Our work with large and complex projects exposes us to a multitude of new practices in Israel and around the world, and I can say with pride that despite all the difficulties involved, construction in Israel is still a sophisticated and professional industry.
A major aspect of any construction project is the contract that governs it. In the construction sector, the contract is highly respected, and defines the activities and practices in the project. There is a reason, after all, for the term “contractors”!
In terms of construction contracts, the British are leading the way. In the past decade, the most common contract form among large civil and government projects in the UK has been the New Engineer Contracts (NEC). It is, in many ways, a brilliant example of how construction contracts ought to work.
NEC contracts were written with the aim of implementing proper principles for project management. Yes, you heard it right. The person who originally wrote the contract was not thinking about how to sabotage the other side or concentrating on creating the toughest terms for the tender. Rather, the efforts are purely on building a project in the most efficient and effective way possible and allocating the risks and rewards accordingly. This contract succeeded in an unprecedented manner and completely transformed the construction and infrastructure industry in Britain.
In this blog post I’m going to share some key points for “contract” innovation that I believe can be successfully implemented into some building projects in Israel with major benefits.
Mutual Trust and Cooperation
A main principle of NEC contracts is that a partnership between the parties involved in the contract should be sought with the end goal of delivering the best project. It is obvious (or at least to those who do not work in the construction industry) that if everyone works together collaboratively, the end product will be more successful and everyone will benefit.
Accordingly, the first clause of the contract reads:
“The parties to this contract shall act as stated in this contract and in a spirit of mutual trust and cooperation”
Truth be told, there is room for scepticism. British contractors were not born yesterday. No contractor or owner operator will take seriously a clause that tells everyone to ‘behave well’.
However, it kind-of works. The principle of partnership that sits at the heart of this clause is backed by dozens of very sophisticated mechanisms that directly encourage parties to cooperate. No doubt, there are “hard” mechanisms involved as well, but it is important to remember that it’s the small things that count too.
The contract obliges the contractor and the Owner PM staff to share a trailer in the field so that they share a common space and have a place to communicate. This alone changes the dynamics and makes it much harder to form an US vs. THEM mentality. Similarly, the contract requires extensive workshops between the teams before the project begins. It is so much harder to lie to and cheat someone who you know as a person or as a friend. The parties are required (by contract) to share what their respective risks are and how they plan to make money. This means everyone understands the other side’s responsibilities and concerns. By humanizing the process, each party understands the other, which, in turn, encourages teamwork.
The Partnership Contract – NEC ECC (option C)
The flagship contract for the NEC family of contracts is the contract that currently runs almost all mega-projects and infrastructure projects in the UK, and is based on a simple but sophisticated mechanism. Its essence: the idea that parties should share both “gain” for successful delivery and “pain” for failure, and therefore have an interest in the project’s success, regardless of their specific role and responsibility.
Mechanistically, the tender is for target cost. That is, the contractors are bidding on who will submit the lowest target price, with all changes and additions changing the target price. The actual settling between the developer and contractor during the project is based on the contractor’s actual costs and an agreed margin (with open accounting). The target price enters the game only at the end of the project. In the end, any difference between the actual costs and the target cost (whether positive or negative) is divided equally between the commissioning party and the contracting party.
For example, if the target cost of the tender was 100 million NIS and the actual performance was 90 million NIS, the contractor would receive 95 million NIS. Therefore the contractor earned 5 million NIS of clean profit above his cost. However, if at the end of the project the cost is 110 million NIS, the contractor will then receive 105 million NIS, so in this case the contractor and the owner operator will both spend 5 million NIS beyond what they intended. This means that financially, they are also working together. In this case, every shekel saved is divided equally between the parties and every shekel wasted is a shekel both parties miss out on. This creates a common interest between the two parties, which further encourages them to work smoothly together.
However, the real genius of the mechanism is that it isolates variations and claims from the interest to execute. The way it works is that the Compensation Events (often called “variations” or “change orders” in different contracts) are a product of contemporaneous assumptions calculated against the target costs (i.e at the time of the compensation event, by how much the total cost would likely increase) rather than against real costs. This creates a situation in which a Compensation Event will never motivate the contractor to “do damage” (through delay or by increasing quantities), and the fact that a contractor demands a Compensation Event will never motivate the owner operator to “make problems.” Compensation events and implementation are handled separately. Thus, even if a project enters into conflict, everyone still has a common interest to work together.
The contract separates “owner risks” and “contractor risks” in a very clear way and provides instructions on how to divide them. The principle is simple: risks should be born by the organization that has more control over the issue. Risks that have no clear side on who has the better ability to deal with the issue are then subject to specific negotiations or can be divided. In any event, each party bears part of the risk through the Partnership Mechanism. Therefore, everyone has a common interest in minimizing risks.
How is risk managed differently in Israel?
First, it is different at the level of the tender. A general assumption amongst Israeli owners is that there is an interest in transferring as many risks as possible to the contractor.
Second, it is different at the level of implementation. There is a very positive effect of a clear division of risks and joint management. Overall cooperation to work together and minimise risks on the project is also unique to UK construction culture.
Perhaps the most distinguishing factor between contracts in the two countries, is the way programs and planning are treated. Whereas in Israel a planner may appear on a project once a month, in the UK, there are multiple planners on every project. The program is the baseline for almost all contractual activities, and hence, the first step of a project is to agree on an “accepted program.” The program must then be updated and the changes to the program divided between contractor risks and owner risks.
Accordingly, the contract is very distinctive in dividing between time compensation events and quantum compensation events (reminder: compensation events are similar to variations or change orders).
The impact of having a fully updated and accurate schedule is (to one unaccustomed) awe-inspiring, but that is a whole other topic. The main impact here is that the contract actually requires the sides to engage about the implications and impact of activities on an ongoing basis.
If you’d like to learn more about the NEC contracts, check out the NEC website: https://www.neccontract.com/