Jacob Austin 00:00:00 Hi all. Jacob Austin here from QS.Zone. And welcome to episode 118 of the Subcontractors Blueprint, the show where subcontractors will learn how to ensure profitability, improve cash flow and grow their business. And today, we'll be embarking on the start of a mini series on the NEC four suite of contracts and zoning in on the engineering and construction subcontract. Whether you've never used NEC contracts or you're a seasoned veteran, we'll be breaking down what the X is all about, why it exists, and how you can make it work for your business. We'll cover its purpose, its structure. The main options A through E in NEC speak and what they mean, and the secondary X clauses, along with the risks that they manage and how each time you're awarded an NEC subcontract, you should be looking closely at these to determine exactly the deal that you're embarking on, because each of those options can vastly change how the contract operates, which is all really important for you to know before you sign on the dotted line. Now let's start with the most basic question what is the X and why does it matter to you? So let's set the scene.
Jacob Austin 00:01:31 You're a subcontractor and you're signing up to undertake a segment of works on behalf of a main contractor, who in turn holds the contract from the client. For the main contractor to be using an NSI subcontract, they will likely be on an NEC for engineering and construction contract themselves with the client, and the X is the subcontract equivalent. It's the off the shelf contract that the main contractor can put in place to appoint you with aligned terms to their main contract, according to the NEC themselves. The Ex is there to provide back to back protection for the main contractor and consistency of approach throughout the supply chain. And so when the main contractor is appointed under NEC four conditions, they will more than likely use this subcontract. So you need to know how it operates and what the various options that the main contractor can trigger within the subcontract are, and how they change your approach. One thing that's quite refreshing about the ex is that it is almost the same contract as the main contract. It's not watered down, it's not using different numbering.
Jacob Austin 00:02:42 And very importantly, from my point of view, is it uses the same straightforward language throughout. There's very little difference between the main contract and the subcontract at all, other than the names of the parties. And that is one of the things that makes it vital to use. it, uses the same NEC definitions. The roles of the various parties, including subcontractor and contractor, the procedures, the early warning, the compensation event, the program, the principles of these are all the same. That means as a subcontractor, you're operating in a framework that talks back to the main contract and feeds in to the main contractor's obligations to their client, so it reduces surprises and mismatches in timescales and obligations. It also starts off with a back to back situation when it comes to risk, the main contractor under the SEC takes certain risks and it will more than likely want to pass similar or back to back risks down to you as the subcontractor so that it isn't overexposed. For example, the client may trigger delayed images via option X7, so the main contractor will require you more than likely to take delay damages in the same fashion under the ex, and there may be similar options triggered for things like information modeling or third party rights.
Jacob Austin 00:04:06 The X supports this arrangement by providing identical or aligned clauses and options for the contractor to feed in. One of the most important things for the main contractor is that the early warning mechanisms and compensation event mechanisms all tie up together. This is the single bite at the cherry concept that wraps up time and cost under one umbrella, with timescales built in that allow the contractor to notify you of instructions that they receive from their client. Request your quote and feed it back into their own using notification, quotation, assessment and instruction processes that work within the main contractor's own obligations upstream. It also features the same terminology about entering into the arrangement with the same spirit of mutual trust and cooperation, with the idea being that not just the client and the contractor are there working on the same job together, but also the whole supply chain is brought in to this collaborative situation where you're trying to build something for the good of a community in collaboration and cooperation with each other. And that also means that the most collaborative tool within the main contract, the early warning process, is flowed down to you as a subcontractor as well.
Jacob Austin 00:05:30 So that means you're obligated to warn the main contractor about events that could affect time, cost or quality on your project. You warn the contractor, and the contractor can then decide whether that's something they can resolve between you and them, or whether they need to warn the client about the same issue. The subcontract scope in X also often refers to the main contracts works information, including things like the level of design and responsibility. The subcontract will likely also factor in the main contractor's own requirements for things like site rules, safety standards, but things like the BIM protocol, which is probably shared between them, the client and yourselves, and where things are referred like that to the main contractor's scope, it's important that you're able to inspect that and understand the obligations that are being passed on to you so that you know what you're taking on. So quite clearly, the main contract and the subcontract are designed to mesh into each other really well with back to back obligations and even things like the timescales for responding to quotations and so on have been devised so that as long as nobody's tampered with them, the client can instruct the contractor to do something, trigger a compensation event.
