Understanding Hong Kong SAR NEC compensation events ‘crucial’ to projects’ success

After identifying and notifying CEs, parties must assess the effect of the CEs and implement them. A contractor is required to quote the time and cost consequences of any CE as part of their quotations, in line with clause 62, and the project manager (PM) may instruct a revised quotation with reasons, accept that quotation, or step in and make its own assessment if it is not satisfied with the contractor’s quotation, in line with clause 64.

Significantly, penalties apply where the PM fails to assess. A notified CE is deemed a CE if the PM fails to reply within two weeks, in line with clause 61.4. A contractor’s quotation is deemed accepted if the PM fails to reply within two weeks of the contractor’s notification of failure to reply, in line with clause 62.6, and a contractor’s quotation is also deemed accepted if the PM fails to assess within two weeks of the contractor’s notification of failure to assess, in line with clause 64.4.

Graphic: Hong Kong NEC compensation event flowchart

Practical considerations for parties

The purpose of assessing CEs is to identify the time and cost impact as a result of the CEs. There are a few nuances specific to the NEC assessment process that parties should consider.

Project manager’s impartiality

An architect or engineer must fulfil their duties of assessment and certification independently, impartially, fairly and honestly, as such duties benefit both parties. This has long been recognised in both English case law – in a 1974 case between Sutcliffe and Thackrah - and Hong Kong case law – in a 2016 case between Chun Wo Building Construction Ltd and Metta Resources Ltd.

In the NEC context, the PM is likewise subject to the same obligations of independence, impartiality, fairness and honesty when making assessment and certification, as shown in a 2005 case between Costain and Bechtel.

Prospective assessment of change to the prices

NEC requires assessment to be made prospectively based on the forecast for works not done, in line with clause 63.1. While it may be tempting for the PM to take a ‘wait and see’ approach because forecasts will often be incorrect - especially with the benefit of hindsight and actual records - this approach is contrary to the spirit of NEC and should not be encouraged.

The NEC seeks to prevent any delay to the assessment of any CE - for example, if the contractor delays in submitting their quotation, the PM can step in to make an assessment itself, in line with clause 64.1, and if the PM fails to assess, the contractor’s quotation is deemed to have been accepted, in line with clause 64.4.

Assessment of delay

Delay is assessed based on the length of time that a CE causes completion to be later than the planned completion shown on the ‘accepted programme’ under NEC3 clause 63.3 and NEC4 clause 63.5. This incentivises the contractor to ensure that the programme is up to date. It also makes it clear that terminal float between planned completion and the completion is owned by the contractor and is not used to mitigate the time effect of the CEs.

Read more of our series on Hong Kong SAR NEC forms

• Using the NEC4 standard form contract for construction projects in Hong Kong SAR
• Clarity on compensation events in Hong Kong SAR NEC forms can help to avoid construction disputes
• Impact of potential variations of scope in Hong Kong SAR NEC forms must be thoroughly assessed
• Hong Kong SAR NEC forms encourage proactive communication
• Hong Kong SAR NEC forms hold limits to instructing changes to construction works’ scope
• Optional clauses in Hong Kong SAR NEC forms can boost construction project outcomes

Early warning

To facilitate early collaboration to resolve issues, the contractor and the PM are required to give each other early warning if either is aware of any matters that could increase the price or delay completion, under NEC3 clause 16.1 and NEC4 clause 15.1.

If the contractor fails to do so, the PM must state this in its instruction to give a quotation in line with NEC3 and NEC4 clause 61.5, in which case NEC3 clause 63.5 and NEC4 clause 63.7 operate to sanction the contractor by stipulating that CEs are assessed as if the contractor had given the early warning.

This means that, firstly, if early warning could have reduced any of the effects of the CE, the contractor may be penalised as it will not be entitled to time or an increase in prices for those effects. Secondly, if the CE could have been entirely avoided by the contractor’s early warning, the PM could argue that the CE arose entirely through the contractor’s fault with the effect that, under 61.4, the contractor would lose any entitlement to a change to the price or the completion date.

