NEC3 – Option C – Target Cost with Activity Schedule
‘The NEC Option C is a target cost contract with activity schedule where the out-turn financial risks are shared between the client and the contractor in an agreed proportion.’ NEC.
Target cost contracts can be beneficial where the scope of work is not fully defined or where the risks anticipated are greater than usual.
The option C contract allows the financial risks to be shared between the parties (employer and the Contractor) which motivates the contractor to deliver the works in the most cost efficient way.
A ‘target cost’ is agreed between the parties which is made up of the Contractor’s estimate of the ‘Defined Costs’ plus a fee which is to cover the Contractor’s costs, overheads and profit.
Throughout the works the Contractor is reimbursed for his “Defined Costs” plus fee minus any “Disallowed Costs”.
These components together constitute as the ‘Price for Work Done to Date’ (PWDD).
Defined Costs (actual costs) are assessed by the Project Manager during the course of the works by auditing the Contractor’s accounts.
Throughout the works the target cost is adjusted to reflect any compensation events which may arise.
On completion of the works the final Defined Costs and Fee (the final “Price for Work Done to Date”) and the target costs are compared.
If the final PWDD is less than the target cost the Contractor will receive a pre-agreed share of the saving depending on the ratio. If the PWDD, it is greater than the target cost, the Contractor will pay a share of the difference (again at the agreed ratio).
This known as the “pain/gain” mechanism of the contract.
So what are defined costs?
Under Option C, Clause 11.2(23) defined costs are stated as:
“the amount of payments due to Subcontractors for work which subcontracted without taking account of amounts deducted for
- Payment to the Employer as a result of the Subcontractor failing to meet a Key Date;
- The correction of defects after Completion;
- Payments to Others;
- The supply of equipment, supplies and services included in the charge for overhead cost within the Working Areas in this contract; and
- The cost of components in the Schedule of Cost Components for other work.
Less Disallowed Costs
Therefore, Defined Costs in broad terms are the actual costs incurred by the Contractor for the Works less retention less all costs which would fall within the overheads covered within the Fee. From those are deducted “Disallowed Costs”.
“Disallowed Cost” is defined by Clause 11.2(25) and are costs that the Project Manager has decided are either:
(1) not justified by the Contractor’s accounts and record;
(2) shouldn’t have been paid to a subcontractor in the first place; or
(3) were incurred because the Contractor did not follow the acceptance or procurement procedures laid down in the Works information or didn’t give an early warning notice as required.
The Contractor’s “Defined Costs” will be subject to audits with the level of information required to justify the sum being substantial.
We hope this blog has been a useful insight to the NEC3 Option C with activity schedule contract.