Jacob Austin 00:06:44 The contractor can cascade that instruction down to you. They've got long enough to ask you for a quote for a day or two to collate that and other quotes from other subcontractors and so on, and then feed it into their own quote upstream to the client. So it's really well thought through to work together. One thing that isn't always back to back, between the main contract and the subcontract is the main option. There are five main options of X, which are A through E. And as you go through the options from A to E, you start with a situation where the subcontractor holds the biggest amount of risk through to option E, where the subcontractor holds the least amount of risk, and the main options replicate themselves in exactly the same fashion in the main contract. But there there is also the main option, F, which is a kind of management contract. It's really crucial that you understand what the difference is because that letter makes a massive difference. As I said, it starts with you holding all the risk and it goes through to the contractor basically holding all the risk.
Jacob Austin 00:07:52 And what I mean by that is option A starts with a fully lump sum price. And it's termed priced subcontract with activity schedule. The principle behind it is that as long as nothing changes, you get the full subcontract sum at the end of the job, and the activity schedule is there to list out the various activities that form your subcontract works. And these are treated like milestones. So you need to think clearly about those activities when you're putting your quote and your contract together. Because following the rules of the subcontract, you'll only claim and you'll only get paid for activities that are fully completed. So to make your cash flow work, you're going to want as many little activities as you can fathom up so that you've got plenty of flexibility about what you get done each month to be able to value your work properly. What you don't want is big lump sums against a handful of items, because that means you're not entitled to payment until you finish those items. Now, the contractor might come up with some workaround for you on that, but it's always worth asking the question upfront.
Jacob Austin 00:09:03 The principle around the price subcontract is that you deliver the activities in the schedule for the fixed price you quote. The risk of cost and quantity lies with you. If you under price or unforeseen conditions arise, the extra cost for all of that falls to you unless there's a compensation event that covers it. But it also means if you're able to deliver for less money than you've quoted, then you reap all of the rewards as well. Next, we've got option B, which is a price subcontractor with a bill of quantities. Here you'll be pricing quantities that the contractor has set for you in this arrangement. The contractor takes the quantity risk. You take the price risk. So the risk of quantity change lies with the main contractor. But you, as the subcontractor, still need to price your work diligently. The contract also encourages you to get the big ticket items right, because errors in the bill aren't corrected unless they're worth more than half a percent of the subcontract that is there to stop you from chasing split hairs throughout the contract.
Jacob Austin 00:10:12 And just to focus on re measuring as you go against the rates that you quoted originally. And unlike the schedule of items approach under option A, under option B at the end of each month, your application includes the cumulative measure for all of the work you've done to date. Next, we have the target subcontract with activity schedule. So this is a risk sharing contract where a target cost is agreed upfront by the subcontractor and main contractor. And if you beat the target, both of you get a share of the savings. If you exceed the target, then you and the main contractor share the pain. It's good for situations where there's some design involved, or you've got a good idea of what it's going to cost, but you think you might be able to better it, or you might have some ideas on efficiency that might not pan out. Well, this option is there for those potential upsides to be shared with the main contractor and therefore also with the client if they're on a back to back arrangement. In my experience as a main contractor, these are time consuming subcontracts to operate, so you're not likely to see very many of them.
Jacob Austin 00:11:22 And it probably only will be where the main contract itself specifies that certain subcontracts have got to be let on a target cost subcontract. The principle is that as things change throughout the job, the target cost keeps getting amended so that it stays an accurate target given the changes from the original contract, and then wherever your costs come in, underneath or above, or even if you meet the target on the nose, which would be completely unheard of territory. Whatever the difference between the two, you're paid in accordance with a set of percentages that are set out in your subcontract, so it will specify if your underspend then savings are shared 50 over 50. If you overspend, then savings are shared. 6040. Obviously I'm just pulling figures out of nowhere, but your subcontract will have particular percentages for you to apply and ranges perhaps at which those percentages do apply. And quite often that will either limit the amount of saving that you can earn, but it will also often limit the amount of loss that you can make on the subcontract itself.
Jacob Austin 00:12:35 Option D is very much like option C, but the target cost is set by a bill of quantities, so you get the a hybrid of the option C and the option B contracts together. This time, rather than measuring your potential over or underspend against a fixed target that's only adjusted by compensation events, you're measuring it against a fluctuating target that's calculated by measuring the bill of quantities you set out with. This sounds like the biggest administration exercise going, so I'd be really surprised if you end up on one of these kind of subcontracts. So reach out to me if you do, and tell me what your experience of operating it was like. I'd be genuinely intrigued to see it in action. Finally, we have option E cost reimbursable subcontract, in which case you are paid your actual cost for completing the full scope of the works, plus a fee for doing it. And that fee can either be a lump sum, or it can be a percentage that's added to the base cost. In this option, the contractor bears a lot of the uncertainty, and it's only rarely used when the scope is really uncertain or the risk is really, really high.
