New rules on compensation events in the third edition of the New Engineering Contract mean it is fraught with difficulties for the unwary employer

Any employer who, on a fully informed basis, signs up to the latest version of the New Engineering Contract (NEC3) without substantial amendment is mad. The alternative explanation is that it trusts the contractor enough to know that, once the work begins, neither party will in fact rely upon any of the terms. So what are the problems with the changes made in the third edition, published earlier this year?

Perhaps the most serious from the employer’s point of view is a new “compensation event”. Compensation events give the contractor an extension of time, together with money, in principle. There are now 19 such events, surely something of a record – even the JCT2005 form makes do with only five loss and expense events. The new villain of the piece is any event that “neither party could prevent” and that causes delay. The contractor must also show that any experienced contractor would have judged the event to have had such a small chance of occurring “that it would have been unreasonable for him to have allowed for it” (in his price, presumably).

The guidance notes to NEC3 state that this is aimed at “force majeure” events. This term usually covers matters such as war, terrorism and chemical or nuclear contamination. However, the guidance notes cannot be used to interpret the contract (as they themselves make clear). Meanwhile, this new event could easily cover such matters as a subcontractor insolvency, an unexpected shortage of labour or materials, or even an uncharacteristically dire performance by a subcontractor. Any of these could easily come within the definition of a matter that neither party could prevent, and that an experienced contractor could not foresee. Remember also that the contractor gets not merely an extension of time, but compensation as well. For a subcontractor insolvency, this is absurd, but the contract appears to allow it.

Nor should employers assume that the clause will be construed in a sympathetic fashion. In a 1989 case, the House of Lords decided that even the provision, by a subcontractor, of defective cabling for a submarine was “beyond the control of the contractor”. The reasoning was that a contractor would not ordinarily be able to supervise the manufacturing processes of its suppliers. The NEC wording is not dissimilar.

The next problem relates to the procedure in the NEC for the contractor’s notification of compensation events and their subsequent assessment/valuation. In short, if the project manager misses a time limit, the contractor now has the opportunity to serve a “last chance” notice. There are three separate clauses within the contract where the contractor can do this. In each case, if the project manager misses the further time limit, it is deemed to have accepted either that a compensation event has occurred, or that the contractor’s valuation of that event – in terms of time and money – is correct.

The contractor gets an extension and compensation. For a subcontractor insolvency, this is absurd

The net result of all this is that if the project manager does not keep completely on top of things, the employer will have to pay compensation, and/or give an extension of time, in the terms demanded by the contractor – and possibly for an event that is not even a compensation event in the first place. The employer can challenge all this in adjudication, but will have had to pay up first.

There are other points that should concern employers. Requiring the contractor to hit certain “key dates” as the works progress might seem like a good way of monitoring progress, until you discover – predictably – that any employer interference to these dates can give rise to yet another compensation event.

Finally, in the target cost versions, interim payments are partly based on forecasts of cost as to what the contractor will have paid by the due date. As the guidance states, this will improve the contractor’s cash flow. Another way of looking at it is that it will increase the interim payment obligations of the employer.