Disallowed cost and the cost of subcontractor disputes in NEC4 ECC

Key Points

• In NEC3 ECC, disallowed cost includes all costs of preparing for and conducting adjudications and tribunals.
• NEC4 ECC clarifies this as costs for disputes between the parties.
• Costs for disputes between contractors and their suppliers can be allowed provided the project manager had been notified.
• But clients, project managers and contractors all need to be take a proactive and pragmatic approach to reducing the costs of such disputes.

NEC3 ECC clause 11.2(25) states, 'Disallowed Cost is… …the cost of preparation for and conduct of an adjudication or proceedings of the tribunal.'

Project managers and contractors had differing interpretations of what this clause covered, with some considering it included adjudication with subcontractors too. Nothing limits it to disputes between the parties, except that the ‘tribunal’ is identified in the contract data. At the time, Thomas (2012) in Keating on NEC3 noted this was a new but probably unnecessary provision introduced in NEC3.

The issues, including a dispute about a dispute on a major infrastructure project, were reflected on by the NEC drafting team and the clause was amended for the NEC4 ECC in 2017. NEC4 ECC clause 11.2(26) currently states,

'Disallowed Cost is cost which

• was incurred only because the Contractor did not
  •  give notification to the Project Manager of the preparation for and conduct of an adjudication or proceedings of a tribunal between the Contractor and a Subcontractor or supplier

and the cost of

• preparation for and conduct of an adjudication, payments to a member of the Dispute Avoidance Board or proceedings of the tribunal between the Parties.'

The second part of this amendment has certainly clarified the position insofar as it clearly now only deals with disputes between the parties. Therefore, it can be concluded the costs incurred in disputes with subcontractors should escape disallowed cost. But it is not quite as simple as that.

Challenges for contractors

The addition of the first new sub-clause suggests that certain costs associated with adjudications and tribunals with subcontractors or suppliers can now be disallowed but only under certain circumstances. The new clause is intended to encourage the contractor to make the project manager aware of disputes and issues at lower levels of the supply chain. The intent is supported by Gerrard (2017), in which he states, ‘This gives the project manager an opportunity to attempt to resolve the issue on behalf of the client’.

So, if the adjudication or tribunal costs could have been mitigated by notifying the project manager of the dispute, they will be disallowed. If notification is not given, the project manager must assess the extent of disallowed cost as a direct result of a failure to notify. This is quite a rigid test, and it might be an unenviable job demonstrating that the adjudication or some part of the dispute could have been avoided if the contractor had notified the project manager of its existence.

Thomas (2022) picked up on the lack of any express obligation to notify. However, under clause 15.1 on early warnings, he noted the contractor would be obliged to do so if the anticipated adjudication or tribunal could delay completion or meeting a key date. This is equally applicable in the NEC4 Engineering and Construction Subcontract (ECS), with subcontractors having to notify the contractor about any potential disputes with sub-subcontractors or suppliers and the disallowed cost provision working in the same way.

Also, there is limited guidance on how to operate the additional disallowed cost clause, which may lead to subjectivity and differences of opinion. Thomas (2022) notes the assessment of the extent of disallowed cost and its proximity to the failure to notify ‘may be difficult to show in practice’.

Challenges may also arise from quantifying the costs incurred and what should be disallowed. It should be easy to identify adjudicator fees, legal costs and dispute consultant costs, but it may be more difficult to identify a thickening of project team resources or existing project team members contributing to the preparation and conduct of the dispute.

Challenges for clients

Certainly in a cost-reimbursable contract, funding a contractor’s dispute can be beneficial to the client, such as resulting in a lower assessment of a subcontractor’s compensation event. In this scenario, it appears logically and morally right to reimburse the costs subject to the contractor taking a reasonable position in the dispute.

However, Rowlinson (2019) warns it is in the client’s interest to ensure that the money spent does not exceed the benefit it receives in the form of a reduced defined cost. In this scenario, getting a proactive project manager involved who understands the implication of the contractor losing the adjudication or tribunal will mean that the client may incur both the sum in dispute and the preparation costs may help the parties avoid the dispute altogether.

As Waterhouse (2021) states, ‘the considerable expense of adjudication, arbitration or litigation often exceeds the costs of a sensible compromise’. This is undoubtedly the intent of the drafting, stimulating good management and hopefully mitigating protracted disputes and the associated costs wherever possible.

Nazzini and Kalisz (2023) note that ‘smash-and-grab’ is now the most common form of claim adjudicated in the UK. So, in a situation where the contractor has failed to issue a valid payment or pay less notice to a subcontractor, should clients stump up the bill if the defence is on shaky ground? In such cases it does not feel logically or morally right, and it is unlikely the project manager will be able to contribute much to mitigate that type of dispute.

Adjudication can be a costly process: professionals involved may include barristers, solicitors, claim consultants, quantity surveyors, forensic planners, expert witnesses, and the project team. If such costs are allowable, this might encourage a contractor to launch a ‘kitchen sink’ defence where otherwise it may be more minded to settle using a cheaper form of alternative dispute resolution, noting the client’s obligation to pay these costs may be lessened by any pain share apportionment under a target price form of contract depending on individual project performance. This does little to promote the mutual trust and co-operation which underpins NEC.

Clients should also be very wary of the continuing escalation of cost when a contractor loses an adjudication and wishes to take the matter to a tribunal given the potentially high legal costs inevitably involved.

Conclusion and recommendations

Clause 11.2(26) puts the onus on NEC4 ECC project managers to prove that adjudication and tribunal costs for disputes between contractors and their subcontractors and suppliers could have been avoided if they had been notified about the situation.

For contractors and subcontractors alike, it will be important to ensure compliant notifications are provided to avoid another potential dispute between the parties, for which it can be said with clarity, the preparation of an adjudication will be a disallowed cost.

Although the intent of the additional disallowed cost clause in NEC4 ECC is clear, meaning users are in a better position, the practical application still presents challenges. The parties should be aware of this amended disallowed cost provision, how they intend to use it, and the behaviour it is trying to encourage.

Whether you are the client, project manager, contractor or subcontractor, a proactive and pragmatic attitude to managing and mitigating project disputes will help keep the costs for all to a minimum. 

References

Gerrard R (2017) NEC3 and NEC4 Compared. London: ICE Publishing.
Nazzini R and Kalisz A (2023). 2023 Construction Adjudication in the United Kingdom: Tracing trends and guiding reform. London: Centre of Construction Law & Dispute Resolution, King’s College London.
Rowlinson M (2019) A Practical Guide to the NEC4 Engineering and Construction Contract. Oxford: John Wiley & Sons Ltd.
Thomas D (2012) Keating on NEC3. London: Sweet & Maxwell.
Thomas D (2022) Keating on NEC (2nd ed.). London: Sweet & Maxwell.
Waterhouse P (2021) NEC4: Defined Cost and Compensation Events. London: Thomas Telford Ltd.