Understanding defined cost in NEC3 ECC and its simplification in NEC4 ECC

Key points

• Defined cost is used to assess compensation events in all NEC3 and NEC4 ECC main options and for routine payments in the cost-reimbursable options. Most defined costs are real but some are based on tendered rates and percentages
• Defined cost is as stated for options A and B in the short(er) schedule of cost components (SSCC) while in options C, D and E it is as stated in the schedule of cost components (SCC).
• In NEC3 ECC, the SSCC can, by agreement, also be used to assess compensation events in options C, D and E.
• NEC4 ECC schedules differ from NEC3 ECC in having an additional heading for subcontractors.
• Overall NEC4 ECC is simpler with regard to defined cost than NEC3 ECC.

For all payment options in the NEC3 and NEC4 versions of the Engineering and Construction Contract (ECC), ‘Defined Cost’ is the default for assessing compensation events. For costreimbursable options C, D, E and F, it is also used for routine payment. Note it is not ‘actual cost’: it has capital letters in the contracts so is a defined term (see clause 52.1).

In NEC4 ECC priced options A and B, defined cost is as stated in the short schedule of cost components (SSCC), and in cost-reimbursable options C, D and E, it is as listed in the schedule of cost components (SCC). This is simplified compared with the NEC3 ECC, in which there is the shorter schedule of cost components (also abbreviated here to SSCC) in options A and B and the SCC in options C, D and E. But options C, D and E can also use the SSCC instead of SCC for assessing compensation events, and only by agreement.

Defined cost versus fee

Figure 1 represents everything a contractor needs to get paid under an NEC4 ECC. Clause 52.1 − a core clause and so in all the options – draws the line between defined cost and fee. Simply, if it is not in defined cost, the contractor will be deemed to have included for it in its tendered fee percentage. The fee is the fee percentage times defined cost.

There are some rates in defined cost (see below) but all other elements of cost are, ‘at open market or competitively tendered prices’ (see clause 52.1). In options C, D and E, those elements of cost are, ‘open book,’ and records can be inspected at any time (clause 52.4). Another simplification in NEC4 ECC is that there is just the one fee percentage rather than the direct fee percentage and subcontract fee percentage in NEC3 ECC. With regard to subcontractors, in ECC options C, D and E the amounts due to a subcontractor have always been defined cost. In NEC4 ECC that is also the case in options A and B as subcontractors is now a cost heading (4) in the SCC and SSCC. This is a significant simplification.

Real costs and rates

The slices in Figure 1 represent all eight cost headings in the NEC4 SCC and SSCC: 1 people, 2 equipment, 3 plant and materials, 4 subcontractors, 5 charges, 6 manufacture and fabrication, 7 design and 8 insurance. In the slices green represents ‘real money’, being whatever the contractor pays. In the case of options C, D and E with the SCC, that includes in people (1) something very close to the real cost to employ the people working in the working areas: real salary, wages and what the accountants call the cost to employ. Plant and materials (3), subcontractors (4) and charges (5) are all also real money.

The orange bits in Figure 1 are where a heading in the SCC points to a, ‘rate stated in the Contract Data’. That tendered rate then is part of defined cost: it does not matter what the contractor really pays, it recovers the rate as part of defined cost. Examples are rates for people doing fabrication and manufacture (6) and design (7) outside the working areas. Normally the client will set out in the contract data part two the categories of people for which it wants bidders to provide a rate. Note that NEC4 ECC has done away with the unnecessary overhead percentages on top of those rates for manufacture and fabrication and for design − another simplification.

For equipment (2) in options C, D and E in the SCC, most is real money: that is the cost of hiring the equipment or, if owned by the contractor or a company in the same group as the contractor, what it would cost to hire. But there is the opportunity to get rates for special equipment listed in the contract data. Clients use this for items for which it might be difficult to establish a market rate, such as a piling barge. That is the little bit of orange in slice 2. A difference in options A and B with the SSCC is that the contract data points to a standard published list of prices of equipment. The bidder tenders a percentage mark up (or down) to be applied to those standard rates. This is shown as the red area in slice 2. Also note that in NEC3 ECC Options A and B, for people in a compensation event assessment one has to pull out the real cost of employing the contractor’s people and the subcontractor’s people. Thankfully in NEC4 with the SSCC, for the contractor’s own people it recovers tendered people rates, again indicated by the red colour of slice 1.

Charges

The other difference in NEC4 ECC is what is not there. In NEC3 ECC under charges (SCC heading 4) there is item 44 for, ‘A charge for overhead costs incurred within the Working Areas calculated by applying the percentage for Working Area overheads stated in the Contract Data to the total of people items… The charge includes provision and use of equipment, supplies and services, but excludes accommodation for…,’ followed by a list of site overheads such as sanitation and computing. In the NEC3 ECC SSCC there is similar item for people overheads that includes more items than the working areas overhead in the SCC. So, in NEC3 ECC the bidder has to quote a percentage of its people costs to cover all the stated equipment, supplies and services.

This means that, especially in options C, D and E, a contractor has to keep the real cost of these things out of its stream of other directly reimbursable elements of defined cost. If it does not, it falls to the project manager to make sure the contractor is not effectively being paid twice. On the other hand, when assessing compensation events, these NEC3 ECC percentages are a useful quick fix for the equipment, supplies and services.

Consider site toilets for example: the cost of the cabins in NEC3 ECC and NEC4 ECC is simply paid as the real cost of hiring them. In NEC3 ECC the toilet paper is covered by the tendered percentage. But in NEC4 ECC, the project manager will see and certify the cost of every toilet roll. When it comes to the forecast cost of toilet paper and the other equipment, supplies and services in a compensation event assessment, including some prolongation, the quantity surveyors will need to see sense and do some approximations.

Disallowed cost and fee

In options C, D, E and F there is another defined term, ‘Disallowed Cost’, which is indicated by the blue band in Figure 1. This gives headings of cost that are deducted from the total of defined cost.

Finally, the contractor’s tendered fee percentage has to include for anything missing in the SCC or SSCC, such as: insurance premiums; people whose normal place of work is not within the working areas unless they happen to be working in the working areas (other than those doing manufacture and fabrication or design outside the working areas); disallowed cost (in options C, D and E); and profit.

Summary

Overall NEC4 ECC is much simpler with regard to defined cost thanks to: the single fee percentage; having just the one schedule in Options C, D and E; paying the contractor the amounts due to subcontractors in options A and B; the people rates in options A and B; and deleting the unnecessary overhead percentages on top of the rates for manufacture and fabrication and for design.