Particularities of NEC Contracts

When discussing innovations in the Peruvian market regarding engineering and construction contracts, two types of standardized contracts come to mind that have been introduced recently: FIDIC (Fédération Internationale des Ingénieurs-Conseils) and NEC (New Engineering Contract).

However, these contracts are not as new as they might seem. The first edition of FIDIC contracts was created in 1957 and has been used in Peru for some years now, while NEC contracts were introduced by the Institution of Civil Engineers (ICE) of the United Kingdom (UK) in 1993, only entering the Peruvian market for the Lima 2019 Pan American Games.

Today, we will delve into the particularities and advantages of the NEC, which is now in its fourth generation (NEC4), compared to the traditional approach of ad hoc contracts that many clients develop through their legal departments or law firms.

Back in 1986, ICE’s newly formed legal advisory panel tasked project management consultant Martin Barnes with drafting a new type of contract aimed at encouraging, rather than discouraging, good project management practices.

If you were to ask Martin Barnes what is most important in NEC contracts (this is not hypothetical; he has been asked and has answered), his response emphasizes its holistic concept. No single aspect is more important than another. However, Barnes highlights three characteristics: simple and straightforward language, flexibility, and a focus on promoting collaboration to complete the project in the best interest of all parties involved.

Having studied the NEC4 Engineering and Construction Contract (ECC) in depth and after 30 years of dealing with traditional engineering and construction contracts, I would like to comment on aspects that stood out to me and that I consider highly beneficial.

General Structure Overview

The NEC4 ECC, similar to its previous generation, includes a standard section for which one of six main options is selected:

Additionally, clients can choose from other sets of secondary optional clauses:

• W Clauses: Provide three options for dispute resolution, including dispute avoidance boards (DAB) and adjudicators.
• X Clauses: A set of 22 clauses, including X29 on Climate Change, dealing with price adjustments, penalties, bonuses, guarantees, partial deliveries, early termination by the client, and other typical but variable aspects depending on the client and project.
• Y Clauses: Primarily used in the UK, addressing banking and payment methods.
• Z Clauses: A catch-all for any additional points the client wishes to include.

In practice, Z Clauses are where some clients end up distorting NEC contracts (“tropicalizing,” as we say in Peru), introducing conditions that make them resemble traditional contracts, thereby nullifying several advantages initially sought for the project and aligning the parties.

Core Clauses

The standard section is comprised of nine essential core clauses, forming the "heart" of the contract. These highlight the distinguishing features and ultimate goal of aligning parties toward the common objective: successful project completion with minimal impact on schedule and cost.

The purpose of this article is not to delve into the details of each core clause but to briefly comment on the concepts I find most appealing, and in some cases, even innovative, within the NEC4 ECC

1. Spirit of Actions

The core clauses begin with a fundamental declaration, leaving no doubt about the intended objective. From the first clause, it is stated that parties must act in accordance with the contract and in ‘a spirit of mutual trust and cooperation.

This is more than a declaration of good intentions. The spirit of mutual trust and cooperation is established as an express contractual obligation. Any party that seeks undue advantage or fails to demonstrate trust toward the other party is in clear violation of their contractual duties.

Traditionally, contracts often invest significant effort in protecting the drafting party (usually the client) through onerous requirements on the contractor. This frequently leads to contentious relationships, with parties preparing for conflict rather than cooperation.

2. Early Warning

The concept of early warning isn’t entirely new. Many contracts require contractors to notify clients of any event that may affect the schedule or cost. NEC goes further by obligating both parties to maintain an early warning register and conduct specific meetings to address potential issues collaboratively.

This proactive problem-solving approach is a cultural paradigm shift in the Peruvian market, where the tendency has often been to avoid reporting problems until they become unmanageable.

In my experience, I have often heard phrases such as: 'Well, that's their responsibility, so they will have to resolve it,' 'That's not my problem,' or 'Look, I don’t know how (nor do I care), but you need to solve it.' The result is that the natural inclination of the parties is to avoid reporting problems to save themselves the trouble, with the naive and unprofessional hope of finding a solution quietly and resolving the issue without anyone noticing. Of course, the final outcome is usually that the problem becomes evident when there is no longer time to solve it, leading to a major impasse that is also costly.

Of course, it is not just about good intentions; failing to provide an early warning affects the contractor's entitlement to compensation events, which is entirely logical.

