Jacob Austin 00:00:00 I'll Jacob Austin here from Q.Zone. And welcome to episode 123 of the Subcontractors Blueprint, the show where subcontractors will learn how to ensure profitability, improve cash flow and grow their business. And today we are continuing our mini series on the engineering and construction subcontract from the good old neck and up. This week is the compensation event clauses. So we're going to cover early warnings versus compensation events. What the difference is and how they interact with each other, the general principles behind compensation events, what constitutes one and when and how you notify it. That and some of the technicalities that you ought to know about as a subcontractor using NEC contracts, along with some warnings about contractors assessments and what you can do to avoid the impact of those. So nice to have you with us. And as ever, if it's your first time here, remember to subscribe for more user friendly advice on all things subcontracting. So welcome, welcome and let's get stuck in. Let's start with the crossover with early warnings and compensation events.
Jacob Austin 00:01:29 The principle behind these is that it's a proactive risk management tool to flag up issues that could impact time, cost and quality. And importantly, early warnings differ from our change clauses, which are the compensation events because an early warning doesn't automatically lead to more money or time. It's about fostering collaboration. It's about getting together to discuss problems and if changes come about because of those problems, then you've discussed them in advance and you've agreed the best way to deal with them. And that is where the two things are linked. Because the idea being, you foresee things in enough time to be able to discuss them in advance. Warn the contractor, hey, there's a change on the horizon. I can see it. And before you get to that change, you've decided. Hold on. Let's navigate around this by changing the way we do X, or let's not wait until the horizon comes to us. Let's get on with the change. Now, whatever the decision, the point of early warnings is to prompt conversation.
Jacob Austin 00:02:38 It's to prompt collaboration with a view to getting to the best outcome for the project and the word of warning when it comes to compensation events and their interaction with early warnings, is that if the contractor realizes that you could have given an early warning and you just didn't for whatever reason, you flagged a compensation event and you started charging them extra money. If the contractor realizes that you had the opportunity to issue that early warning. Then they've got a really important and powerful tool because they can award the compensation event and notify you of that failure to give an early warning. And what that means is, when it comes to assessing the compensation event, is that they would assess it as if the early warning was given. So let's just put that in context. Let's say you're a cladding contractor and you're doing a facade replacement. It's a fairly light touch in terms of the work you're doing. You're stripping off the existing cladding and its carrier frame, but then the intention is to leave in situ the breather membrane insulation and the cement particle board that sits behind that.
Jacob Austin 00:03:48 But when you rock up on site, you've taken off the cladding off the first elevation and you found that the breather membrane is no good. It's not quite littered with holes, but there's a couple of big areas where it's properly damaged, and the best thing to do is just to pull it down and replace it altogether. So you submit a compensation event. The condition of what you've seen on site doesn't match what you're anticipated, or you were told to expect in the contract scope, and you've been proactive. You've cracked on with replacing the membrane and you've notified a compensation event. But here's the issue because you could have actually notified an early warning carried on stripping the cladding off of different elevations, carried on inspecting the membrane and said, hey up, Mr. contractor, how do you want to deal with these holes? And the contractor could have said, right, why don't we just over clad this membrane with new membrane in these sections? Or why don't we cut this section out, join in some new membrane with a bit of a lap and keep the costs down, because the client is very budget sensitive and they want to save money wherever they can.
Jacob Austin 00:05:01 So when they issue the confirmation on the compensation event, they write in there that you fail to give an early warning and therefore you haven't discussed and minimized the cost impact. So you submit your quote and the contractor assesses it and comes back and says, actually, looking at the evidence, there is a clear five square meter area here and a two square meter area over there that you definitely needed to replace. So I'm going to pay you for that, but I'm not going to pay you for the other 280m² that you've done off of your own bat. And because of that intersection between early warnings and compensation events, they're more than entitled to do so. So if there are elements of a compensation event that are avoidable, and you could have notified it as an early warning, these are the areas that you're in danger of having or written back or knocked out of an assessment by the contractor if you haven't given an early warning. So this is a very clear stick for the contractor to use against you, to force you to do early warnings at the right time.
