Defined Cost is cost calculated under the rules of the NEC4 Engineering and Construction Contract (ECC). The selected main option determines which costs can be included and how they are valued. The result may differ from the amount recorded in the Contractor’s accounts, since some components use contractual rates rather than the amount spent.
Defined Cost is used in payment assessments and compensation event assessments, with different provisions applying under the main options. The ECC provisions described here are those of the June 2017 edition incorporating the January 2023 amendments. The selected options, Contract Data and any project amendments need to be checked before applying them.
On the fictional Ironbark Recycled Water Scheme, introduced in NEC4 Explained, a regional Australian water utility is procuring a pipeline, pumping station and balancing tank under Option C. The scheme will supply recycled water from an existing treatment plant to an industrial estate, with the plant remaining operational during construction and connection.
Defined Cost under the main options
Under the priced Options A and B, routine payment is based on the priced work completed. Option A uses completed activities or groups of activities in the Activity Schedule; Option B uses completed quantities at Bill of Quantities rates and the relevant proportions of lump sums. Defined Cost is used in assessing compensation events, rather than as the basis for routinely reimbursing the Contractor’s expenditure.
Options C and D are target contracts, while E is cost reimbursable. In all three, Defined Cost is the cost of components in the Schedule of Cost Components, less Disallowed Cost. It is used in payment as well as compensation event assessment. C and D also apply the Contractor’s share against the target, while E has no corresponding sharing mechanism.
For C, D and E, the Price for Work Done to Date is the Defined Cost the Project Manager forecasts the Contractor will have paid before the next assessment date, plus the Fee. On Ironbark, the payment assessment would therefore include a forecast of eligible payments, rather than simply adding up invoices already paid.
Option F is a management contract with its own definition of Defined Cost. It includes payments due to Subcontractors for subcontracted work, subject to the contractual adjustments preventing duplicate payment or retention, and prices for work done by the Contractor, less Disallowed Cost. The Contractor manages delivery through Subcontractors apart from work identified in Contract Data for it to undertake itself. Its own work is priced, rather than valued using Option E’s cost schedule. Option F also adds the Fee in calculating its Price for Work Done to Date.
What the cost schedules determine
The Schedule of Cost Components applies to Options C, D and E, while the Short Schedule of Cost Components applies to A and B. Neither applies to F. The schedules identify which components can be included and how they are calculated, including people, Equipment, Plant and Materials, and subcontracted work. They also provide for deductions, including specified insurance-related costs.
Each schedule allows an amount in only one component and only where incurred to Provide the Works. The conditions within each component determine whether a cost can be included. The people provisions, for example, distinguish categories of personnel and their working arrangements. Several components depend on the contractual definition of Working Areas, with specific provisions for eligible work outside them. Charging time to an Ironbark project code would not, by itself, establish that it meets those conditions.
Suppose a failed pressure test on Ironbark’s pipeline leads to the discovery of a leaking joint. The Contractor would identify the components applying to the people investigating the leak, the Equipment used and any replacement materials. If a Subcontractor carries out the repair, the assessment needs to follow the subcontract payment rules. The same labour cannot also be included separately as the Contractor’s own people cost.
Contractual rates and the Fee
Clause 52.1 requires the applicable rates and percentages in Contract Data to be used. Other amounts must be at open-market or competitively tendered prices, with recoverable discounts, rebates and taxes deducted. The invoice value may therefore differ from the amount included as Defined Cost.
The Short Schedule values the Contractor’s people using People Rates multiplied by the relevant time. Listed Equipment uses published rates with the stated percentage adjustment. Under the Schedule used for Ironbark, the Equipment rules depend on ownership and the relevant Contract Data entries. Where Contractor-owned Equipment is valued at open-market rates, its recorded depreciation would not establish the amount to include. Specified design or manufacture work outside the Working Areas is valued using Contract Data rates.
The Fee is calculated by applying the fee percentage to Defined Cost. Clause 52.1 treats all Contractor costs outside Defined Cost as included in the Fee. The percentage therefore needs to cover those costs, including relevant overheads, as well as profit and provision for risk. Those costs are not reimbursed separately as they arise.
The Fee is added in the payment calculation under C to F and forms part of compensation event assessment under clause 63.1. It is not an additional percentage routinely applied to A or B’s priced work. When preparing an assessment, check that a component has not been included twice or a separate overhead charge added for a cost already treated as included in the Fee.
What counts as Disallowed Cost
Disallowed Cost is a defined exclusion from Defined Cost under Options C to F. The Project Manager must apply that definition, rather than deduct costs simply because work was inefficient, unsuccessful or the Contractor’s fault. C, D and E use the definition in clause 11.2(26), while F has a different definition in clause 11.2(27). Neither definition applies under A or B.
Under C, D and E, cost is disallowed if it is not justified by the Contractor’s accounts and records or should not have been paid under the relevant subcontract or supply contract. Evidence that a payment was made does not establish that the recipient was entitled to it. Without supporting records, a cost may be excluded from the current assessment. Later records may allow the assessment to be revisited, subject to the contract’s provisions for finalising cost and assessments.
