Where a compensation event has occurred and additional costs have been incurred, can a contractor claiming compensation rely on forecast costs to assess the effect of the compensation event?

Common sense dictates no.

The issue recently came before the Northern Irish High Court in the case of Northern Ireland Housing Executive v. Healthy Buildings (Ireland) Limited [2017] NIQB 43. This dispute arose from two NEC3 Professional Services Contracts where the consultant’s job was to carry out asbestos surveys on two properties owned by the Northern Ireland Housing Executive. The terms and conditions of the contracts were similar and the court treated the two contracts as one.

The employer, contrary to the contract, failed to notify a compensation event on 10 January 2013, upon issuing the instruction. As a result, on 21 May 2013, the consultant notified the compensation event, four months after the instruction was issued and work arising from the compensation event completed. On 19 August and 22 October 2013, the consultant submitted its quotations. On 14 November and 21 November 2013, the consultant’s quotations were rejected and the compensation events were assessed by the employer as having no impact on the consultant’s costs. The consultant subsequently referred this assessment to adjudication, got a decision in its favour, was paid and the employer unhappy with the adjudication then referred it to the court.1

This judgment arises from an interlocutory application launched by the employer to compel discovery of the consultant’s actual records and costs for its claims. In order to address the issue, the court had to answer two questions: firstly, did the NEC contract allow for the court to look at the actual time charges; and secondly, on a proper interpretation of the contract, does the NEC contract allow for an assessment of the events by utilising forecast costs and actual costs incurred by the consultant..2

Central to the consultant’s case was clause 63.1 of the NEC3 contract which provides that “the changes to the prices are assessed in terms of the effect of the compensation event upon (1) the actual Time Charge for the work already done and (2) the forecast Time Charge for the work not yet done. The date when the employer instructed or should have instructed the consultant to submit quotations [in this case, the date of the instruction] divides the work already done from the work not yet done.” The consultant argued that it was not obliged to submit its actual costs as only its forecast costs were relevant to the assessment, since the amount claimed by the consultant related to work executed after 10 January 2013. The consultant further relied on clause 65.2 which provides that “the assessment of a compensation event is not revised if a forecast upon which it is based is shown by later recorded information to have been wrong”. The court noted, however, that this clause relates to the implementation (and not the assessment) of compensation events and, as such, did not apply in the case before it.

Given that the compensation event had occurred and actual costs had been incurred, the court favoured a retrospective approach to assessing the claims. The court emphasised that “evidence, such as time sheets and other material, illustrating what the consultant actually did during the compensation event, particularly with change in instructions, is not only relevant evidence but clearly the best evidence to assist the court in calculating the ‘compensation’ to which the consultant is entitled.”

The court referred to UK case law which emphasised that a court must at all times avail itself to all information accessible at the time of making its award. The court should not guess the calculation of the potential claim nor should it “shut its eyes and grope in the dark”, in circumstances where actual costs were incurred and are known.

The judge further noted that an effective and business-like interpretation of the contract meant using the best information available to determine the consultant’s actual costs and time incurred (as opposed to forecast costs) as a result of the instructed variation. This approach is in line with the direction laid down by the Supreme Court of Appeal in the South African case of Natal Joint Municipal Pension Fund v. Endumeni Municipality that documents must be interpreted in a manner “that does not lead to impractical, unbusinesslike or oppressive consequences or a manner that will stultify the broader operation of the legislation or contract under consideration. The process is objective, not subjective. A sensible meaning is to be preferred to one that leads to insensible or unbusinesslike results or undermines the apparent purpose of the document."

David Thomas QC notes in Keating on NEC3 (2012) that, on a complex project a backlog of compensation events is a reality. As a result of the complexity, compensation events are bundled and the assessment occurs after the compensation event has occurred. In such circumstances, compensation events are priced and assessed after the event has occurred. The assessment is based on actual costs incurred. He further submits that it would be “wrong to ignore any actual costs that have been incurred or avoided by the time of the quotation or later assessment by the Project Manager. This would not result in a reasonable assessment and would be inconsistent with general principles applied in assessing damages.”

There are circumstances where an event may have occurred but it may have a continuing effect. In such circumstances, the compensation event is assessed on forecast costs. This was not the case here. The court found in favour of the employer and compelled the consultant to produce records of its actual costs.

While the wording of the NEC3 envisages a prospective approach to assessing compensation events, the court’s finding is supported by the NEC3 Guidance Notes (2005) which advocate for actual costs to be used where a compensation event and its related costs has occurred. Accordingly, if some or all of the work arising from a compensation event has been complete, consultants and contractors are encouraged to submit their actual costs where both a compensation event and its effects have occurred. Where there is a dispute about the assessment of compensation events, the courts will look at all of the evidence before it, including contemporaneous records, in order to determine the claimant’s compensation.

It is noted that clause 60.1(20) of NEC4 introduces a new compensation event where the consultant is entitled to recover the cost of preparing a quotation. This ensures that the consultant is not left out of pocket if it is required to prepare quotations for numerous proposed instructions. This amendment has no impact on this judgment.

Some legal commentators have noted that this judgment may encourage employers to delay notification or assessment of compensation events in the hope of saving costs by relying on actual costs rather than forecast. In our view, this is misguided. It could never be the intention of a contract founded on “mutual trust and co-operation” and that prides itself on a common-sense approach to contracting for either the employer to behave as such or the contractor to be rewarded for costs it did not incur. Given the types of projects on which NEC contracts are used and the usually accompanying long-standing relationships between the parties, it would be short-sighted for either party to utilise this judgment for anything other than what it is – as welcome instruction in interpreting a difficult provision. It is noted that the defendant is considering an appeal. Confirmation is awaited on its correctness, but this decision reflects a common-sense approach to contract administration envisaged by the drafters of the NEC.