NEC: Unconventional Pricing for Compensation Events?

This is thefirst of a series of articles on the NEC standard form of contract.

The premise indeveloping the NEC standard form was to create a user-friendly contract, whichprovides clarity and simplicity through the use of simple language. The question is whether it achievesthis. Judging by the confusionfrequently seen in regard to the pricing of variations, or Compensation Eventsas this contract choses to call them, the contract could be said to fail indelivering clarity due to frequent misunderstanding and a sometimescounter-intuitive approach to pricing.

The method tobe used is described under Clause 63.1 in the various Options as:

“The changes tothe Prices are assessed as the effect of the compensation event upon:

• theactual Defined Cost of the work already done,

• theforecast Defined Cost of the work not yet done and

• the resulting Fee

The date whenthe Project Manager instructed or should have instructed the Contractor tosubmit quotations divides the work already done from the work not yet done.”

This methodidentifies a base date for pricing, which for ease in this article, is referredto as the “switch date”. This serves asa point in time to differentiate forecasted and actual costs used by theContractor in pricing quotations. Inaddition, account should be taken of the effect upon Planned Completion asshown on the latest accepted programme.

One keydifference in pricing under NEC is that unlike other forms of contract, whichrequire existing contract rates to be used where appropriate, NEC promotes thephilosophy that no party should unfairly gain an advantage or suffer a loss asa result of the event. This could ofcourse be the case using already agreed contract rates. The premise is then that the Contractorshould be adequately compensated for the effect of the compensation event uponthe Prices, whilst at the same time the Employer pays a fair price.

To arrive atthis situation, rates and prices agreed within the Contract are not used,rather pricing will reflect an assessment of the effect of the event upon theContractor’s Defined Cost. In makingthis assessment, risk will also be priced into the compensation event. It should be noted we are “assessing” theeffect not “calculating” it. This beingthe case only actual costs to the switch date will be included. Thereafter costs are forecasted. This is also true even when all of the workhas been carried out after the switch date but before the date of the quotationbeing submitted. This is where thegreatest misunderstandings arise and the counter-intuitive assumptions aremade.

Effectively weare stepping into our “time-machine” and travelling back to the switch date toprice based upon knowledge held at that point in time, although currentknowledge will always have an effect on the outcome. This is especially true in the case of riskwhere disagreement is likely to occur in regard to materialised risk at thepoint of preparation and submission of the Contractor’s quotation compared torisk evaluated at the switch date. Itshould be remembered in pricing a quotation that we are dealing with DefinedCost, being the costs incurred in Providing the Works, and not actual cost.

This does notmean, however, that actual cost cannot be used. If there is an express agreement between the Parties to use actual cost,then this will prevail. The ProjectManager cannot however insist on using actual cost unless all of the works wereprovided before the switch date. Neithershould the Project Manager be using the benefit of hindsight to carry out theirown assessment, rather he should be assessing whether the forecast was correctin the given circumstances prevailing at the switch date based upon what wouldhave been reasonable to have allowed for at that time.

The moral ofthis story is that parties should understand what is required by the Contractand in keeping with the requirements of Clause 10.1 act as stated in (the)contract and in a spirit of mutual trust and cooperation.

In the next article I will be looking atissues surrounding the contractual requirement for an Accepted Programme andacceptance by the Project Manager.

About the Author

John Blackshaw is a dualqualified specialist construction law lawyer who worked as a commercialmanager, project/programme manager and contracts manager before qualifying as asolicitor. John has worked internationally for in excess of 25 years in NorthAmerica, South America, and in Western, Central and Eastern Europe on a widerange of projects across the energy, nuclear, roads, rail, marine,infrastructure, automotive, industrial, residential and commercial sectors,both with Employers, and with Tier 1/Tier 2 Contractors as well as in-house.

Prospect Law is amulti-disciplinary practice with specialist expertise in the energy,infrastructure and natural resources sectors with particular experience in the low carbon energy sector. Thefirm is made up of lawyers, engineers, surveyors and other technical experts.

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This article is not intended toconstitute legal or other professional advice and it should not be relied on inany way.

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Prospect is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, insurance and risk management specialists, and finance experts.

This article remains the copyright property of Prospect Law Ltd and neither the article nor any part of it may be published or copied without the prior written permission of the directors of Prospect Law.

This article is not intended to constitute legal or other professional advice and it should not be relied on in any way.