Take notice of key differences in NEC3 contracts

Confuse compensation events and early warning notices in the NEC3 contract at your peril, says Eugene Lenehan.

The NEC3 includes some important provisions that require the Contractor to issue notifications, particularly in relation to early warnings and compensation events. These two types of notice have completely different purposes and the consequences of not issuing them are quite different.

Both the Contractor and Project Manager have a duty to issue both early warnings and notifications of compensation events but this article is based on the Contractor’s perspective. I have often encountered situations where Contractors have struggled to understand the difference between the two notices, often with costly results.

Early warnings

Clause 16 and the early warning provisions are an example of how the parties can act in a spirit of mutual trust and cooperation, and they have done much to enhance the status of the NEC3 as a collaborative contract.

Early warning notices, referred to at clause 16.1 of the NEC3, are to be issued for potential problems. Both the Contractor and the Project Manager must issue an early warning as soon as either becomes aware of any matter that could possibly (not definitely) delay the works, increase costs or impair quality.

The Project Manager is motivated to give an early warning to maximise the opportunity of involving the Contractor and finding the best solution to the problem and therefore keep the Employer happy. It might be said that the Contractor’s motivation is similar — but they also have the potent incentive of protecting themselves from the Project Manager imposing the sanction at clause 63.5 of the compensation event process.

The Velodrome was built for the 2012 Olympics under an NEC3 contract. Photograph: Eleanor Bentall

Clause 63.5 emphasises the importance of the Contractor giving a required early warning. If the Contractor fails to give a required early warning and a compensation event then occurs, the clause gives the Project Manager the opportunity to assess the compensation event as if the Contractor had given an early warning.

This enables the Project Manager to consider the mitigation measures that could otherwise have been taken, as it may be possible that an early warning could have allowed actions to be taken which would have reduced costs and/or saved time. The Project Manager is effectively allowed the benefit of hindsight when carrying out their assessment of delay and extra cost, reducing the Contractor’s entitlement.

So the consequences of the Contractor failing to issue the appropriate early warning can be serious and substantial.

Notices of compensation events

Compensation events deal with the effect of an event on time and money. In JCT parlance they relate to variations, extensions of time and loss and expense. Consequently, they are of great importance to Contractors. However, to enable a Contractor to receive the benefits of a compensation event it must be notified.

For compensation events that arise from an instruction of the Project Manager, for example to change the Works Information (ie a variation), it is for the Project Manager to notify the Contractor of the compensation event (and instruct them to provide a quotation). For numerous other categories of compensation event it is for the Contractor to notify the Project Manager.

Where a Contractor fails to notify the Project Manager of a compensation event within eight weeks of becoming aware of the event, clause 61.3 prevents their right to claim an adjustment to the Prices and the Completion Date (unless it is an event which the Project Manager should have notified to the Contractor).

The difference

One distinction between an early warning and a compensation event is that typically the early warning process deals with events that have not yet happened but have a strong possibility of occurring, whereas the compensation event process is usually for events that have already occurred.

So, if a Contractor becomes aware that the Employer’s choice of the floor tiling to be laid next to their swimming pool is not a non-slip tile it would be appropriate to issue an early warning. When the Employer subsequently issues an instruction to change to a non-slip tile it would then be appropriate to issue a notice of compensation event.

Both of these notices are important, yet Contractors frequently place more importance on the early warning notice. It is quite reasonable for an Employer to encourage the early warning procedure. If the topic of an early warning is going to result in a compensation event it will invariably cost the Employer time and/or money. The earlier an event is notified the greater the opportunity to resolve the problem or minimise its impact.

The early warning procedure helps keep the project on track and is a chance for both parties to show they have embraced the spirit of trust and cooperation. Also, as mentioned above, the Contractor has the incentive of wanting to avoid the sanction at clause 63.5.

However, when comparing the sanction at clause 63.5 for failing to issue an early warning, with the possible consequences of a Contractor’s failure to comply with the eight-week condition precedent at clause 61.3, it is clear to me which should be more important to Contractors. From my experience, Contractors have suffered a lot more from one than the other.

I have repeatedly seen Project Managers impose the eight-week time bar, preventing Contractors from receiving extra time and money. However, I have not once encountered a Project Manager successfully imposing clause 63.5. It can, and I have no doubt does, happen, but it is rare. Contractors may often fail to issue early warnings but it is not often that a Project Manager can demonstrate that, had the early warning arrived, it would have taken alternative action that would have resulted in a cheaper outcome.

Eugene Lenehan is a chartered surveyor and barrister at construction consultancy Driver Trett