Jacob Austin 00:13:50 You will probably only see this applied where the main contractor is also on an option, so that they're back to back up and downstream on the price fluctuating, which it might do wildly under this option. As a subcontractor, you might not pick the option that you're contracted under, but the main contractor might approach you and discuss how you feel about option A or option C, probably trying to sound out if they've got some KPI to hit of, they've got to sublet a proportion of their packages under an option. C say they might want your opinion as to whether you can administer it. It would certainly be sensible to discuss before you set off down a road that you both struggle to get to the end of, but you need to understand with this, the option isn't just a letter. It completely changes the feel and the nature of the subcontract. It changes how much you're going to be paid and the mechanism for getting there. You might think that the main contractor has to place the same subcontract as the main contract, and if you're thinking that, then it's just not true.
Jacob Austin 00:14:56 The idea of the ex is that it's got back to back obligations for things like changes for the early warning process, but it allows the contractor to manage the risk up and downstream by placing lump sums if they want to, or re measurement contracts if they want to go down to the subcontract supply chain and feed in the costs from those various subcontracts into their main contract, whatever that option might be. It's down to them to manage the risks involved with doing that, and it might not always be appropriate for them to place target cost subcontracts even though they're on a target cost arrangement themselves. But the main option clause only covers part of the picture. It's the biggest thing that changes how the subcontract operates. But then there's a list of secondary option clauses that can be added in to suit the scenario. And these are w, x, y, and z clauses. Now z clauses tend to be bespoke amendments to the subcontract. And this is where you're going to find the main contractor tinkering with the conditions. Now these will vary from place to place.
Jacob Austin 00:16:04 So you'll need to read these on a case by case basis. The others follow a fairly straightforward recipe. There are three W clauses w1 to three, and in the UK we typically only get W2. Now this is a clause that goes back to back with the Housing Grants Construction Regeneration Act to bolt in the adjudication provisions that the Construction Act demands that you have. There is also an option for senior representatives to try and negotiate disputes before they end up at adjudication. That, however, is optional. And if it's clear that senior reps aren't going to be able to reach an agreement, then adjudication can be triggered at any time. W1 you will probably not see in the UK, but this has got a more structured approach, giving timescales at which things have got to be notified to senior reps. Then there's an adjudication process that follows and a final tribunal that follows that. If adjudication fails, if you do end up with W1 because you're working abroad, read it really carefully because there are set timescales and set routes to follow, and you will need to know what they are to be able to follow them properly.
Jacob Austin 00:17:18 W3 is for a dispute avoidance board. This again is something that typically doesn't apply in the UK, but it can happen. But because of the Construction Act, adjudication has got to be an entitlement. So if it does apply, it applies with W2 at the same time. So W is about resolving disputes. You've also got the series of X clauses. Now these are about tailoring the risks for a particular contract, and offer a load of options to flexibly tailor the approach to suit the situation. And they start with X1, which is adjustment for inflation. It's rare, in my experience, that you see in X1 clause triggered in a sub contract, but it may well happen in a longer term agreement, and it allows for prices to be adjusted by an index to protect all the parties from cost escalation. You've got X2, which gives a compensation event. If there's a change in the law, you've got X3 for using multiple currencies and X4 for a parent or holding company guarantee you've got X5 for sectional completion.
Jacob Austin 00:18:27 And with this within the subcontract data, you should find some extra dates advising you of the completion dates for each of the sections you have X6 bonus for early completion. This is designed to incentivize you to finish early, and it might be a lump sum. It might be an amount per week. If you're confident you can deliver ahead of time, then you can get your hands on a reward for it. Moving on. We've got X7, which is liquidated damages for delay. Obviously the reverse of X6, the subcontractor may hold you responsible for certain delay damages and triggering this clause includes the mechanism for it. You've got X8, which is undertakings to the client or others, which generally is where you'll find the details of collateral warranties and third party rights, and so on. You also have X9 for transfer of rights. This is if the contractor or the client wants to assign the benefit of the contract or the obligations to another party. For example, if they sold the property onwards, they might want to assign the benefit of the latent defect period.
Jacob Austin 00:19:34 Then you have X10, which is information modeling. This is where you'll find the details about BIM. You have X11 which has additional termination rights for the contractor. X12 is not used, but X13 is for a performance bond. So if the main contractor requires you to deliver a performance bond to them, then they'll select this clause. Then we have X15 for subcontractors. Design. This clause addresses your liability and your design responsibilities. Under the package we have X16 for retention. It's an optional clause, but you'll expect to see it triggered nine times out of ten. I would have thought then we have x 18 for limitation of liability. This is an important one because it provides a cap on your liability for subcontract works, which is vital for you to control your risk. So you want to see this triggered with sensible amounts written into the contract data for it. Then we have key performance Indicators X20, and this will likely be used if the contractor has got KPIs of their own to achieve, and they're trying to cascade those down to you to ensure that they meet their obligations by getting your help with it.
