UK Court holds no interim adjustment for pain/gain share in NEC target cost contracts

13 February 2020, Construction, Newsletter, by Joseph Chung,

One of the issues recently considered by England’s Technology and Construction Court in Doosan Enpure Ltd v Interserve Construction Ltd [2019] EWHC 2497 (TCC), was whether pain/gain share adjustments could be made under NEC3 form to interim applications due for payment before works are completed. The Court held that they could not.

Background

Doosan entered into a joint venture agreement (JVA) with Interserve for the purpose of carrying out upgrade works at Horsley Water Treatment Works for Northumbrian Water Ltd (NWL). They also entered into a NEC3 Option C (Target cost contract with activity schedule) form of contract with NWL (Contract).

Works commenced and monthly interim payments were made by NWL to the joint venture by payments into the Joint Venture Account. The practice was for Doosan and Interserve to submit a consolidated payment application to NWL, including a spreadsheet, setting out their respective costs. Payments were certified in a similar form by the project manager and the amount certified paid into the Joint Venture Account. Doosan and Interserve then produced an allocation spreadsheet setting out the sums which each party was entitled to from the Joint Venture Account, which they would then sign for payment to be released.

Interim payments were made monthly in the above way until a dispute arose. Interserve refused to sign the allocation spreadsheets in respect of one of the Payment Certificates, asserting that there was a risk that the amount certified on an interim basis by the project manager for work done by Doosan (Doosan’s Works Part Costs) could exceed its Adjusted Works Part Target Costs. This, Interserve said, would result in amounts certified exceeding the amount finally recoverable in relation to those costs, as a result of the pain/gain share provisions in the Contract, which provisions were reflected in the JVA. No further payments were made to either Doosan or Interserve from the JV Account, which led to Doosan commencing the proceedings and applying for summary judgment.

Did the Contract allow pain/gain share adjustments at an interim stage?

No. The Court held that Clause 53.3 of the Contract (unamended from the NEC3 standard form) was clear “The project manager makes a preliminary assessment of the Contractor’s share at Completion of the whole of the works using his forecasts of the final Price for Work Done to Date and the final total of the Prices. This share is included in the amount due following Completion of the whole of the works.”  The Court said that the intention of the Contract provisions was clear. During the course of the works, the Contractor is paid by reference to the Price for Work Done to Date, which reflects what the Contractor has paid and which falls within the definition of Defined Cost plus the Fee. The Prices operate as the target cost. Following completion of the works, there is a comparison of the Price for Work Done to date with that target and an assessment of the extent to which the Contractor will benefit from any saving (against target) or bear the cost from any overrun. That, the Court said, is the pain/gain sharing nature of the Contract and the allocation of pain and gain occurs after completion of the works and not on an interim basis.  Further, there was no other provision in the Contract for the assessment of the Contractor’s share at an earlier stage.

Did the JVA allow pain/gain share adjustments at an interim stage?

No. Clause 8.6 of the JVA provided that “The parties shall receive interim payments from the JV in reimbursement of the Works Part Costs incurred by each party as shown on the parties’ Interim Cost Statements. Works Part Costs shall be reimbursed in accordance with the principles set out in Schedule 4.” Doosan argued that in accordance with the first sentence of clause 8.6, it was the amount in each party’s Interim Cost Statement that was to be paid to the relevant Joint Venture partner. Interserve’s case was that the operative words of clause 8.6 were those in the second sentence and that Doosan was only entitled to be reimbursed in accordance with the principles in Schedule 4.

The Court agreed with Doosan and held that the operative words of clause 8.6 were the first sentence and not the second. It said that it did not contain any provision for allowing pain/gain share adjustments at an interim stage. It said that Schedule 4 made no obvious reference to principles applicable to interim payments and there was no principle set out that reimbursement is net of internal charges, delay damages and “other adjustments”. The Court said that paragraphs 1-5 of Schedule 4 were patently about what happens at the end of the project in terms of pain/gain, which was consistent with the position under the Contract (Clause 53.3).

The Court also referred to two express provisions in the JVA which dealt with the situation where one of the Joint Venture partners considered that the other will exceed its Work Part Target Cost and can ask the Joint Venture Committee to agree to suspend payments. The Court  said that whilst these provisions contemplate that adjustments to the Works Part Target Costs will be agreed as the works progress, that did not amount to an agreement that the pain/gain sharing mechanism will be applied in some way on an interim basis or that corresponding deductions will be made from the interim payments. That, the Court said, was completely at odds with the structure of the JVA and the Contract, in which there is a reckoning, at the end of the project, of costs incurred as compared with Target Cost and a sharing of the relevant pain/gain.

Discussion

Whilst the main focus of the judgment was on the specific terms of the JVA, the Court confirmed the interpretation of ECC Clause 53.3 under NEC3 (see also ECC Clause 54.3 of NEC 4) that the pain/gain share adjustment can only be made and the pain/gain share only applied after completion of the works and not during interim valuations.  From the employer’s perspective, this may not be particularly desirable given the potential need to recover any overpayments upon completion of the works.

The above said, the judgment needs to be considered carefully in the Hong Kong context.  Under the Hong Kong Government’s Library of Standard Amendments to NEC ECC Standard Documents, a new clause 53.2A is inserted after Clause 53.2 providing that the Project Manager will make interim assessments of the Contractor’s pain/gain share and under a newly inserted bullet point in Clause 50.2, the amount due to the contractor will include “less the Project Manager’s interim assessment of the Contractor’s share, if the Project Manager’s forecast of the final Price of for the Work Done to Date exceeds his forecast of the final total of the Prices.”

This case also highlights the importance of consistency between the joint venture agreement and the relevant construction contract.  In this case, the Court found that the terms of the Contract were relevant to the construction of the JVA.