3. Communication Deadlines

There are deadlines for communications, not only for the contractor but also for the Project Manager, who represents the Client, and the Supervisor, responsible for ensuring the quality of the work.

Since the parties are expressly obligated to act in accordance with the contract, a lack of timely communication or response constitutes a contractual breach. However, what stands out most is the innovative aspect of situations such as the notification of compensation events by the Contractor to the Project Manager. If these are not responded to on time (with even an obligation to reiterate in case of no response), they result in acceptances explicitly supported by the contract. This is legally known as 'positive administrative silence.' In the context of an engineering and construction contract, this is extremely uncommon. In fact, I have not seen it in my 30 years of experience.

Furthermore, if the Project Manager expressly rejects a Contractor's proposal, they are obligated to provide a reason. The NEC4 ECC establishes reasons for a negative response, but the rejection must detail the reasoning and, even if it is not for a reason explicitly listed in the contract, the denial must be justified so that the Contractor can take appropriate corrective action: ‘...the Project Manager states the reasons in sufficient detail to enable the Contractor to correct the matter’ .

Many readers will resonate with experiences of unresponsiveness from clients, culminating  in 'negative administrative silence.' This concept of requiring justified responses for denials, under penalty of obligating the client to accept, represents a significant advancement in encouraging effective project management.

4. Cost Acceptance

Another interesting topic, closely related to communications, is the acceptance of costs for  ompensation events (i.e., additions and deductions).

Once it has been determined that a situation ordered by the Project Manager or notified by the Contractor constitutes a compensation event, the Project Manager requests a budget or quotation. Up to this point, there is nothing new. However, if the quotation is rejected, the Project Manager must request a new one, providing the reason for the rejection, or indicate that they will prepare the quotation themselves. Again, the rejection cannot lack justification.

Even more interestingly, if the Project Manager fails to respond to the Contractor’s quotation after being notified of the lack of response within the stipulated timeframe, the Contractor’s quotation for the compensation event is considered accepted. Here, we are talking about costs and timelines.

Finally, and perhaps even more surprisingly, is a novelty introduced in the fourth generation of NEC: ECC NEC4 considers that the cost of preparing quotations for compensation events ordered by the Project Manager, which are ultimately not accepted due to the Client’s decision to withdraw, are themselves compensation events. In other words, the Contractor recovers the cost of preparing proposals for potential changes that do not materialize. While these are moderate costs, even small compared to the full execution of a project or additional construction work, their recognition is a very important detail for  maintaining a healthy and equitable relationship between the Client and Contractor.

5. Schedule Updates

An interesting topic is the obligation to update the schedule at pre-established intervals.However, the most novel aspect is that the Contractor is not required to wait for the pre-set interval for periodic schedule updates or for a request from the Project Manager to submit an update; instead, the Contractor may present an update whenever deemed appropriate.

I must acknowledge that many of the contracts I have executed treated the schedule as if it were set in stone, with clients only accepting modifications when there was an officially approved change. This resulted in schedules that bore no relation to the reality of execution and failed to achieve consensus unless, artificially and unprofessionally, an official date—likely already physically unfeasible—was adhered to.

In any case, when the Contractor submits a schedule, the Project Manager must respond by either accepting or rejecting it with justification. If the Project Manager fails to respond within the stipulated timeframe, the Contractor is obligated to follow up. Once again, the Project Manager’s failure to respond within the deadline results in the schedule being deemed accepted.

Conclusion 

NEC is an excellent instrument, demonstrating from its very first clause a collaborative approach and a commitment to aligning the parties toward completing the project with minimal  djustments to cost and schedule, without imposing unnecessary additional costs  on the Contractor. The overarching concept is that the Contractor is adequately compensated for their actual costs arising from diligent execution, and the Client pays only the real cost of the project they have ordered and received, including any additional costs corresponding to changes they introduce.

However, the NEC contract is still just a tool, and tools do not do the work. The work is done by project teams. When I refer to the project team, I also include those who select and define the contract to be used. It is not enough to have the right tool; they must also have the willingness, commitment, and capability to carry out the project through genuine collaboration with their counterparts.

A contract with Z Clauses that distort the contractual relationship, a failure to take actions aimed at real solutions while only seeking to assign blame, and the inefficient allocation ofresponsibilities can derail any project.

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