Jacob Austin 00:06:08 So the message from this is raise early warnings to protect your position, but remember that you do need to follow through with compensation events. When events turn from just a risk into an actual thing that has transpired and it's happened. And the principle between the two is that early warnings are future events. They're unknown. They may happen or they might not. Compensation events are guaranteed to happen. And in our little situation, they're what our friend, the cladding contractor has decided to do is replace all of the membrane without having the conversation, without giving the contractor the choice of saying, actually just replace the bits that are affected. Now in practice, you might think some of that was unfair because he's actually got a situation that has happened. There is damage to the membrane is going to have to replace some of it. But what the issue is, is, is cracked on without instruction to replace all of it, without giving anybody any choice. And it's a prime candidate for using that early warning process to force the discussion and decide what the best way forwards is.
Jacob Austin 00:07:15 So what ideally would have happened is you said we've encountered some damage, how do you want to deal with it? Then the contractor would have instructed. Deal with this over here. Deal with that area over there. Leave the rest as it is. Job done. You both protect yourself and you walk away from it. Happy. Following that through the contractor would have given then a contractor's instruction. This would have then been a change to the scope of the contract. That change is the first compensation event on the list and acting in line with that instruction, you had been entitled to adjust your prices and adjust whatever completion date is affected by that membrane work. A contractor's instruction that changes the scope is a clear change, and it's the most common CE. You've also got a list of other events which generally fall under the theme of somebody failing to do something or something happening that's outside of your control. So we've got failure by the client or others to act as agreed. That might mean not giving access on time, not providing something that they're down to in the scope, or not communicating or giving instructions when they should have done.
Jacob Austin 00:08:26 You've got differences in physical conditions. This is an interesting one because it applies a foreseeable or reasonableness test, and it says conditions which an experienced contractor would not have anticipated at tender stage. This could potentially cover our cladding issue, but there is a bit of subjectivity about what is foreseeable. And when you are doing a facade replacement, you probably would anticipate that some elements of whatever substrate you're going to find are damaged or no good. So this actually prompts a word of warning that you might be deemed to have included certain things like that. So you need to get things like that bottomed out and agreed in the scope upfront. We also have extreme weather now with weather. The NEC uses a different approach to JCT, requiring a quantified exercise to be taken out to determine what the 1 in 10 year statistical averages for the defined metrics set out in the contract, which are rainfall, temperature, and the number of days with snow lying on the ground at 9:00. Additional measures can be added to that. It's unusual, but it can be done.
Jacob Austin 00:09:40 Those events are usually measured at a local weather station and the effects of the 1 in 10 year statistical frequency causes each person down the line to hold nine out of ten years worth of risk. That risk covers for what's deemed ordinary bad weather. You, as the subcontractor, hold your chunk. The contractor holds their own and it leaves the client holding the 1 in 10 or worse risk. That means your program and your price needs to allow for that risk. It also means when it comes to pricing a change, because you hold 9 in 10 years worth of weather risk, you need to allow for that risk. There's also client breaches, which is a bit of a catch all compensation event for if the client causes any breach in the contract, and then a long list of other events. The SEC stopped short of calling it force majeure. But that's pretty much what it's covering. Things like war, terrorism, natural disasters and so on that it's nobody's real fault if they happen now. Crucially, to be entitled to additional time and cost, the event has got to be one of the listed events in the contract.
Jacob Austin 00:10:54 There is no general catch all to pick up anything you thought was unfair, or extra time for delays outside of those events. So if you suffer a delay and it's not covered by clause 60.1, then it's at your own risk. The NEC is all about to see when we talk about notification also doesn't allow global claims, so you can't get together all of the delays that have happened across your project and ask for a big extension of time at the end. Time has got to be assessed along the way individually, relating to each event as and when it happens. Notification is the first critical step in the compensation event process and the contract is really strict about that. Either party can notify a compensation event, but typically the contractor notifies you if it's something that either the contractor or the client is responsible for, and the subcontractor notifies an event which is either happened or is expected to happen if it hasn't already been notified by the contractor. When the contractor notifies an event, the intention is for that also to act as the notice to submit a quotation.
Jacob Austin 00:12:10 But sometimes that piece of admin gets missed, and if it does, there is no time bar for raising a compensation event of your own. That failure is the only time it happens. For all other compensation events, the neck has a strict time bar, and if you don't meet that time bar, you lose the right to claim any time or money for the compensation event. This is a really harsh but clear rule, and it's a condition precedent to any claims. That means you have to pay the utmost attention. And if something happens, notify it quickly. Waiting beyond your submission period is likely to be fatal to getting your hands on time and money. And when you submit that notice, it needs to give enough evidence and enough of a description so that the contractor can tell whether it is a genuine compensation event or not. Assuming they agree, then they move forward by requesting a quote from you. There's also what I think of as a petition clause. If the contractor has forgotten to respond and their period for reply has timed out, then you can poke them.