Cost incurred only because the Contractor failed to follow an acceptance or procurement procedure stated in Scope is also disallowed. The words “only because” require a connection between the failure and the cost. A failure to follow a procedure does not automatically disallow the whole subcontract value. The Project Manager needs to identify the cost which would not otherwise have arisen.
The same test applies to costs incurred only because the Contractor failed to give an early warning required by the contract, or failed to notify the Project Manager about preparing for and conducting adjudication or tribunal proceedings with a Subcontractor or supplier. The failure and its cost consequences need to be established in each case.
For Plant and Materials not used to Provide the Works, the definition allows for reasonable wastage and makes an exception where their non-use results from a change to Scope. For unused resources, it allows for reasonable availability and utilisation. The definition also excludes the cost of resources left in the Working Areas after the Project Manager has requested their removal. A period of standby needs to be examined against those conditions before being treated as Disallowed Cost.
The definition also excludes specified costs of disputes between the Client and Contractor, including preparation for and conduct of adjudication or tribunal proceedings and payments to a Dispute Avoidance Board member.
Defect correction at Ironbark
The obligation to correct a Defect and the treatment of its cost are separate questions. Clause 44.1 requires correction whether or not the Supervisor has notified the Defect. The cost provisions determine whether the associated expenditure qualifies as Defined Cost.
If Ironbark’s leaking joint is repaired before Completion, the cost is not automatically disallowed because the joint was defective. The Project Manager would examine the applicable components and exclusions, the work undertaken and the circumstances that caused the Defect.
Clause 11.2(26) specifically disallows the cost of correcting Defects caused by failure to comply with a constraint in Scope on how the Contractor is to Provide the Works. If Ironbark’s Scope prescribed an installation method, the assessment would need to establish whether the Contractor departed from it and whether that departure caused the Defect. Failure to achieve the specified finished result does not, by itself, establish a failure to follow a constraint on how the work was to be carried out.
If the joint is corrected after Completion, C, D and E expressly disallow the cost of correcting the Defect. This exclusion applies even if the Defect was discovered before Completion. The assessment needs to establish when the correction occurred and what the investigation, repair and retesting involved. Costs should be examined according to the work they relate to, rather than treating every invoice associated with the failed test in the same way.
The Client’s cost of repeating a test or inspection after a Defect is found is assessed separately under clause 41.6 and paid by the Contractor. Under Option C, the Contractor’s own repeat-test cost is excluded from that assessment of the Client’s cost. Its treatment as Defined Cost must be considered separately.
Option F has different exclusions
Option F retains the exclusions for cost not justified by accounts and records, payments not due under subcontracts or supply contracts, and costs incurred only because of the specified procedural failures. It also excludes subcontract payments for work Contract Data says the Contractor will do itself or for the Contractor’s management, alongside the specified dispute costs between the Parties.
F does not reproduce C, D and E’s express exclusions for correcting Defects, unused Plant and Materials or unused resources. The Project Manager needs to examine F’s own definition and the relevant subcontract entitlement. Ironbark’s Option C assessment therefore cannot simply be applied under F.
Records that support the assessment
For C, D and E, clause 52.2 requires accounts of Defined Cost payments, proof of payment, subcontract compensation event communications and assessments, and other records specified in Scope. The Project Manager can inspect these during working hours under clause 52.4. F has corresponding inspection provisions, but its record requirements in clause 52.3 focus on subcontract payments.
On Ironbark, timesheets and Equipment records should identify the affected pipeline section and the work carried out. Relevant invoices, subcontract terms and payment evidence need to be read with the test results and repair records. Together, they should establish what was done, when it was done and the basis for the cost claimed.
The Contractor keeps and presents the records, and the Project Manager assesses the amount due. The Supervisor’s testing and Defect records help establish what happened during testing and Defect correction, but the Supervisor has no general power to approve or disallow costs. Linking the quality records to the cost records allows the Project Manager to examine the same work while keeping their responsibilities distinct.
Payment and the Option C target
If Ironbark’s repair costs qualify as Defined Cost, including them in payment does not increase the target. Under Option C, the total of the Prices forms the target and changes through the applicable contractual mechanisms. The Contractor’s share compares the relevant total of Defined Cost plus Fee with that adjusted target under clause 54. An overspend is not itself a ground for disallowance, although cost included in payment may affect the Contractor through its share of an excess or saving.
Expenditure does not, by itself, establish a compensation event. The event must qualify under the contract, and its assessment follows the relevant main option’s rules. Clause 63.1 distinguishes actual Defined Cost for work done by the dividing date from forecast Defined Cost for work not done by then, with the resulting Fee. F also has specific provisions for changes to the price of work undertaken by the Contractor itself.
At Ironbark, investigation and correction of the leak can proceed while the Contractor and Project Manager examine how the costs should be treated. The assessment should identify the work concerned, show how its cost has been calculated and explain any exclusion. A disagreement about a particular cost can then be considered separately from any question about changing the target or assessing a compensation event.
