Impact of potential variations of scope in Hong Kong SAR NEC forms must be thoroughly assessed

Variations are known as ‘change to the Scope’ in the NEC, and the authority to instruct these variations is granted to the project manager. Unlike some other standard form contracts which include specific and stand-alone mechanisms for valuating variations, NEC factors this into the compensation event (CE) framework, and applies the same process to claiming and assessing variations as other events at the client’s risk.

Clause 60.1 provides that it is a compensation event if the “Project Manager gives an instruction changing the scope”. The NEC4 User Guide gives some examples of such changes, including deletion, addition or alternation to the works, and changes to the client’s or contractor’s design. One peculiar feature of NEC is that it has no order of precedence clauses so that any ambiguity or inconsistency between the contractual clauses and documents is ‘resolved’ by the project manager. The NEC4 User Guide suggests that if resolving the ambiguity or inconsistency involves changing the scope, it is a CE under clause 60.1.

There are two exceptions to this. The first is a change made in order to accept a defect. This is dealt with specifically in clauses 45 and 46, and therefore excluded from the CE mechanism. The second is a change to the scope provided by the contractor for its design made at the contractor’s own request or to comply with the scope provided by the client. This is an event for which the contractor is responsible, so the contractor is not therefore entitled to additional time and costs.

Generally, CEs, including variations, entitle the contractor to additional time and payment. However, on rare occasions, CEs may result in reduced payment - for example, if the event is a change to the scope other than a change to the scope provided by the Client, which the contractor proposed and the project manager accepted.

The CE procedures for instructing a variation are:

• the project manager should notify the contractor of the CE – that is, the variation - at the time of the communication;
• the project manager should include in the notification of the CE an instruction to the contractor to submit quotations for the effect of the variation. Alternatively, the project manager may decide to make an assessment;
• the CE should be assessed in terms of its impact on price and time; and
• any changed prices, completion date and key dates following the CE should be implemented.

Prospective assessment of variations

Prospective assessments of CEs are one of the main features of NEC, it requires the change to the price to be assessed by reference to the forecast costs of the work not done by the dividing date – which is the line delineating ‘actual’ costs from ‘forecasted’ costs in the assessment of a CE.

In the context of a variation, the dividing date is defined as the date the project manager communicates the variation, and for this reason an assessment of the impact of variation should be based on a forecast of the future costs. Although the NEC allows for assessment based on records of costs incurred, this is likely to be rare for a variation.

It is the intention of NEC that the assessment of CEs will usually be based on a forecast because CEs are not intended to be cost-reimbursable. According to the NEC User Guide, “…This prevents the practice of a Project Manager making a retrospective and selective choice between a quotation and the final recorded costs of dealing with a compensation event. This practice was never intended to be allowed because it clearly disadvantages the Contractor and, if adopted, will inevitably lead to adversarialism and game playing.”.

Importantly, once the CEs are assessed and implemented, the changes to prices and time are generally final, barring the project manager and the contractor from conducting a re-assessment even if the forecast turns out to be wrong. This provision shares the risk of wrong assessment between both the project manager and the contractor.

Understandably, the prospective assessment and the irreversible approach to wrong assessment could cause uneasiness between the parties. To reduce this, NEC includes provisions which allow a second chance for re-assessment. Clause 61.6 allows the project manager to state assumptions about the CE in the instruction to the contractor to submit quotations if the effects of the CE are too uncertain to be forecast reasonably. If the assumptions later prove wrong, the project manager may notify a correction which constitutes a separate CE. This allows the parties to re-assess the effect of the CE based on the corrected assumptions.

Delay in assessment of variations

Despite the clear intention of the NEC for assessment to be based on the forecast of the costs, in reality, the “adversarialism and game playing” envisaged in the NEC User Guide is common in practice. Unfortunately, project managers are tempted to delay assessment until all varied works are completed and all costs are incurred.

This tendency to delay assessment is often justified by reference to what happened in a 2017 UK case, between Northern Ireland Housing Executive and Healthy Buildings (Ireland) Ltd (16-page / 144KB PDF). There, under an NEC3 Professional Services Contract, the employer communicated to the consultants an instruction changing the scope of works in January 2013. The employer did not notify this instruction as a CE which it ought to have done. The consultant then notified that instruction as a CE to the employer in May 2013. Quotations were sought by the employer in August and October 2013 and provided by the consultant shortly afterwards. By this time, the varied works had all been completed. The employer rejected the consultant’s quotations and assessed the effect of the CE as being zero because the consultant failed to provide records of the actual costs incurred.

The consultant contended that it was not obliged to submit its actual costs as the assessment should be based on the forecast costs at the dividing date, which was January 2013 when the employer ought to have notified the variation as a CE.

The court rejected the consultant’s position and ordered them to make discovery of the actual costs incurred and time spent because of the variation. Essentially, the court favoured a retrospective approach to assessing the variation given that the varied works had been completed and all actual costs had been incurred. The court emphasised that the actual records are the best evidence to assist the court in calculating the compensation to which the consultant is entitled and saw no reason why the court should “shut its eyes and grope in the dark”.

This case must be read in the context of its factual circumstances where both employer and consultant were not properly operating the NEC contract and the court’s power to order discovery. It would be an incorrect reading of the case if parties think that they can adopt a ‘wait and see’ approach to assessment until all actual costs are incurred in every case. Neither the project manager nor the contractor is entitled to delay assessment under NEC. If the contractor does not submit quotations as instructed, the project manager is to step in to make the assessment, although this is unlikely to happen as the contractor has an incentive to receive the additional payment and time in respect of a variation. Alternatively, if the project manager does not reply to the contractor’s quotation or delays in making an assessment, it is treated as having accepted the contractor’s quotation.

In this case, had the consultant been more prudent in protecting its own self-interest, it could have notified the employer that the variation was a CE at a much earlier stage. This would have obliged the employer to instruct a quotation before the varied works were completed, and then the assessment could be based on the forecast costs.

If the project manager refuses to instruct a quotation or make an assessment itself, it will be in breach of the contract itself and this gives rise to a further CE. In addition, employers should be aware that, under common law, they have a positive duty to instruct the certifier they have appointed - including the project manager under NEC - to perform its certifying function as required by the contract.

The prospective assessment of variations - and other CEs - together with the various devices encouraging parties to comply with the contract provisions, is the manifestation of NEC’s emphasis on efficiency and equitable risk allocation between the contract parties. Even so, efficient project management depends not only on clear contract drafting, but also on the contracting parties’ collaboration. While parties should “act in the spirit of mutual trust and co-operation”, they should also be familiar with their contractual rights and remedies to protect their own self-interest.

Co-written by Jason Wong of Pinsent Masons.