Jacob Austin 00:13:23 You can petition them to respond. And then if the contractor still doesn't respond within two weeks of that reminder, then the compensation event is deemed to be accepted and a quotation Instructed. This is one of the only times where silence can actually mean acceptance in a contract. The only way that can be overturned is by an adjudicator. So by going through that deemed acceptance process, you're confirming the validity of a compensation event. Once that event is notified and confirmed, attention then has to go to quantifying the impact of it. The contractor is either going to request a quote if they haven't already done so, when they notified the event, or they're replying to it to say, okay, I can see a point, give us your price. And under clause 62 you'll find your default period. These default periods are often tinkered with to make sure that the contractor has got time to submit quotes upstream themselves. So this is one that you're going to want to check and understand yourself to be certain of it. This is the all in one, one stop shop compensation assessment.
Jacob Austin 00:14:36 Key points to always bear in mind. Compensation of events are assessed on the basis of defined cost, which is essentially the reasonable cost that you incur yourself, plus an applicable fee in a lump sum contract that results in a price adjustment. In target cost contracts, it adjusts your target, meaning it affects the amount of pain and gain. Share that you get quote and not a blank check. They need to be built up from actual costs for work already done, and forecast costs for work yet to do. Essentially, the aim is to compensate you as the subcontractor, as if the event hadn't happened. So covering extra time or costs or even reducing the price or the change. If an emission happens, profit is handled via the fee and there are no other markups other than what the contract fee covers. When I mentioned actual and forecast costs. These are split around the dividing date. This is a concept that only rarely applies to events that get caught partway through. So if you notified a compensation event but you've been cracking on with the work, then the dividing date is the date that you notify it.
Jacob Austin 00:15:52 You've got the benefit of actual cost data for some of that work because you've started it already. So you use that as the basis for the claim up to the dividing date and anything beyond that dividing date. You charge as a forecast. This avoids a bit of an argument about whether you should be using actual cost or forecasts. The contract gives you a clear decision. Submit actual cost for what you know and forecast what you don't know straight forward. We then have evaluating time impact. We spoke about this a lot under the program. Essentially, the crux of it is to work out how much later the completion date is going to be. Because of this compensation event, only the change due to the compensation event shall be counted. So you're not supposed to cover off unrelated delays within this assessment. The yardstick for it is the accepted program, and keeping that program up to date is important because if it becomes outdated, the contractor gets entitlement to assess your delay based on what should have been the latest program. And they're more than likely to assess the effects in their favor.
Jacob Austin 00:17:07 The next thought on quotation is that you should always, always include risk allowances. Now you carry quite a bit of risk under the subcontract. All of the things that you're not allowed to charge a compensation event for. You hold the risk for. So that means things, for example, like 9 in 10 years worth of weather compared to the average ground conditions that are arguably foreseeable, risk related to method, and so on. All of those things because you hold the risk for them and that risk increases due to the compensation event. You need to charge extra money for holding and managing that risk. This is an important one to consider because if you under allow and the risk turns out to come true, you can't come back for more money for it later. Once the see is implemented, it's final. The only way this is slightly different is if the contractor states assumptions in their instruction to quote, because something's too uncertain. Now let's say going back to our cladding example this time you've given the early warning, you've discussed an outcome, and the contractor is then said price for two more areas on the next elevation total of five square meters each.
Jacob Austin 00:18:27 Assume all of the membrane is intact on the other elevation. By them confirming those assumptions, they take the risk for those quantities. Otherwise, it would be down to you to assess what a reasonable allowance would be, and you'll probably on the side of caution. Obviously, you don't want to get caught with your pants down, but actually the contractor taking these kind of risks can help themselves achieve a more cost effective and realistic outcome, because it reduces some of the risk allowances that you build in. They take the risk on certain things, and they only pay you more money if that risk occurs and it triggers a new compensation event for the difference. Now a note on presentation a well prepared quote is critical. It needs to be clear with breakdowns of your labor, plant materials, and descriptions of how it's been calculated, particularly for time related costs. Your contractor is going to review the quote in line with the contract rules, and poor and vague quotes often get rejected or sent back for revision. Or even worse, the contractor assesses them themselves and decides how much you're going to charge them.
