Under NEC, there are 7 different options for procuring work. This article will provide descriptions of how each option works and explore the pros and cons to establish which option works best for you. Briefly, the options are titled as follows:
1. Option A: Priced contract with activity schedule.
2. Option B: Priced contract with bill of quantities.
3. Option C: Target contract with activity schedule.
4. Option D: Target contract with bill of quantities.
5. Option E: Cost reimbursable contract.
6. Option F: Management contract.
7. Option G: Term contract (for the appointment of a consultant based on a priced schedule of tasks).
Activity Schedule – A list of activities (prepared by the contractor), which they expect to carry out while providing the works. Each activity is linked to a price (prepared by the contractor) to be paid by the client.
2. Priced contract – Price for works to be carried out as stated within the contract documents
3. Bill of Quantities (BoQ) – A document that lists specific measured items of work identified by the drawings and specifications. Each item will be allocated a price.
Option A: Priced contract with activity schedule
This option contains a priced lump sum contract. The lump sum contract is then linked to a contract programme with an activity schedule. Each activity on the schedule is then allocated a price.
Each interim payment is then made upon the completion of;
1. Each group of completed activities (without defect)
2. Each completed activity not within a group
Often used upon appointment of a contractor to carry out infrastructure, highways, buildings, and process plants. Can be used regardless of the level of design responsibility.
Simplified payment process – it’s easier to measure when an activity is completed rather than the output of work completed on an option with a BoQ.
For clients – Greater cost certainty then with a Target Cost option
For contractors – there is no provision for part payment, if there is an issue with completing an activity, no payment is made until the activity is completed.
Option B: Priced contract with bill of quantities
This option contains a priced contract which is linked to a Bill of Quantities (BoQ). The BoQ will contain project-specific measurements which are derived from the drawings and specifications. Each measurement will then be linked to a rate.
For example, let’s say a contractor won a bid for some work under NEC Option B. Within the tender would be a priced contract with a BoQ. Within the BoQ, there is an item for installing a new fence around the boundary of a garden.
The rate as seen above will contain the labour, plant, material and subcontractor cost required to supply and install the boundary fence. Interim payment will be assessed based on the quantity of work carried out for each individual item. For example, at the point of application for payment, the contractor may have supplied and installed 10 meters of fence. The contractor will then be paid for that 10 meters based on the £50 per square meter rate.
If there is any error of measurement in the BoQ, then both parties will know how much extra is to be paid and received.
Greater flexibility for all parties in terms of cash flow
For items which contain multiple elements of work built into a singular rate, it can be difficult to assess the % of work complete.
Option C: Target contract with an activity schedule
This option includes a target contract linked to an activity schedule. The target contract contains a price commonly referred to as a target cost.
Under Option C, the interim payment process is as follows;
- The contractor submits an application for payment to the client’s representative (often the Project Manager) on a monthly basis.
- The application will contain a breakdown of the contractors’ cumulative “defined cost” plus fee minus any “disallowed cost”. This combined is known as the “Price for Work Done to Date” (PWDD).
- The application is then reviewed by the client to ensure all cost is allowable under NEC
- The agreed cumulative cost is then deducted from the amount previously paid under the contract. This amount is then paid to the contractor.
As the works progress the target cost may be adjusted to reflect any agreed Compensation Event.
Once the works are completed, the final “Defined Cost” plus fee and the Target Cost are compared. The difference between the two is then shared between the contractor and client. This is known as the “pain/gain” mechanism and the method of how the split is calculated will vary from project to project. For example, let’s say there is an agreement that both pain and gain is split 50/50. The contractor finished work and the final PWDD is £800k. This, in comparison to the target cost of £1mil, means the project is £200k in gain. Due to the 50/50 “pain/gain” arrangement, the contractor will receive an extra £100k on top of their final PWDD. The final account will be issued to the contractor for £900k. Alternatively, assuming the same target cost in the previous example, the final PWDD could have been £1.2 million, resulting in a £200k pain. In this scenario and assuming the same 50/50 split arrangement is in place, the contractor’s final account will be their PWDD minus £100k (£1.1 mil).
This arrangement forces both parties to work more collaboratively as the financial success is shared by both client and contractor. Similarly, the financial failure of a project is shared. This collaborative working can reduce disputes and accelerate innovation.
Some share ranges can sometimes be disproportionately unfavorable to contractors. Care should be taken to ensure you are not being put at financial risk.
Option D: Target contract with Bill of Quantities
This contract contains a target cost contract which is linked to a Bill of Quantities.
Like Option C, financial loss and financial gain are shared by both Contractor and Client. However, unlike Option C, this Option utilizes a Bill of Quantities to make up the price of works.
This option is sometimes used on framework agreements, where an agreed Schedule of Rates is in place and used to build multiple Target Costs throughout the framework agreement.
It should be noted that unlike Option B, this is not a re-measure contract. So, any error in measurement which won’t amend the price and could cause a financial loss.
Option E: Cost reimbursable contract
This option is a cost-reimbursable option. Works are paid on an open book basis. Under this option, the contractor is paid all of their incurred “Defined Cost” and an agreed overhead and profit percentage. The client often takes on huge financial risk with this option.
Although this contract is often referred to as “Cost Plus,” contractors should not get complacent and think Option E means a blank chequebook for works. The terms within the contract should set out clearly what is and isn’t to be reimbursed to the contractor.
Works that require immediate attention and cannot be defined at the project outset may benefit from a fast contract agreement.
Less cost certainty for the client.
Inability for both parties to accurately plan cash flow.
Option F: Management contract.
This option is a cost reimbursable option. Unlike Option E, this option is tailored towards the management contractor procurement route.
The works are constructed by multiple subcontractors who are directly employed by a management contractor. The management contractor will be responsible for the procurement, coordination, and implementation of works in exchange for a fee. This means the client often takes on the financial risk.
Beneficial for developers who are just entering the market as responsibility for procuring and managing the works is with the management contractor.
Nearly all financial risk lies with the client.
Options G: Term Contract (use with PSC)
This option can either be Cost Reimbursable or pre-agreed Lump Sum. This Option is used with a Professional Services Contract for the appointment of consultants, paid on a time basis or pre-agreed cost.
Consultants employed under this option often include: Architects, QS’ and Engineers
Similar to an activity schedule, this option uses a priced task schedule which will list out the different rates for different consultants depending on skill and experience.
Provides flexibility to employ a single person consultant or consultancy firm.
Possible confusion of who holds liability for negative eventualities