (UK) 2). Payments to be withheld from the contractor are also covered by this optional clause. The Employer is required to inform the contractor if a payment is to be withheld, not later than 7 days before the final date of payment. The Contractor may suspend performance if the Employer does not issue a notice of withholding and payment is not made in full by the final date for payment. Errors in assessing amounts are also provided insofar as the project manager can correct an error in a later payment, but not necessarily the next payment. Additionally the ECCB provides (clause 51.3) for interest on late payments, which ‘is not less than 2% over a specified bank rate’. The payment procedures for managing costs pertaining to payments rely on the diligence of the project manager adhering to the timescale and burdensome duties that are not collaborative. The withholding of retention is not automatic in this contract, which only applies only when secondary option X16 (Retention) is included. However interim payments are subject to a 25% reduction until a first programme is submitted for acceptance (clause 50.3). This stipulation has been designed to remove future difficulties in assessing and managing additional costs, arising out of changes to the works information, and the resultant impact on programme. Retention is a standard clause in other forms of building contracts, therefore employers need to be aware that if they wish to apply retention charges they must ensure that they have selected X16 (Retention) secondary option.

Managing additional costs arising from unforeseen problems and work changes.The most significant aspect of managing costs on a construction project is managing costs that arise when unforeseen problems and/ or the scope of the work changes. In

ECCB changes in the amount that the contractor is paid is based on his quotation. The contractor then carries the potential risk or reward inherent in a quotation, whilst the employer has a firm cost commitment. In the ECCB clauses 60 and 61 provide simple management procedures for ascertaining additional unforeseen costs. These procedures are known as compensation events. The compensation event clauses detail the mechanism to reimburse the contractor for extra time and money. Managing costs in compensation events requires the parties to adhere to the express contractual provisions detailed in Clauses 60 and 61. Clause 60 identifies nineteen compensation events (CE) listed in the core clauses that can be applied to all the main options. Additionally further events can be found under ECCB secondary option clauses. The compensation event procedure requires a proactive and collaborative approach to the recovery of damages. Even before a compensation event actually occurs, the contractor is required under clause 16.1 to issue ‘as soon as’ an ‘early warning’ that costs may increase. The early warning is then required to be entered onto the ‘risk register’. This proactive approach to risk is further reinforced in clause 63.5 ’failure to give an early warning’ which can result in the project manager assessing compensation assessment as if an early warning had been issued and that measures had been taken to mitigate the risk. In the event that the contractor has failed to issue and early warning, the process of compensation as defined under Clause 61 specifically establishes a simple four stage process of ‘notification, quotation, assessment and implementation’. Fundamentally it places a precedent to the recovery of damages on the notification stage. There is a responsibility on either the project manager (to do so with the issue of an instruction) or the contractor, (no later than 8 weeks of becoming aware of the event), to notify the other party of a potential compensation event. This requirement tested and upheld in a recent Court of Appeal hearing (Northern Ireland Housing Executive v Healthy Buildings (Ireland) limited (2014) which held that notification must be given, without which the claim was not time barred. At the heart of this condition is the issue of unforeseen cost, added during the final stages of a construction project thus promoting a proactive approach to the management of additional costs. The quotation stage requires the contractor to submit a quotation ‘no later than 3 weeks after being instructed to do so’. The project manager will either accept the costs or ask for a revised quotation of make his own assessment (if the contractor fails to submit a quotation). The assessment of additional costs are ascertained in accordance with clause 63.1 which states that change to prices are assessed by ‘the actual defined cost of work already done, the forecast defined cost of work not yet done and the resulting fee’. As mentioned earlier the ECCB provides that the bills of quantities can be used to ascertain the defined costs - if the project manager and contractor agree. Despite the collaborative approach to managing unforeseen costs the management of the compensation event creates an extensive administrative burden due to the requirement of detailed calculations supported with programmes of forecast effects. For example Clause 63.6, 63.7 and 64.1 stipulate that the contractor must ‘demonstrate the risks of cost’ and ‘react competently and promptly’, ‘additional costs are reasonable’ and ‘submit the programme effects within his quotation’. Additionally there is no ‘reduced’ provision for dealing with a compensation event of a smaller value/minor nature, which undermines the ‘flexibility’ of this contract insofar as the compensation event procedure is not flexible. Often an element of additional costs is the cost of delay, yet all the Core clauses of the ECCB are silent about delay damages. Provision has therefore been made within the secondary optional clauses (X7) that states that the ‘contractor pays