Jacob Austin 00:19:45 The point is to create early and binding agreements as you go throughout the contract, to avoid the need for lengthy disputes and final account meetings, and so on. So to support the process, give the contractor as much information as they need to be able to agree with the answer that you want. If you're using bespoke rates that you've made up for this particular change, then be expecting to provide a build up, have a materials quote and a labor assessment that shows how you got to the answer. After you've submitted the quote, the contractor has a fixed period to respond to it. That period is set out in your subcontract and you'll need to check it for yourself. There are three options for the contractor at this point, because they've already assessed whether the compensation event is valid or not. All they're now doing is either accepting the quote, in which case the C is implemented straight away, rejecting the quote, giving reasons, or instructing a revised quote which is effectively a specific rejection where the contractor wants more information or a different price.
Jacob Austin 00:20:59 This triggers a re quote within the same timescales as the original, similar to the notification stage. If you don't receive a response from your contractor within the right period, you can notify them and they get a further two weeks to respond if they fail still within that two week period. Then the compensation event is implemented and your assessment is used to do it, so that becomes deemed acceptance of your quotation. Don't hesitate to use that. If the contractor is late, they will do it to you if the shoe is on the other foot. Have no doubt about it. An interesting thought is if there is more than one option associated with the CE, then when you submit that deemed acceptance, you get to choose which quote is implemented. So obviously you're going to pick the one that makes the best sense to you. Be aware again though, once a quote is accepted and implemented, the only way for it to be challenged is via adjudication. Now we've mentioned here and there the contractor's assessment. This happens if you fail to submit your quotation within the allowed time.
Jacob Austin 00:22:12 If your program isn't accepted at the time of submitting, or if the contractor doesn't like your quote, that usually means that you haven't provided enough information to support what you've said, so the contractor can assess your price and tell you how much that change is worth. They don't have to go with your quoted figure, but contractor's assessments are mandatory if you fail to submit or your program is out of date. This is another example of the contract giving either a little slap on the wrist or using a stick to incentivize proper use of the contract. When the contractor makes assessments of your quotations, they should be using the same methodology. Same timescales, same dividing date inclusions for risk allowances, and so on. And it should be fair as per the contract is not meant to be punitive, but you will find that contractors price with their knowledge of the situation, rather than all the potential specialist knowledge that you have as a subcontractor. So it's in your interest to make sure that you're quoting on time your program is up to date and you're providing enough information to support your quotations.
Jacob Austin 00:23:25 Clause 64, which allows the contractor to do his own assessments, is really there as a safety net to be able to sort of help along compensation events that would otherwise stall because of somebody's inactivity. Once the contractor has decided he accepts a quotation, the compensation event is implemented. The effects on the completion date and the prices are locked down and the event is finalized as far as the contract is concerned. The only caveat to sort of reopen it, which it doesn't really open up that event. It opens up a new one. Link to it is the assumptions that we mentioned earlier. So if an assumption was given that said price on the basis of X weeks of delay price on the basis of this quantity, those kind of assumptions made by the contractor can be corrected if they're found to be wrong at a later time. Of course, that happens in an up and a downwards fashion, so if you have four weeks of delay never occurs, it can be revisited. But as I say, beyond the assumptions, there is no revisiting a closed compensation event.
Jacob Austin 00:24:32 That means that your final account just becomes your activity schedule plus any implemented compensation events. This should make final accounting a formality. It's a matter of signing a piece of paper to acknowledge the correct amount. Here's some thoughts on best practices and practical considerations. The whole of the NEC contract is best served by being proactive. You need to be alert because there are time bars. The contract is unforgiving if you miss them, so you need to make a habit of notifying things as soon as you suspect that they could be a CE. Of course, it's better to notify and have it turned down than miss out a legitimate entitlement. The whole point of a window to notify. Seize is to give you that bit of flexibility about deciding whether it's worth notifying it, but it's not a big window, so don't get in the habit of packing it for later. You also need to use early warnings. They're not a trap. It's not admitting liability for anything. It's not saying you don't know how to do something, it's just a chance to voice some concerns.
Jacob Austin 00:25:44 This might happen. I'm concerned about it. This might hurt the quality for the project. The best case scenario for early warnings is that a mitigation can be thought up. That doesn't cost anybody anything, and you solve a problem with barely a cost incurred. But if you fail to notify, there is the risk that compensation events can be downgraded, which might mean not even paid at all, because a theoretical lesser scope could have been got away with, if you like, if an early warning had been raised. Good practice. Looks like referencing the contract clauses that you're issuing these notices under. It does give the contractor something to think about because it shows that you know the contract. You can also reference the clauses for determining your quoted amount to demonstrate your using defined cost. It helps to defend and build confidence in your position. And of course, in the case of the initial notification, it does away with arguments of we don't think this is an event under that clause, particularly if you're including a narrative that demonstrates that it is.