Jacob Austin 00:20:48 There is also X20 nine, which is climate change. This is a relatively new addition, and it gives an opportunity to incorporate additional incentives and additional measures relating to the performance of the building, or perhaps the use of carbon during the construction stage. Eagle eyed listeners. Does that work? Eagle eyed listeners, those of you with keen hearing anyway, will have noticed that I skipped a few numbers there between those last two clauses, and that is purely because this numbering aligns with the main contract, and not all of the main contract clauses are transferable into the subcontract. Moving on though, to Y clauses, these are secondary options that are specific to particular countries legislations. So all of the why clauses that we see in the UK obviously involve UK legislation. So we have one UK one which is for project bank accounts, one UK two, which is to bring the contract's payment provisions in line with the Housing Grants and Regeneration Act, and finally UK three, which allows for third party rights to be enforced under the contract.
Jacob Austin 00:21:57 Now, I appreciate I've probably bombarded you a little bit with a list of letters and numbers, but it's important that you appreciate what those letters and numbers mean because when you read the subcontract data for an NEC contract, it will list out all of the option clauses that apply to that particular subcontract. And it makes a big difference as to how you need to price things. Let's say X1 is triggered. That means you don't have to price a fixed price period into your rates. Let's say section or completion x5 is triggered. That means you've got to sharpen your program and plan to deliver certain sections of the building at the right time. There's then the bolt in element for subcontractors design. It can either be triggered if the contractor wants you to design something, or it can be left out altogether. Hopefully, you can see how the contract can be adapted to suit the needs of the situation. And we're not having to refer to 5 or 6 different versions of a contract. We've got one overarching document and then a handful of clauses that either apply or don't, depending on which options have been triggered.
Jacob Austin 00:23:05 So right from the outset that for me makes the NEC contracts really user friendly. But at the same time, the fact that they're so customizable means that you have to pay attention to that detail to get your understanding of the requirements right. So next week, we're going to move on into discussing some of the provisions of the NEC subcontract and what they're obligating you to do. But to finish off for this week, I'm going to leave you with a little bit of a checklist so that when you pick up an NEC subcontract, you can decipher what you're looking at. So here are the pointers that you need to look out for. First off, which main option A to E is being proposed. And do you understand what pricing risks you're going to carry under that particular option? Next you want to see clear clarification about the assessment dates, the payment intervals and the interest that's due for late payment. That should all be clearly defined in your contract data. So you want to see it populated. Next what are the secondary option clauses.
Jacob Austin 00:24:08 So the x and the y clauses that have been selected. You've been asked to accept them. Do you understand how to operate them. I've just given you a run through of what they're about, but it's worth flicking through the actual document and seeing what it entails. Does the scope contain constraints that you need to price in, and does it include things like design obligations? In which case you'd also expect to see x15 for design triggered in the subcontract clauses. Has x 18 been triggered to cap your liability? And are you comfortable with the limited liability that's being proposed? Is there a delayed damages clause? X7. How much is being proposed per day or per week? Does it seem reasonable to you? Are there collateral warranties being asked for? This is either going to be by X8 or perhaps introduced by a Z clause. This can extend your liability under your subcontract and cost you money to keep re insuring. So make sure you know what you need to provide and that there's no malicious wording in it. If the contract's long, then you want to see X1 triggered so that you're not carrying all of the inflation risk.
Jacob Austin 00:25:19 It's either that or you need to build in some working contingency in to cover your risk on it. And you can point out to the main contractor that this might not be the best way forward. They're likely to get better value for money. For them, taking the risk of inflation over you. If you know there are BIM requirements, you want to see X15 and X10 triggered and you want to see sensible information in there that you can work with, and that give you a proviso to put your cost together for working with the model requirements. What about bonds or guarantees? Are there any obligations? What are the costs and the timelines for them. And of course everybody's favorite retention. Presumably it's selected. But how much when is it released. And is it the going rate and final thought? Bringing all of that together is the price that you've tendered more than enough to cover your obligations under all of these option clauses? If you haven't established that before you submitted your price, your next best chance is before you agree on a subcontract sum.
Jacob Austin 00:26:24 Now, I hope that's been helpful for you. That was quite a high level overview of the NEC subcontract, and we'll be delving into more detail on various aspects of it over the coming weeks, so I'll be sure to come back and listen to next week's episode to continue where we've left off. Remember, my mission with the podcast is to help the million SME contractors working out there in our industry, and I really need your help. If you take into value away from today's show, I'd love it if you'd share the show and pass that value on to somebody else who'd benefit from hearing it. And thanks for tuning in. If you like what you've heard and you want to learn more, then please do check us out at www.QS.Zone for more information or we're also on all your favourite socials at @QS.Zone. Thanks again! I'll be Jacob Austin and you've been awesome!
