Disallowance Under the NEC

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Disallowance Under the NECICES Seminar

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Presentation ─── September 2013

Section OneNEC and Disallowed Costs Overview



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Contract Overview

● The NEC is now in its 3rd edition as has been with us for over 20 years

● There is considerable debate over how it works and how it will be interpreted by the Courts as there remain very few cases on it

● This is a highly sophisticated form of contract with complex ideas and methodologies

● As with most standard forms you see a wide variety of amendments

Contract Overview

● Just looking at the main form ECC● You can have disallowance in the subcontract and

even the professional services contract but that is less common• Why?

● Disallowance is only relevant to those Main Options based on cost recovery (C, D and E)

Basic Principles of Disallowance

● Disallowance is intended as a means of ensuring that there is no overpayment for sums which are not properly due

● It forms part of the calculation of the Amount Due which therefore becomes part of the payment notice

● As part of the calculation of the Amount Due it is for the Project Manager to ascertain

● It is not part of a payless notice● Disallowance should be specific identifiable sums

for specific identifiable reasons

Disallowance in Context

● The “cash” options contracts are intended to be low risk for the contractor

● They are intended to give keener prices and more transparency on costs

● However, disallowance used incorrectly can cause significant cash flow problems for a contractor

● A low risk contract can very quickly become high risk because there is no margin or supply network for a contractor to hide behind

Section TwoContractual Framework for Disallowance



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● Definition of Disallowed Costs● Costs which the Project Manager decides

• A changed decision is a Compensation Event (60.1(8))

● There are 8 basic reasons for disallowance, some used much more frequently than others

● Grouped today into five categories• Accounts and records• Sums which shouldn’t have been paid • Correcting defects• Failure to follow procedure or give early warning• Things not used to provide the works

Clause 11.2(25)

● “is not justified by the Contractor’s accounts and records”

● There should be a statement from the Employer somewhere on what accounts and records are expected, probably in Works Information

● Very rarely set out explicitly and in detail● Should be agreed at an operational level as early as

possible to make interim payments functional

Accounts and Records

● “should not have been paid to a Subcontractor or supplier in accordance with his contract”

● This would include any designer and is intended to prevent gratuitous payments

● Care needed when finalising and settling an account to make sure the settlement is in accordance with the contract

● If delay damages could have been levied then a disallowance may arise if they were not taken

● A Project Manager should not need to re-assess the subcontract payments but he could

● This can cause problems where the Project Manager does not have access to the terms of the Subcontract

Sums which should not have been paid

● “correcting Defects after Completion” and “correcting Defects caused by the Contractor not complying with a constraint on how he is to Provide the Works stated in the Works Information”

● Intended to encourage early identification and correction of defects

● It is the “cost of” that is relevant so there has to be a cost actually incurred, an assessment of possible cost is not appropriate to the disallowance although it can be under 45.1 in assessing the defect

● This clause is often amended as Employers do not like the idea of paying for the correction of any defective work which shifts the risk balance

Correcting Defects

● “was incurred because the Contractor did not follow an acceptance or procurement procedure stated in the Works Information or give an early warning which the contract required him to give”

● The first part of this test is wide and would include all interim and final testing and commissioning

● There is cross over with the defect provisions● Works Information would include any from the

Contractor and process it may have given at tender● The second part focuses on early warnings and needs

to be read in conjunction with 16.1 for when early warning should be given and 61.5 which allows compensation events to be valued at a lower level

Early Warning and Procedure Failures

Not Used to Provide the Works

● “Plant and Materials not used to Provide the Works…resources not used to Provide the Works”

● Plant and Materials are permanent not temporary items

● Provide the Works is very broadly defined• To do all the work necessary to complete the works

in accordance with this contract and all incidental work, services and actions which this contract requires

● There is an allowance for wastage and reasonable utilisation, in the Project Manager’s assessment

Section ThreePractical Issues in Disallowed Costs






Disallowed Cost [DC]Practical Management

• DC Review at Tender• Managing DC at Contract Commencement• Managing DC during the Contract• Common Issues• Cost risk under the Contract

DC Review at Tender

• Contractor Paid PWDD• PWDD = Defined Cost + Fee• Defined Cost = Actual Cost - DC• DC allowance in the Fee• DC allowance % in Fee?

