On 23 November 2022, the Secretary for Development, Ms Bernadette Linn, answered a question in the Legislative Council regarding the New Engineering Contract (NEC). Her answers provide useful information about the use of NEC in public works projects so far, as follows:
- The Development Bureau (DEVB) introduced the NEC form in public works contracts with a view to advocating the spirit of collaborative partnering and bringing the project team together to tackle difficulties, which would be conducive to the smooth implementation of the project. The conventional form of the contract previously adopted in public works, focusing more on the obligations and responsibilities of the two contracting parties, often put them in adversarial positions. Once problems or foreseeable risks occurred during the construction period, both parties tended to focus on identifying the responsible party, and hence more disputes arose in the process. As a result, the problem was not dealt with promptly and it might take more time or even cost to complete the works, which was not conducive to the smooth implementation of the project. In contrast, the NEC embraces a collaborative culture and through contractual mechanisms fosters the building of a mutual assistance/trust partnering relationship between the contracting parties as well as joint risk management, thereby enhancing project management performance and cost-effectiveness.
- In 2009, the DEVB piloted the first public works contract in the NEC form. Since 2013, the application of the NEC has been extended in a progressive manner. In 2017, the DEVB issued guidelines requiring all large-scale public works contracts to adopt the NEC form. For public works contracts engaging Group C contractors (viz. contract value above $400 million), the NEC form shall be adopted unless there are justifications with prior endorsement.
- From 2009 to now, there have been over 400 public works contracts adopting the NEC form with a total value of over $250 billion, of which over 80 works contracts have been completed with the accounts finalised.
- Since the issue of the above guidelines, the ratio of the NEC contracts to all public works contracts has been increasing, from 22 % in 2017 to 47% in 2022. Over 90 % of the large-scale public works projects commenced this year have adopted the NEC form.
- The forecasted expenditure and actual expenditure of the completed NEC contracts and the forecasted expenditure for each ongoing NEC contract are given in the Annex. Since there are over 400 contracts involved in total, the Annex only provides the data on the capital works contracts in the past three years.
- Consolidating the DEVB’s experience in managing the NEC works contracts and the feedback collected from the sector and various stakeholder groups through questionnaire surveys, focus group interviews and workshops, the NEC form in general has an advantage over the conventional contract form, in the following three aspects:
- Enhancing risk management: With the introduction of an early warning mechanism in the NEC, both the client’s representative and the contractor are encouraged to identify and raise potential risks that may affect the project as early as possible, and when construction difficulties and problems are encountered, to negotiate and formulate the optimal solution for the smooth implementation of the project according to the prescribed procedure framework and timeframes in the contract. In addition, the risk management system of the NEC has helped shorten the actual construction period of some construction projects. For example, the Drainage Services Department has been carrying out the construction of sewerage works in various rural areas in the New Territories. After adopting the NEC form, the actual construction period has been shortened by about 6% on average as compared with the conventional contract form.
- Optimising claim management: The NEC has a mechanism to deal with compensation events, which serves to compensate the contractor resulting from unforeseeable or uncontrollable difficult situations, etc. that take place at the construction stage. Compared with the conventional contract form, the NEC expressly prescribes the timeframes for handling compensation events, thus making it possible for the majority of the compensation events to be properly dealt with in a timely manner during the course of the contract. This effectively reduces claim disputes and the need to refer such disputes to mediation, arbitration or even litigation, and in turn significantly shortens the time required for finalising the account. Based on statistical analysis, there is a time saving of over 30% on average to finalise the NEC contracts as compared with conventional contracts.
- Enhancing cost effectiveness: The “Target Contract” option of the NEC form provides a mechanism for the contracting parties to share the difference between the actual construction cost and the Target Cost, which offers incentives for the client’s representative and the contractor to work in collaboration and formulate the optimal construction method, rendering the smooth implementation of the project and avoiding budget overrun. The actual construction cost of a “Target Contract” is based on the actual expenses of the contractor which is to be calculated on a reimbursement basis. When the actual construction cost is lower than the Target Cost, both contracting parties will share the difference equally. On the contrary, the client has to bear half of the difference subject to a cap of 5% of the Target Cost. “Target Contract” is suitable for adoption in projects with higher complexity or risk level, or where the scope of works cannot be clearly defined.
- Enhancing risk management: With the introduction of an early warning mechanism in the NEC, both the client’s representative and the contractor are encouraged to identify and raise potential risks that may affect the project as early as possible, and when construction difficulties and problems are encountered, to negotiate and formulate the optimal solution for the smooth implementation of the project according to the prescribed procedure framework and timeframes in the contract. In addition, the risk management system of the NEC has helped shorten the actual construction period of some construction projects. For example, the Drainage Services Department has been carrying out the construction of sewerage works in various rural areas in the New Territories. After adopting the NEC form, the actual construction period has been shortened by about 6% on average as compared with the conventional contract form.
- To sum up, under the NEC’s collaborative partnering principle, the project team works together proactively to resolve construction problems and difficulties in a timely manner, thereby reducing the risk of time or cost overrun in works contracts.
- Upon review, the DEVB considers that the NEC form is suitable for application in the majority of public works contracts. The DEVB has issued guidelines requiring all large-scale public works contracts to adopt the NEC form, making it the dominant form of contract in large-scale public works. For small and medium-scale contracts, as the contractors are mainly small and medium-sized companies, the DEVB will consult them in due course for mapping out the timetable of full implementation of the NEC form, so as to allow sufficient time for them to get familiar with the contract form.
Since 2018, the Hong Kong Government has also started to use NEC4. Over recent years, NEC have also been progressively introduced in the non-public works sector such as CLP, MTR and the Airport Authority related projects. With the wider use of NEC and its perceived benefits, it remains to be seen how the use of NEC contracts may develop in private development projects.
For further information, please contact:
Joseph Chung, Partner, Deacons
joseph.chung@deacons.com