Jacob Austin 00:26:50 There's always a point in the contract where records are important and with compensation, events demonstrating cause and effect and actual costs are prime examples of the need for those records, site diaries, delivery receipts, time spent invoices for materials, all of these kind of records, photographs of the work that was done They can all support your quotation, and it makes arguing your case for the amount of money you want that much easier. You absolutely must maintain your program if it's one of the requirements of your subcontract, that means regularly updating and submitting it for acceptance. And don't forget chasing up acceptance if the contract is slipping. Remember, a strong, accepted program helps your position when negotiating compensation events. It demonstrates how you've got to where you are, and it means you're in a better position to negotiate time associated with the change. It also does away with that contractor's ability to assess the program just because you haven't submitted a program. The contract is a process. Don't skip the paperwork involved. Often there can be side deals done, verbal agreements, and little of the formal notifications followed through with under NEC.
Jacob Austin 00:28:12 That's risky. As I said, it's a process driven contract. Use that process to your advantage where you can submit your notifications. Chase responses to notifications. The sequence should be fairly simple. It's notify quote, assess. Implement. If things slip, then use your deemed acceptance provisions. That means you submit a reminder. You put the contractor on notice that they're missing their dates. If they carry on missing them, then you can push the button on deemed acceptance. Often, just reminding your contractor that things are running late will spur them into action. And if not, then you get the benefit of your position being confirmed by default. Remember that spirit of mutual trust and cooperation collaboration is key to a successful neck project, and where you've got time working up a quote in an open book fashion and justifying your allowances with the contractor around the table. That is the best way to build that trust, to help the contractor understand why it's costing what it is, to generate an accurate forecast and agree on the impact.
Jacob Austin 00:29:23 It's collaboration. It's not being a pushover. Critical analysis and discussion is healthy, but be prepared with the backup to what you're quoting. The more effort you put in, the more you get out. If you can demonstrate you've used logic, you're thinking reasonably. You're even willing to compromise on certain areas. That's how you move forward at pace and create yourself. Payment certainty. The straight talking truth is that compensation events can become contentious. If people can't get around the table and talk sense and come to sensible agreements. It shouldn't be a one sided show. The goal is to achieve fair compensation as if an event never happened. So you walk away with the same money you always should have and always remember there is no second chance. This isn't a sort things out at the end kind of contract. There's no global claim. There's no late extension of time once you realize you're going to miss the completion date. So you need to ask for time as you go and make sure you push the agreement of that time alongside the cost agreement.
Jacob Austin 00:30:31 Your best bet is if everybody working on your project team understands how compensation, events and early warnings work. Many, many issues with compensation events arise from pure ignorance of the contract and not knowing what to do. Treating it as if it's the same old JCT process of quota variation. Ask for time when I think I want some time ignoring the timescales. If you do that, you will get in trouble. Whereas on the flip side, if you know your approach, you're talking to your contractor, you are sending them formal notices in a collaborative fashion so that they know they're coming. You're in dialogue with them about the build up to big quotations, so that they understand why you're asking for X amount of additional time, and how the cost is coming to this amount of money. Communication is key. That communication starts with the early warning that we mentioned earlier. That's your first chance to give the contractor and potentially their client the heads up. All parties to the contract can benefit from that collaborative discussion. The approach that says what's the best way through this for the benefit of the contract.
Jacob Austin 00:31:42 It's that collaboration, that discipline that wins you the contract. Not only that, but it builds rapport with your contractor. It makes you easy to work with. It keeps the project on track. All these good things that, if you build a reputation for, are going to lead you to repeat orders. Being the first on the inquiry list and making each NEC contract a success and it's as simple as that. Know the rules, stick to the process and communicate. I hope today's episode has been helpful for you. My mission with the show is to help the million SM contractors working out there in our industry. If you take into value away from today's episode, then I really need your help to share the show and pass that value on to somebody else who'd benefit from hearing it. And of course, subscribe yourself if you haven't already. And thanks for tuning in. If you like what you've heard and you want to learn more, then please do find us at www.QS.Zone for more information, you can also find us on all your favourite socials again at @QS.Zone.
Jacob Austin 00:32:47 And thanks all! I've been Jacob Austin and you've been awesome!