delay damages at the rate stated in the contract data or from the completion date’, and ‘delay damages may repaid by the employer’ from the contractors payment. DISCUSSION AND CONCLUSIONThese following discussion and conclusions are not empirically based but, rather informed but subjective views set out to provoke argument in this conference.

Both standard forms provide terms and procedures for robust cost practical management. Table 1 and Table 2, below, offer a framework that may be used for evaluation and comparison of the provisions pertaining to management of costs of the two contracts. The long-standing nature of the JCT contract makes it a document that uses readily recognised terminology and processes that are, arguably, more familiar to the building fraternity.The ECCB aspires to be a successfully collaborative contract that manages costs through the adoption of simple and flexible procedure. The detailed procedures and defined timescales provide an effective means for construction managers to effectively manage costs, improve project performance and ultimately client satisfaction. This requires construction managers to innately understand the requirement of the contracts and the philosophy behind the cost management clauses. Key points in time dictated by the contract at which actions of the parties have to happen, should be on a time chart or attached to the project programme with details of the administrative processes to be followed and documents to be used at various times.

Table 1 Practical evaluation and comparison of the management of payments in JCT and ECCB

Man.Cost

AdjustLump sum

Fluct Com.withConst.Act

Payment linked to prog.

Re-tention

Flexible Remeasure

Adjustfor error

JCT option

X x x

ECCB option

Option 1st pay Option Option

Table 2 Practical evaluation and comparison of the management of additional costs in JCT and ECCB

ManageCosts

BQ basis for pricing changes

Time bar for additional cost

Quotebasis for additional cost

Early warning of extra costs

Cost of delay

JCT ECCB If agreed optional

Having made these points, these contracts all place significant obligations on both parties to employ a bureaucratic system to ensure that the terms of the contract are complied with. Failing to comply with the contractual procedures can lead to financial burden that can amount to a significant proportion of the contract sum. However the challenge for construction managers will be ensuring that the spirit of collaboration is adopted within these contractual frameworks, thereby complying with the imminent requirements of collaborative multidisciplinary working underpinned by the technical requirement (Level 2) Building Information Modelling.

REFERENCESBroome, J. (2012). NEC3: a users guide, ICE, London

EC Harris (2012)http://www.echarris.com/pdf/EC%20Harris%20Construction%20Disputes%202013.pdfEgan, J., (1998) Rethinking Construction: The report of the Construction Task Force to the Deputy Prime Minister, John Prescott, on the scope of improving the quality and efficiency of the UK construction industry, London, Department of the Environment Transport and the Regions.

Hudson (2014) Hudson Building and Engineering Contracts, 12th Edition Sweet & Maxwell, London.

Keating (2013) Keating on Building Contracts, 9th Edition with 1st supplement, Sweet & Maxwell, London

Latham, M (1994) “Constructing the team: Final report of the Government/ Industry review of procurement and contractual arrangements in the UK construction industry”, London, HMSONBS National Construction Contracts and Law Survey (2012); available at http://www.thenbs.com/topics/contractslaw/articles/nbsNationalConstructionContractsLawSurvey2012.asp ), accessed December 2014.

Northern Ireland Housing Executive v Healthy Buildings (Ireland) limited (2014) NICA 27Pinsent Mason (2011) Standard Form Contracts: NEC, [online]. Available at: http://www.out-law.com/en/topics/projects--construction/construction-standard-form-contracts/standard-form-contracts-nec/ [Accessed 14th October, 2013].Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd (1970) 1 B.L.R. 111].Sutcliffe v Thackrah [1974] AC 727