Clarity on compensation events in Hong Kong SAR NEC forms can help to avoid construction disputes

CEs represent risks carried by the Client. Entitling the Contractor to claim for lost time or money, these clauses are at the heart of the equitable risk allocation for which the NEC suite of contracts is known.

The NEC engineering and construction contract (NEC4) includes 20 CEs in its core clauses spanning a wide range of events. Additional CEs can also apply, depending on which main option and secondary options the parties to the contract choose to include.

The CEs in the NEC4 vary substantially but can broadly be allocated into five categories:

• CEs arising from the instructions of the project manager (PM) or supervisor,
• CEs arising from the Client’s breach of contract,
• CEs arising from the project manager or supervisor’s default,
• CEs arising from neutral events, and
• CEs that are ’catch all’ provisions.

Compensation events arising from project manager instructions

These CEs can occur whether or not there has not been a breach by either of the parties. The types of instructions covered are:

• instructions to change the scope – that is, a variation - except when the change arises due to the Contractor’s default,
• instructions to stop or change key dates,
• instructions to deal with antiquities on the construction site,
• instructions to take over part of the work before the completion date,
• making a correction to ‘assumptions’ about a CE. This could arise from a key feature of NEC, which requires the PM to make a ‘prospective’ assessment of the anticipated effects of a CE by making a forecast at a very early date – which is generally the date the CE event was notified. An incorrect assessment would not be subject to revision even by the PM, so it is vital that the PM carefully decides whether to use clause 61.6 to state assumptions about the CE if they feel that the effects of a CE are too uncertain to be reasonably forecasted at that early date.

Compensation events arising from Client breach of contract

This is another unique feature of NEC. The Client’s breach of contract is treated as a CE, and its effects are assessed by the PM in lieu of common law damages. This feature does raise the issue whether - when read with the exclusive remedy clause in 63.6 - damages at law are thereby precluded.

Some instances of this type of CE use similar language to what is commonly found in other contract forms, such as failing to give access to the site by the date shown in the accepted programme, and failing to provide material, facilities and samples for tests and inspections as stated in the scope.

Other instances of breach, however, use NEC’s characteristically plain language. These include where:

• the Client has not provided “something” in line with the accepted programme,
• the Client has not worked according to the accepted programme or according to the conditions stated in the scope, or
• there has been a breach of contract by the Client which is not one of the other CEs in the contract – this is a catchall provision discussed below.

Compensation events arising from project manager defaults

As the PM generally acts as the agent of the Client, his defaults fall within the risks carried by the Client.

Some instances of a PM’s breach use similar language to that commonly found in other contract forms, such as:

• if the PM instructs a search but no defect is found, and
• tests or inspections by the PM cause unnecessary delays.

Other instances of a breach are unique to NEC and are drafted in plain English. These include:

• “late replies by the project manager to communication” - what is considered ‘late’ would have to be determined by the period for reply proposed by the Client,
• “the project manager’s change to a previous decision” - In the broadest sense, ‘decisions’ could include all instructions and assessments made by the PM, but it is unlikely that the NEC’s intention is to allow the PM to revise an incorrect assessment of a CE,
• “the project manager withholds acceptance for reasons not stated in the contract” – some clauses provide the reasons for the PM to withhold acceptance of the Contractor’s submissions or proposals. The PM may withhold acceptance for other reason, but these will be CEs entitling the Contractor to additional time or costs,
• “a quotation for a proposed instruction is not accepted” – this is new to NEC4 and prevents a situation where a PM instructs the Contractor to submit a costly quotation for a proposed instruction and then turns it down, allowing the Contractor to recoup extra money and time wasted.

Compensation events arising from ‘neutral’ events

Like many other construction contracts, the NEC provides for the possibility of certain ‘neutral events’ occurring through no fault of any parties. These include:

• an ‘improbable’ physical condition that is not weather related. The term ‘improbable’ is coined by the author to describe the NEC’s philosophy of using probability rather than reasonable foresight, which is used in many other standard forms, to allocate risk. Instead, NEC allocates risk based on the probability of the CE occurring, and whether an experienced Contractor would, at the time of tender, have felt it unreasonable to allow for that risk,
• an improbable weather condition – in the HK NEC this is restricted to a tropical cyclone warning signal no.8 or a rainstorm warning, but parties may include other weather conditions in the contract data,
• an event which is a Client’s liability - clause 8 in the contract provides for some neutral events, such as loss or damages caused by war, strikes or radioactive contamination, to fall within the Client’s liability,
• an improbable event which stops work, that is both unavoidable and unforeseeable -this is commonly regarded as a ‘force majeure’ provision. Contractors should note that the test is based on probability, not foreseeability and, even if they foresee that an event may occur, they may decide not to give price allowance if the probability of the event occurring is negligible.

An important feature here is that the CEs do not cover a change to law unless the parties opt for it by including the secondary option clause X2.

The ‘catchall’ provision

This clause provides that any breach of contract by the Client which is not one of the other CEs is also a CE. The NEC has essentially absorbed all possible breaches by the Client into the CE framework.

Examples of such breaches of contract not covered in other CEs include the Client’s failure to pay, or other defaults by the PM acting as the Client’s agent. An interesting scenario would be if the PM acted in an unfair manner, for example when assessing CEs. Some cases have suggested that the Client is under a positive duty to remind the PM of their proper function, and failure to do so could be a breach of contract. Given that this breach is itself a CE, this would result in the rather odd situation of the PM having to assess their own unfair assessment.

Including the Client’s breach of contract as a CE must also be considered together with clause 63.6 which provides that ‘changes to the prices’,  ‘completion data’ and ‘key dates’ are the only rights for the Client and Contractor in respect of a CE – that is, an exclusive remedy clause of sorts - and, if so, whether the Contractor would be entitled to the rights such as termination or interest when the breach is failure to pay.

While NEC provisions enshrine the spirit of mutual trust and collaboration, there are also ‘hard’ contractual clauses such as clause 6 - including the time bar in clause 61.3. It is ultimately incumbent on parties to put this spirit of collaboration into practice by ensuring effective communication between parties and resolving disputes as they arise.

Co-written by Zita Chan and Jason Wong of Pinsent Masons.