Assessing the amount due under ECC option C


JOHN ROSSITER DOIG AND CO.


The current climate may have seen a degree of procurement strategy regression from some corners, yet option C (target contract with activity schedule) remains one of the most popular forms of


the NEC3 Engineering and Construction Contract (ECC). In principle, target cost contracts are simple:


a realistic target is set, a fair share mechanism is agreed and the parties work together to share the risk and reward. If the contractor outperforms against the target, it will share in the saving; if the contractor exceeds the target, it will pay its share of the excess. However, the fact that the ECC deliberately


avoids use of the term ‘target cost’ and that the definition of cost under option C is not merely, ‘amounts paid by the contractor’ hints that things are not always quite as simple as they may seem. Through my own personal consultancy


experience, one of the most common problems I have encountered with option C (in addition to employers wanting to have their cake and eat it by misusing the share mechanism) is a lack of understanding as to how the amount due to the contractor is calculated, with contractors often finding that when their costs are reimbursed in accordance with the contract, it is not as they envisaged at tender stage. I recently took the opportunity of conducting a


series of surveys and interviews as part of an MSc dissertation to take a closer look at the provisions for assessing the amount due and attempt to determine the following.


■ Does the industry understand how costs are reimbursed under ECC option C?


■ If they do not understand, why? Is it the fault of the contract or the users?


■ What can be done to improve understanding?


Is the contract clear? Clarity and the use of plain English by NEC3


contracts has been the source of much debate, dividing opinion between respected legal authority as to whether it, ‘requires one to focus on what is truly intended and not on what is to be presumed’ (Lloyd, 2008), or if it is, ‘a triumph of form over substance’ (Edwards-Stuart, 2010). Generally, I consider that the use of plain


English is a success. The defining objective of NEC3 contracts being a stimulus to good management could not be achieved if they were not written and structured in a way that the users can understand. However, one must not forget that they are also contractual documents designed to create legal obligations and intended for a variety of applications both in the UK and internationally. It is therefore almost inconceivable that in their core form they can be distinctly clear and readily understandable to all people in all respects. I believe that assessing the amount due under


option C is one of those respects – specifically the schedule of cost components – and as such requires a little more thought.


4 NEC USERS’ GROUP NEWSLETTER•No.61•JANUARY 2013


How cost is reimbursed For those not familiar with ECC option C, the


project manager assesses the amount due to the contractor at each assessment date calculated as follows.


■ ‘Amount due’ is the price for work done to date plus amounts to be paid to the contractor less amounts to be paid by or retained from the contractor.


■ ‘Price for work done to date’ is the total defined cost the project manager forecasts will have been paid by the contractor by the next assessment date, plus the fee.


■ ‘Defined cost’ is the amount of payments due to subcontractors for subcontracted work (without taking account of certain deductions) and the cost of components in the schedule of cost components for other work, less disallowed cost.


As the television meerkat says, ‘Simples’! ECC aims to define boundaries for


reimbursement of cost that reflect the way in which costs are incurred, and to move away from traditional methods of rate-based cost reimbursement that are not necessarily representative of the contractor’s true position. The question is, has it succeeded in practice?


What the industry thought The findings of my survey showed that


77% of respondents thought contractors did not understand the categories of cost to be reimbursed in accordance with the schedule of cost components, with 68% answering the same for project managers. Worryingly, in our current fragile market, only 10% of respondents thought that the contractor’s costs were reimbursed as they envisaged at tender stage. To try and discover the cause of such a lack


of understanding, I posed a survey question that was perhaps more ‘exam’ than ‘survey’, listing 15 common items of cost and asking respondents to allocate them to a component in the schedule of cost components. A significant number (15%) of respondents exited the survey before completing the question; of those that remained only 63% of respondents allocated the cost to the correct component. The results showed the two most commonly


misunderstood areas as being people and charges, which perhaps is not entirely surprising given that elements of these components represent the most significant departure from traditional practices.


People For people costs, the contractor is reimbursed


according to time worked in the working areas, but must split the cost as defined by components 11 to 14 of the schedule of cost components. In practice, this means that for people directly employed, the contractor must collate the costs of employing all people in the working areas (which may be made up of payroll summaries, pension costs, car costs, travel costs etc.) and allocate these costs to the contract based on the time spent providing the works in the working areas. This can be quite an administratively complicated


calculation and requires a completely open- book approach by the contractor. Even when a contractor is willing this can be a difficult task if its cost systems do not lend themselves to such scrutiny. My research findings supported this, with 48% of respondents considering the contractor’s cost systems least suited to the people component. In issue 36 of the NEC Users’ Group newsletter,


Michael Rowlinson surmised that, ‘more could have been done to simplify the people section of the schedule, for instance by providing a schedule of rates for different grades of staff, tradesmen and operatives to be provided by the contractor at tender, rather than leaving the administratively complicated calculation needed for every individual to who the schedule applies.’ However, the intention of the schedule of cost components is to move away from these traditional practices, where the contractor’s actual cost position may be disproportionate to its cost position when reimbursed through the use of the rates. Similarly, when compensation events arise, the provisions for assessing cost are supposed to establish a fairness for both parties and ensure that compensation events put the party in the position it would have been in had the event not arisen. Survey respondents were asked to consider


if they felt an auditable schedule of rates was a desirable option for assessing people costs, with the results split 50/50. Coupled with the majority of respondents agreeing that the philosophies of the schedule of cost components promote the spirit of mutual trust, it could be argued that while some adaptations may be required, to abandon the principles of the schedule of cost components in favour of rate-based methods would be a victory for the resistance-to-change brigade and not embracing the spirit of the contract.


Charges The cost of utilities, payments to authorities,


cancellation charges, inspections and the like are covered in components 41, 42 and 43 of the schedule of cost components. However, it is item 44 that – although basic in concept – can cause some confusion. Item 44 provides for a charge for overhead


costs incurred in the working areas, calculated by applying the percentage for working areas overhead in the contract data to the total of the people items 11, 12, 13 and 14. The charge excludes accommodation but includes such items as catering, recreation, sanitation, security, computing and hand tools not powered by compressed air: items that may generally be considered ‘preliminaries’, except that supervision is reimbursed under the cost component for people. The contractor must assess, at the time of tender, the estimated people costs and the estimated cost of the items covered by the charge for working area overheads, which is then expressed as a percentage in part two of the contract data. I asked survey participants to assess the


commonality of contractors applying for payment for items which should have been included in the charge for working area overheads, with 85% answering either ‘common’ or ‘very common’. This


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