A recent decision of the Court of Session provides new clarity on a number of important issues concerning the valuation of omitted works under the NEC form of contract. The NEC’s reliance on Defined Cost to value compensation events distinguishes it from other forms of contract and is aimed at ensuring that both parties are no better or worse off as a result of a compensation event. The application of that principle to an omissions case where work was said to have been under-priced resulted in a reduction in the price of work remaining to be performed.
Van Oord UK Limited v Dragados UK Limited
Dragados was the main contractor on the Aberdeen Harbour Expansion Project. Van Oord was subcontracted to carry out dredging works. The subcontract was an NEC3 Engineering and Construction Subcontract (April 2013 edition) with bespoke amendments, with main Option B (priced contract with bill of quantities).
The subcontract provided that a change to the Subcontract Works Information was a compensation event under clause 60.1(1) of the compensation event provisions. A compensation event is assessed as the effect on the Defined Costs of carrying out the works and the resulting Fee (discussed further below). Main Option B provides that if the effect of a change to the Works Information is to reduce the total Defined Cost, the Prices can be reduced. The change in Prices is reflected in the Bill of Quantities in the form of a changed rate, a changed quantity or a changed lump sum.
Van Oord commenced proceedings in the Scottish Court of Session claiming that Dragados had omitted works from its subcontract and transferred those works to others in breach of the subcontract. Dragados denied any breach of contract, but also argued that even if its instruction to omit works was in breach, it was nevertheless effective to reduce the scope of the work and the consequences of that reduction were to be valued under the compensation event provisions of the subcontract. In the circumstances of this case, Dragados argued that those provisions required the bill quantities to be reduced to reflect the work omitted and also a reduction to be made to the bill rates for the remaining items of work.
The court partially resolved the question of breach in favour of Van Oord, except for factual allegations that Van Oord agreed to and/or acquiesced in the omission of the works, which were held over for a separate hearing. The application of the compensation event provisions was therefore considered on the assumption that the instruction to omit works had been in breach of contract. This aspect of the court’s decision is discussed further below.
Had the works been validly omitted?
The court first considered whether an omission instruction issued in breach of contract was a valid instruction.
Van Oord argued that an omission instruction issued in breach was not a valid instruction and thus did not constitute a change to the Works Information under clause 60.1(1) or clause 63.10 of the subcontract. Accordingly, the Prices could not be reduced. However, the court held that, even if an instruction to omit works is issued in breach of contract, it is still a valid instruction. Lord Tyre found that:
“an instruction to omit works is an instruction that changes the Subcontract Works Information, even if the giving of that instruction is a breach of contract. That must be so because as a matter of practicality the omitted works no longer form part of the scope of the subcontract works: the reality is that the subcontractor is no longer able to proceed to carry them out.”
Valuation of the instruction to omit
Van Oord accepted that the omission instructions were compensation events, in the sense of being breaches of the subcontract, but not as valid changes to the Subcontract Works Information. Accordingly, Van Oord argued that it should be entitled to its Fee on the omitted work and to be paid for the remaining work at the original bill rate. It was common ground that Van Oord should not be paid for work it was not going to do. If the compensation event provisions were applied as Dragados contended, resulting in a reduction in the Prices, Van Oord claimed it would suffer a double loss. That loss would consist of a loss of profit on the omitted works and a reduction in the bill rate for the works remaining to be done after each omission.
The parties agreed that the intention of NEC3 is to assess the financial effects of a change to the Works Information, so that the subcontractor is left no better or worse off than it would have been had the change not occurred. Dragados submitted that, unlike the approach in traditional form contracts, the bill of quantities was not the basis of assessment of a compensation event under NEC3. The NEC3 approach is directed at assessing the effect of the change on the Defined Costs of doing the works, using actual past costs and forecast future costs falling within the Shorter Schedule of Cost Components. This is to avoid the kinds of arguments about pricing of variations which can arise under traditional form contracts.
The effect of the NEC3 approach is that losses which were always going to be incurred by the subcontractor remain with the subcontractor; the subcontractor remains in the same position he would have been in but for the omission. If the bill rates within a subcontractor’s tender has been priced too low relative to Defined Cost, for instance because its assessment of its anticipated productivity is wrong, its Defined Cost may exceed the bill rates. Consequently, as the contract requires the Prices to be adjusted in line with the change in Defined Costs, the necessary reduction in the Prices may be greater than would be achieved simply by omitting the bill value for the omitted work. It requires a further reduction to be made to the Prices, which in this case was achieved by adjusting the bill rates to reflect the revised quantities of works to be performed.
If the effect of the omission is to reduce the Defined Cost of carrying out the works, then the consequent reduction in the bill rate for the remaining work is simply reflecting the effects of the subcontractor’s pricing strategy and poor productivity, it is not causing a new loss to the subcontractor. If the subcontractor were to be paid the original bill rate for the remaining works, the result would be a windfall for the subcontractor and a penalty to the contractor, which was not the intention of NEC3.
The court found for Dragados; it was clear that the compensation event mechanism applied to breaches of contract – the listed compensation events under NEC3 were, in the main, breaches of contract, and the contract provided a compensation event for any other breach of contract at clause 60.1(18). It would therefore be surprising if different rules were to apply to valuation of breaches of contract and to valuation of other compensation events. It was also not self-evidently correct that a reduction in the bill rate for the remaining work meant that Van Oord had suffered a loss. The reduction may be doing no more than reflecting losses which would in any event be incurred by the subcontractor.
Conclusions and implications
This is the first time that the valuation of omissions under the NEC form has been considered by the courts, although this issue - in particular the treatment of the Fee in the valuation - has been the subject of discussion in the industry. The court’s findings will be of general application to other Option B NEC contracts, and carries potential implications for Options A, C, D and E as well.
The decision has been appealed to the Inner House of the Court of Session.
References: Van Oord UK Limited v Dragados UK Limited  CSOH 87.