The new NEC3 Early Contractor Involvement clauses : a constructive review.

 

This blog reviews the newly published NEC3 Early Contractor Involvement (ECI) clauses, which are added onto the NEC3 Engineering and Construction Contract (ECC) as additional conditions of contract. It briefly outlines what Early Contractor Involvement is; what I like about the ECI clauses; what I don’t like about the ECI clauses; alternatives and a conclusion.

A downloadable PDF of the NEC3 ECI clauses, together with some guidance notes on them, can be found here.

What is Early Contractor Involvement (ECI) ?

Early Contractor Involvement is an amalgamation of the Preferred Contractor lump sum Design and Build approach and target cost contracts.

The Preferred Contractor approach started to be used in the nineties by big commercial developers, who worked with a few chosen contractors. They selected a preferred contractor early for a project, largely based on past performance, and worked with them to develop scope and the details that mattered to them. When the works were sufficiently developed for the client to be happy with what they were going to get, a lump sum price was agreed. As repeat order intelligent clients, they knew what they should be paying and had significant commercial leverage over and above the terms of any contract to avoid over-paying.

Target cost contracts are a development of cost reimbursable contracts where – using NEC3 terminology - a Contractor is reimbursed their Defined Costs (on the x-axis in the diagram) plus tendered fee percentages as a contract progresses which gives Price for Work Done to Date (PWDD) (on the y-axis) as the contract progresses.

The additional clauses in the target cost options of the ECC, compared with the cost reimbursable option, are to allocate share of pain / gain if the PWDD exceeds or hopefully come in under the contractual target Prices. The diagram shows a 50/50 share split for both pain and gain with the final PWDD reflecting a gain. Target cost contracts started to be used in the very late nineties as the contractual arrangement to underpin partnering as they create a commercial incentive to jointly work together. It is no co-incidence that the rise in their use has followed the rise in the use of the Engineering and Construction Contract (ECC), which was the first standard form to have a target cost option and the NEC's ethos.

Putting these two contractual arrangements together created Early Contractor Involvement. While the Ministry of Defence were the first to do this under their Prime Contracting initiative, it was the Highways Agency who popularised the use of ECI, both because of its widespread use on their major projects and calling it ‘Early Contractor Involvement’ ! An overview of the process is illustrated in the diagram below.

In terms of speeding up delivery of major projects – which was one of the prime reasons for adopting it - it proved very successful by significantly reducing the length of Public Inquiries and the need to re-visit planning conditions. However, potential users should be aware that in very few, if any, ECI schemes has the Contractor ever exceeded the target Prices. This implies that contractors have used the exclusivity (in practice) of being ‘preferred’ to agree initial target Prices that are on the high side and stories abound of them ‘suddenly’ identifying money saving innovations as soon as the target Prices have been agreed i.e. once they get a share of any savings.

Indeed, this is one of the main drawbacks of using the ECI approach for one-off projects – a lack of commercial leverage and knowledge of costs may mean an occasional employer is taken advantage of.

What approach to Early Contractor Involvement have the NEC3 authors taken ?

The authors have split ECI into two Stages called, unsurprisingly, Stage One and Stage Two. While what happens in each stage is defined in detail in the Works Information (the specification in non-NEC3 speak), but in general terms :

  • Stage One is where the Contractor either leads the development of the design in consultation with the Employer and any Others OR is consulted in the development of the design which is done by the Employer or their consultants.
  • Stage Two is where the detailed design is developed and constructed pretty much as per the un-amended Engineering and Construction Contract

The ECI amendments combine Stage One and Two into one contract, with a contractual notice needing to be given on behalf of the Employer to proceed to Stage Two.

What I like about the NEC3 Early Contractor Involvement (ECI) clauses.

The first thing that I like is that they have actually developed these clauses which are long overdue.

The second thing I like is that they are in the same succinct active plain English language of the rest of the contract. Put bluntly, this is far better than the over-complicated ambiguous rambling legalistic dross that I often see when Employer's (pseudo) lawyers alter the base ECC text.

I also like the enhanced provision that the Contractor, in Stage One, is not allowed to replace a key person unless they are “unable to continue to act in connection with this contract”.

