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Although the NEC form of contract has been recognised as being strong on project and contract management, it has always been seen, at least by quantity surveyors, as being weak on cost matters. Option C, the target contract with activity schedule, is one of the most frequently used contracts, as it shares the financial risk between the contractor and employer and fits well with the 鈥渟pirit of mutual trust and co-operation鈥� that is built into the contract.

The old NEC2 target contract was woolly in how it dealt with cost and, despite some tweaking in NEC3, these weaknesses remained. There is a lack of clarity in the definition of which costs the contractor can recover. Before going into the details, it is worth looking at why target contracts suffer from this problem.

Under this form of contract, a target contract sum is agreed; this is the total that the employer is due to pay, as long as there are no employer changes to the scope of the work. In fact, what is paid to the contractor is the actual cost it incurs in constructing the project, together with a share of any savings made 鈥� frequently 50%.

On a project where the target cost is 拢1m, if the actual cost incurred by the contractor is 拢900,000, then the contractor is paid the 拢900,000 plus a 50% share of the 拢100,000 saving 鈥� a total of 拢950,000.

Although target contracts are assumed to incentivise the contractor to spend less, because this will maximise its share of any saving, this may not happen when the definition of what is recoverable is vague. Any lack of clarity will mean that rather than reducing costs, it will be better for the contractor to focus on recovering more costs from the employer. Reworking the previous example will illustrate this.

If you want your NEC project to run smoothly, amend the contract to tighten up what the contractor can recover

Once again the target cost is 拢1m but, this time, the contractor has persuaded the that 拢80,000 of additional costs are allowable under the contract, giving an overall cost incurred of 拢980,000. The 50% share of the saving comes to 拢10,000, so the total paid to the contractor is 拢990,000. The increase of 拢40,000 over the original example shows why it is better for the contractor to argue about entitlement rather than to do what the contract intends, which is to minimise cost. It also shows that in order to get the contract to operate as it should, it is important to define precisely what actual costs are allowable.

Some areas of imprecision in the NEC are:

• The contractor鈥檚 own recoverable costs are defined in the schedule of cost components (SCC). In addition to these costs, the contractor is paid a working areas percentage overhead charge. It is not clear whether the contractor is paid for some equipment under the SCC or whether it is deemed to be included in the contractor鈥檚 overhead charge.
• Some SCC definitions are ambiguous. An example is that the contractor is entitled to severance costs for people 鈥渞elated to work on this contract鈥�. This could be interpreted to mean the redundancy cost of a long-serving member of the contractor鈥檚 staff, even though they might have been working on the project for only a short period of time.
• Some parts of the contract only make sense when read with the guidance notes. A good example is the contractor鈥檚 entitlement under the SCC to payment for 鈥渕eeting the requirements of the law鈥�. It might be sensible to conclude that the contractor is entitled to payment for employer鈥檚 liability insurance, as this is a statutory requirement. The guidance notes in fact make it clear that this is deemed to be within the contractor鈥檚 fee.

So if you want your NEC project to run smoothly, you should amend the contract to tighten up what the contractor can recover. When you do this, bear in mind that the guidance notes do not form part of the contract and that in the event of a dispute a judge will seek to interpret the terms of the contract, not the guidance notes. If you want contractual certainty, build what you need into the contract.