Conversely, while the PM equally has the obligation to give early warning, the NEC does not contain any explicit penalty sanctioning the PM or client for not doing so. There is still a penalty for the client, but it is more subtle – the PM may lose the chance to work together with the contractor to reduce the time and risk impact of an early warning matter and, if it later becomes a CE, the PM has to give full entitlement of time and costs to the contractor, which might not have been incurred had the matters been dealt with at an earlier stage.

Risk allowance

The PM’s assessment includes risk allowance for costs and time for matters which have a “significant chance of occurring” and are not CEs, in line with NEC3 clause 63.6 and NEC4 clause 63.8.

This provision is expressed in probabilistic terms: “significant chance of occurring”. The terms “risk allowances” and “significant chance of occurring” are undefined. What is considered “significant” is vague and unclear, but this essentially means that if such risk allowances are not already included in the forecast of ‘defined cost’, the proposed changes to the prices in the contractor’s quotation may include them.

While the PM’s assessment is required to include risk allowances prospectively, this will depend on the extent to which it assesses that such matters have a “significant chance of occurring”. The greater the uncertainty, the greater the risk allowance included in any quotation and, accordingly, the PM may wish to state various assumptions when seeking a revised assessment to reduce this risk element in prospective assessments.

Reduction in price

If the effect of a CE is to reduce the total defined cost, the default position is that the prices are not reduced, in line with NEC3 clause 63.2 and NEC4 clause 63.3, which benefits the contractor.

There are a few exceptions to this. For example, correction of a mistakes in the ‘bill of quantities’ may lead to reduced prices in Option B under NEC3 clause 60.6. NEC4 clause 63.4 provides two further general exceptions which permit reduction of the prices, including a change to the contractual scope of the works (‘scope’) proposed by the contractor and accepted by PM, and a correction to an assumption stated by PM for assessing an earlier CE.

Apart from that, in the priced contract Options A and B, where the contractor has proposed and the PM has accepted a change to the scope provided by the client, the prices are reduced to the lesser amount of the assessed effect of the CE. This allows the contractor to benefit from value engineering by devising more efficient ways of working under Options A and B.

Prohibition of revision or reassessment of compensation events

A significant feature of NEC is the forward-looking style in assessing the effect of CEs, which discourages conflicts which might disadvantage the contractor. This is reinforced by NEC3 clause 65.2 and NEC4 clause 66.3 which in effect provides that the assessment of a CE is not revised, even if the assessment is eventually shown to be wrong. If a party is not satisfied with an assessment, perhaps because things have changed since the assessment or the forecast was incorrect, the only way to rectify the assessment is to proceed to dispute resolution.

Assumptions

Even though the NEC requires parties to forecast the effect of CEs, it also recognises that forecasting is sometimes difficult. When the effect of a CE is too uncertain to be forecast reasonably, clause 61.6 allows the PM to state assumptions about the CE in the instruction to the contractor to submit quotations. The PM’s notification of the correction of an assumption is itself a separate CE, in line with clause 60.1(17), and the prices may be reduced accordingly in line with NEC4 clause 63.4. Where no correction is forthcoming, contractors may wish to notify PM’s of the need for such correction.

Once the time and cost impact of the CEs are assessed, the parties may proceed to ‘implement’ the CEs, where the “Prices, the Completion Date, and the Key Dates are changed accordingly” in line with clause 66.2.

The exact changes to be made to the prices depend on which ‘main option’ is used. For example, with Option C – ‘target contract with activity schedule’ - the changed price is manifested in the form of changes to the activities schedule, whereas for Option B – ‘price contract with bill of quantities - the changed prices are in the form of changes to the bill of quantities.

Co-written by YC Lung and Jason Wong of Pinsent Masons.