Managing DCAt Contract Commencement

Agreed Protocol• DC Register – Unique Reference• PM Notice• PM Particulars• PM / C Review Meeting• Actions• Agree / Disagree• Allowable Cost / DC

Managing DCDuring the Contract

Risk Register • Driven by Early Warnings• Add 3 columns with a tick mark (pencil)

• CE• DC• P/G

Managing DCDuring the Contact

Accounts & Records• Orders & Invoices Matching• Labour & Plant Allocation Sheets• Material Delivery Notes• Plant on / off Hire Notes• Major Material Reconciliations• Staff Timesheets & Expenses


Subcontractors• 3 Quotes?• Subcontract Order• CEs – The Works & Domestic Issues• DCs – Back to Back Provisions• Agreement if different Option


Defects• Raising and closing out NCRs (Before

Completion)• Where Defects are DC – Timely and

Proper Agreed Resource based records to be signed off by PM.

Common IssuesTimely DCs

When should DC be crystallised?• When the cost is incurred?• Anytime before the final assessment of

the Contractor’s Share?• Assessed monthly by PM?• Assessed Quarterly by external audit

team?


If the DC is levied several months after incurred – what are the implications?• Subcontractor account settled• Cost could have been reduced• Has the Contractor’s position be

prejudiced by the late DC?


If DC is levied several months after incurred – what does the contract say?• Can it be an allowable cost one month

and then DC a later month?• Clause 50.5 allows the PM to correct

any wrongly assessed amount due in a later payment certificate.


What is the Contractor’s Remedy?• The Party alleging the certificate is

wrong bears the burden of proof.• Clause 51.3 allows interest to be paid

on the correcting amount.• Persuade or adjudicate• Tribunal

Common IssuesDC and Pain Gain Relationship

• Standard contract states P/G impacted on certificate at completion.

• That could expose Employer to recover a debt.

• Amended contracts impact P/G when PWDD exceeds the Prices

Common IssuesDC and Pain Gain Relationship

• Experience / history has shown that interim assessments of DC higher when P/G assessed at completion to offset debt risk.

• Impact on certificate is significantly different – with 50:50 P/G its 50p in the £1 but with DC £1 for £1.

Common IssuesSpecific v General

• PM must identify specific items of cost and identify how they fall within the definition of Disallowed Cost.

• PM cannot take a view as to the overall level of Defined Cost or take a view as to the economy or efficiency that should have been achieved.

Common IssuesDC or Pain/Gain Risk Share

• Matters of efficiency and economy are the subject of the pain/gain risk share.

• Procurement losses are the subject of the pain/gain risk share.

• Misunderstanding between lump sum fixed price contracts and pain/gain risk sharing contracts.

Cost risk under the Contract

Contractor is paid Defined Cost regardless of the level of Defined Cost.Exception is Disallowed Cost

• These are specific items of cost defined in the Contract• They are not related to the level of Defined Cost• The PM decides disallowed cost in interim payments

Pain/Gain (Contractor’s Share) is a separate and distinct mechanism which is related to the level of PWDD (Defined Cost + Fee) compared to the Target (Prices).

• The risk is shared• It is a calculation after Completion (Standard)

Section FourQuestions






Contact

Trowers & Hamlins LLP has taken all reasonable precautions to ensure that information contained in this document is accurate, but stresses that the content is not intended to be legally comprehensive. Trowers & Hamlins LLP recommends that no action be taken on matters covered in this document without taking full legal advice.

© Copyright Trowers & Hamlins LLP – October 2012 – All Rights Reserved. This document remains the property of Trowers & Hamlins LLP. No part of this document may be reproduced in any format without the express written consent of Trowers & Hamlins LLP.

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David GibsonCEOd +44 (0) 207 182 4062e [email protected]

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Disallowance Under the NEC