Fourthly, I also like that if the Contractor is leading the design in Stage One, then as design or other documentation is developed, it is incorporated into the contract as “Contractor's Works Information for his design”. This means that the Contractor becomes responsible – and therefore liable, although that liability is shared by the pain /gain formula - for not just any ambiguities or inconsistencies within this developed document, but also with the Employer 's original Works Information or brief. This is a subtlety which has not been picked up in other bespoke ECI amendments that I have seen.

I also really like that the optional ‘tweak’ that they have done to the traditional ECI approach whereby it can used with option E : cost reimbursable contract – so the Contractor is reimbursed their Defined Costs plus Fee. Here the pain /gain is not based on savings compared with the target Prices, but around savings in total Project Costs compared with the overall project Budget.  Project Costs and the project Budget includes not just what the Employer’s pays the Contractor, but also what the Employer pays to Others involved in the same project. The Contractor is therefore motivated to minimise the Employer’s total spend rather than just their own spend. It moves the contracting strategy towards an Alliance type arrangement.

Lastly, regardless of whether the above ‘tweak’ is used or not, I like that the Contractor has to maintain forecasts of the total Project Cost.

What I do not like about the NEC3 Early Contractor Involvement clauses.

The answer is one fairly major thing and two minor things.

Here’s the major thing :

While the provisions for proceeding to Stage Two are plainly and clearly written, I do not like the provisions for what happens if the Employer decides not to proceed to Stage Two and especially if they decide to proceed with another Contractor. While the Intellectual Property for any material developed remains with the Employerthere is no express provision terminating the contract. 

Instead, to quote the contract, “the work required in Stage Two is removed from the Works Information. This instruction is not a compensation event.” So the work is removed but the target Prices stay the same. 

As a result, I think any Contractor could mount a convincing argument that the Employer has effectively terminated the contract for, to quote the ECC, “A reason other than R1 – R21” (see the table in clause 90.2). This leads them to being entitled to be paid not just for the work done and costs committed, but under sub-clause A4 of clause 93.2, their direct fee percentage multiplied by the original Prices minus the Price for Work Done to Date.

To put that in context, let us say the contract is for £10m of which £1m is spent in Stage One and the Contractor has a fee percentage of 10%. The Employer would then be liable for 10% x (£10m - £1m) = £900k for which they would derive no value.

For me, the most eloquent solution would be to have not proceeding to Stage Two as an additional reason for termination in section 9 with an additional procedure to be followed (a P5 in clause 92.2) and the existing payment provisions (A1 and A3).

The two other minor things I do not like relate to the ‘tweak’ (which I liked) to the pain / gain share being based around savings in Project Cost compared with the project Budget :

  1. As it is written, the Employer’s own internal costs are not part of the project Budget or Project Costs. The Contractor therefore has no incentive to help minimise the Employer’s internal costs. This, however, can be easily corrected by a simple change to the definition of ‘Project Costs’; and
  2. The Contractor will only take a share of any pain if the both the Project Costs exceed the project Budget and the Contractor’s own Defined Costs plus Fee (the Price for Work Done to Date) exceed the total of the Prices under the cost reimbursable contract i.e. two conditions have to be fulfilled. Further, if both conditions are to be fulfilled then they only take a share of the over run on the lesser amount. This seems a bit biased towards the Contractor. While the reasoning is explained in the Guidance Notes which accompany the amendments, I can see many Employer’s changing this … and if lawyers have a justification for changing something, they tend to go too far the other way !

Alternative ECI arrangements

Before I finish this article, it is worth while pointing out that there are other approaches to Early Contractor Involvement.

This is normally an overarching agreement where :

  • Stage One is done is done under a Professional Services Contract – either the NEC3 Professional Services Contract (PSC) if the Contractor is leading the design development or either the PSC or the NEC3 Professional Services Short Contract (PSSC) if they are contributing but not leading; and
  • Stage Two is done under the normal the Engineering and Construction Contract.

The agreement contains the conditions precedent – or conditions that have to be fulfilled – to proceed from Stage One to Stage Two.

Conclusion

This is a long overdue and worthwhile addition to the NEC3 family of contracts and, with the exception of what happens if the Employer decides not to proceed to Stage Two of detailed design and construction, it is well done.

I am currently working with a client to develop ECI procedures under their framework and, wherever possible, will be adopting the terminology and wording I use to match that of these clauses.

For further reading on how HS2 will use ECI, go to this webpage.

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