Early supply chain involvement and NEC4 Option X22

In a recent webinar, part of Fenwick Elliott’s webinar series, Claire King and Mark Pantry spoke about Early Contractor Involvement (ECI) and the use of Option X22 of the NEC4 Engineering and Construction Contract. As part of that webinar1, they spoke about how the future of ECI and how the principle of ECI is being extended and developed in Early Supply Chain Involvement (ESI). Mark Pantry explains more. 

ECI is a collaborative procurement technique where the client engages the contractor earlier in a project’s lifecycle so that the contractor can input into the design or pre-construction phase. This brings the contractor’s specialist expertise to the project at an earlier stage and potentially allows the contractor to add enhanced buildability to reduce risk in the project and achieve savings, both in terms of greater value for money and improvements on the project programme. 

Current usage of ECI is predominantly in the public sector and limited to large and complex construction projects. Despite there being increased interest and calls for greater engagement in ECI, it appears that uptake has not increased significantly. In particular, the UK government’s guidance on sourcing and contracting public works projects (The Construction Playbook, Version 1.1) states that “[e]ngaging early with the supply chain and developing clear, appropriate outcome-based specifications are critical factors in achieving timely and cost-effective delivery”.

One criticism of ECI is that the supply chain below the main contractor is not contributing efficiently towards ECI due to commercial behaviours of main contractors and clients. In a 2019 University of Cambridge study2, it was found that supply chain perceptions of ECI were different from the other parties involved in project and that the supply chain was isolated from the collaborative ideals and commercial benefits of ECI which were touted by main contractors and clients. This led to a lack of collaboration and a reversion to the more traditional adversarial relationships.

ESI extends the principle of ECI by formally engaging the main contractor, sub-contractors, and supply chain in the pre-construction phase to input into design, price, programme, and risk management for the project. The intention being to unlock greater value in projects, as well as flowing down key project objectives to the supply chain. For example, if a project had particular sustainability or carbon reduction objectives, these could be achieved through supply chain input and innovation.

ESI and NEC4 Option X22

The provisions of Option X22 were a new option clause introduced in the NEC4 suite of contracts when they were published in 2017, but the drafting itself is based on similar model Z clauses which were published for use with the NEC3 form. 

As a clause, Option X22 is split into two distinct elements:

• ECI: these provisions divide the works into Stage One and Stage Two and incorporate the mechanism of the Contractor’s submission of design proposals and the Client’s subsequent decision to issue notice to proceed.
• Incentive: these provisions introduce a separate financial incentive for the Contractor through the Client’s initial budget for the project when compared to the actual cost of the project. 

Option X22 divides the works into two stages, both of which are defined in the Scope. The Scope should clearly set out what is required from the Contractor in each stage and, in relation to Stage One, these should include details of design, procurement and construction activities, programming, deliverables and other services to be provided by the Contractor. Any of the client’s ESI requirements would need to be included in the Scope; this would likely include obligations on how the Contractor engages with its supply chain and flows down project objectives and requirements to subcontractors, subsubcontractors and suppliers. 

In Stage One, the Contractor is paid its Defined Cost on a cost reimbursable basis, but the contractor must also prepare a detailed projection forecast of that cost at the intervals in the contract data. Such forecasts are submitted to the Project Manager for acceptance. The cost of any work that is not included in the accepted forecast is treated as a Disallowed Cost.

During Stage One, the Contractor is required to submit its design proposals for Stage Two for acceptance by the Project Manager. The design proposals are required to be submitted in accordance with the submission procedure in the Scope. These submissions procedures are usually extensive and detailed and can be where the Client sets out its requirements for ESI and can include obligations in relation to transparency of the Contractor’s supply chain.

If Option X22 is to be used with ESI, then the parties may wish to consider expanding the existing provisions in relation to the roles of the key persons. Most of the studies on ECI and ESI show a clear benefit in having the same key persons from the Contractor and its supply chain involved with the project during the ECI period. Having key persons involved is important for collaboration, consistency, project knowledge and also for the relationship between the parties. Option X22 includes an obligation for the Contractor to maintain key persons in place during Stage One and such persons cannot leave the project without an instruction from the Project Manager or if they are unable to continue to act. This obligation could be extended to key members of the supply chain involved in the project to ensure that continuity of personnel. 

Moving towards Stage Two of a project, the most important element for all parties is agreeing the total of the Prices for Stage Two. Clause X22.3(5) states that the total of Prices for Stage Two is assessed by the Contractor using the Pricing Information it had prepared at the start of the contract and had included in the contract data. If ESI is being utilised, then we would expect the Contractor’s supply chain to have a degree of input into the Pricing Information at an early stage, so that they can be involved in the Contractor’s assessment of the Prices. 

The Client makes the decision whether to proceed to Stage Two and, if it wants to proceed, the Project Manager issues a notice to the Contractor. If the decision is made not to proceed with Stage Two, then a notice is issued and Stage Two is omitted from the Scope of the works. This omission is not a compensation event, and it is not a termination reason under the termination table. This means that the contract does not terminate but it effectively concludes because there is no further Scope for the Contractor to carry out. 

The second element of Option X22 is the financial incentive for the Contractor which is there to encourage innovation and cost saving through the life cycle of a project. If ESI is being used, then this incentivisation could be flowed down to the Contractor’s supply chain, although consideration will need to be given as to how members of the supply chain are incentivised: do they gain their incentive if their subcontract works save on project costs or only if the project as a whole comes under budget?

Option X22 introduces the new defined term of the Budget which is the value declared by the Client at the start of the project and is used to compare the Project Cost for the assessment of the budget incentive. The Budget is intended to be the maximum amount available to cover all costs for the complete delivery of the project and not just limited to construction costs. The Project Cost represents the total amount incurred by the Client from payments made to the Contractor and others for the items stated in the Budget. If the Project Cost on completion of the whole of the works is lower than the Budget, the Contractor is rewarded with a budget incentive payment. It is suggested that, in an ESI arrangement, the incentive payment is shared with the Contractor’s supply chain. 

Conclusion

An increased use of ECI and ESI will undoubtedly see an increase in the use of Option X22 under the NEC4 Engineering and Construction Contract. If ESI is to be used on a project, then the parties will need to consider how the provisions of Option X22 are flowed down to the Contractor’s supply chain so that all members of the supply chain adopt a mutually beneficial, open and collaborative approach, sharing ideas and innovative solutions to enable a successful project delivery.

Previous article | Next article

• 1. You can watch the webinar here.
• 2. Procurement models: is early contractor involvement beneficial to the UK construction industry? [University of Cambridge: 2019]