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29 Jan 2025 • Andrew Shaw

NEC4: compensation events

In this mini-series we will cover issues relating to NEC4 contracts. NEC contracts have been in play for 20 plus years now, so the principles are well founded, or at least you would think so. There is a lot of information available about the NEC4 contract, so we will cover some of the theory but place a bit more focus on some of those practical tips that might help you reflect and think about how to improve your performance or that of your team.

This week we focus on compensation events. The article will cover the employer and contractor relationship in the NEC4 suite of contracts; however, the principles of the guidance we give are applicable to contractor and subcontractor relationships or subcontractor to sub-subcontractor.

The basics

A compensation event is the only mechanism that entitles the contractor to additional time and/or money because an event has occurred that is outside its contract risk profile. This differs from JCT, which has separate variation, time, and loss and/or expense clauses.

The compensation event process is described at core clause 6. The standard form position lists 21 events as compensation events; however, it is almost inevitable that these will be amended in the Z clauses. These essentially define your risk profile, so be careful not to agree to amendments that make you responsible for events that are outside your control.

If the contractor believes that an event has happened or is expected to happen, and there is no notification from the project manager, the contractor must notify the project manager within 8 weeks of becoming aware of the event. This period operates as a strict time bar, and if a notice is not given in the 8-week time period, then you will lose your entitlement to additional time and/or money. Again, if this period is reduced in the Z clauses, then push back so you agree on a suitable period or manage the risk by complying; the impact of not doing this is too serious to ignore.

On receipt of the notice, the standard form position is that the project manager is to respond within one week, and they should either reject the compensation even for one of the reasons stated at clause 61.4 or notify the contractor that the event is a compensation event and issue an instruction to submit a quotation, which the contractor must submit within three weeks (again, these periods tend to be the subject of amendments, so check).

The contractor’s assessment is another fundamental difference with other contracts. Typically, the contractor will want to know the full impact of an event before making a valuation or assessing any critical path delay. However, given the time frames and, often, lack of definition, the contractor must make a prospective assessment of the event. This should include the change to the Prices, being the actual/forecast effect upon Defined Cost and an assessment of the impact to the Completion Date and Key Dates, if any. This process cannot happen effectively unless you have your commercial and planning setup correct from day one.

In practice the assessment is likely to be the subject of some back and forth between the contractor and the project manager, and at the end of that process the project manager will implement the compensation event. This will either be acceptance of the contractor’s quotation, or the project manager will make its own assessment. If the latter occurs and you do not agree, then you have one of two choices: accept it or dispute it.

Practical tips

We have already started to cover these practical tips when covering the basics, but there are a few more areas to cover.

Firstly, it is important to be aware that early warnings do not provide any entitlement to additional time and/or money. The number of times I have heard people say relax because they have issued an early warning is worrying. It is the compensation event notification that is crucial, and, even then, you have a long road ahead before you agree to the time and/or cost impact, so don’t relax until the money is in the bank!

Secondly, if you are operating the early warning process properly and in the spirit of the contract, then you should be identifying and mitigating the possibility of early warning events becoming compensation events. This is crucial to risk mitigation and working with the employer to avoid the time and/or cost impact of events, and given the contractor only has 8 weeks to notify, being ahead of the issues will help you remain contractually compliant.

Thirdly, your quotations are prepared prospectively, so you should consider the time and/or cost implications that have happened and that you anticipate will happen. There might be an element of a crystal ball on occasions, depending on the scope of the compensation event, but you should do your best to estimate the impact. If you don’t, and your quotation is insufficient and is implemented, you are stuck with the assessment you made, for good or for bad. If any of the effects of a compensation event are too uncertain, then you can, and should, ask the project manager to state assumptions upon which you should base your quotation.

Fourthly, it should go without saying, but it is worth saying anyway, that you must stay on top of compensation events and ensure you commercially set up projects to ensure you submit high-quality and timely notifications and quotations. You should work with the project manager to ensure that quotations are implemented regularly; otherwise, problems can arise. Either your cash position will deteriorate because you are not being paid enough through the monthly payment certificate, or the programme becomes fluid because changes to the Completion Date and Key Dates are not agreed upon.

Final reflections

This is a wide subject area and one that could, quite rightly, be an article on its own. We have covered the basics and provided some practical guidance on how you should deal with compensation events, but we know from experience that there is so much more to managing this process.

Possibly the most important piece of advice is to set up projects to enable the smooth and efficient operation of the contract. This is not easy and requires you to connect together the financial, contractual, and planning aspects of a project so that those three things are synchronised and work together. When the pressure comes on and the number of issues grows exponentially, you will be glad you got ahead and made the investment!

In next week’s article, we will build on the subject of compensation events by exploring works information in which we will cover the basics as well as their relevance to compensation events.

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