Disallowed Costs-NEC 4

Guidance and Considerations

Aims of this summary

• Set clear explanations and emphasis the rationale behind the Disallowed Cost; and,
• Minimising the disputes that may arise, encouraging both parties to utilise its time
efficiently that enhances the productivity of all parties involved.

A. What is “Disallowed costs”?

Disallowed Costs are defined in

• Clause 11.2(57) for ECC (Options A & B)

• Clause 11.2(60) for ECC (Option C & D)
• Clause 11.2(56) for ECC (Option E)
• Clause 11.2(19) for ECSC
• Clause 11.2(20) for TSC; and
• Clause 11.2(23) for MSC.

Here are the situations, outlined in the Contract, in which the Client is entitled to Disallow the
Direct Cost incurred by the Contractor:

1. Costs that the Contractor cannot prove without proper records or justification. In that
regard, the Contractor should maintain detailed site records to demonstrate incurred
costs – for example – time sheets and subcontractors’ invoices.
2. Costs incurred because Contractor did not follow a procurement procedure. The
Contractor must familiarise itself of the procurement procedures, procurement
strategies and follow the construction programs.
3. Costs incurred due to the Contractor does not give an Early Warning Notice as soon
as become aware of an event that should be within few days and not few months.
4. When the Contractor pays a subcontractor or supplier for something that is not
stipulated in its Contract with the Contractor.
5. Costs of Personnel and resources which are recovered by the Contractor under the
Management Services Work Order.
6. Costs of plant or materials that were not used for the project.
7. Costs of preparing for an adjudication.

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 8. Costs for rectifying defects after Completion and the cost of correcting defects caused
by the Contractor not complying with the Contract; and
9. Clause X22.2(4) - The cost of any work that is not included in the accepted forecast
(by SW PM) is treated as a Disallowed Cost.

B. Where do Disallowed Costs ‘Fit’ in the ECC

• Disallowed Costs are part of how we calculate the total cost of the work (Defined Cost)
and, in turn, the amount the Contractor gets paid (and therefore Price for Work Done to
Date).
• The Project Manager decides whether a cost should be considered Disallowed according
to the relevant clauses within the Contract.
• The Project manager needs to be specific when identifying these costs and give good
reasons.
• The Project Manager will communicate with the Contractor during the payment process.

C. Why does the NEC4 have Disallowed Costs?

To make sure Sydney To encourage the effective To prevent the Contractor

Water paying the use of certain mechanisms from getting paid for costs
Contractor the right provided by NEC that arise because they did
amount based on their contracts, such as using not follow the contract
actual expenses. Early Warning Notices. properly.

WHAT TO DO

The correct approach for assessing Disallowed Cost is for the Project Manager to:

i) Identify each situation that fits the definition

ii) Figure out how much each situation costs.
of Disallowed Costs in the ECC contract.

The claim should be adequately particularised by the Project Manager and notified to the
Contractor through the payment process.

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D. Key Considerations
Project Manager
Understanding of Disallowed Costs:
Make sure you have a clear
understanding of what Disallowed Costs
are as defined in the contract. Familiarize
yourself with the specific rules and
conditions for disallowing costs.
Specificity in Cost Identification:
When identifying and justifying
Disallowed Costs, be specific and
provide well-documented reasons for
each disallowed item. Avoid a general or
broad approach in your assessments.
Effective Communication:
Maintain open and effective
communication with the Contractor
throughout the Certification process.
Provide clear and timely feedback on
any Disallowed Costs to prevent
disputes.
Early Warning Notices:
Use early warning notices to
communicate potential issues related to
Disallowed Costs as soon as you
become aware of them. Early
communication can help prevent
problems later on.
Avoid Misuse:
Ensure that Disallowed Costs are not
used as a means to penalize the
Contractor for slow or inefficient work.
Disallowed Costs should be applied
according to the contract's defined
criteria.
Contractor
Documentation and Record-
Keeping:
Maintain accurate and comprehensive
records of all project-related costs. This
includes time sheets, invoices, and any
other documentation that can
substantiate your expenses.
Adherence to Procurement
Procedures:
Strictly follow the prescribed
procurement procedures outlined in the
contract. Understanding and
compliance with these procedures can
help avoid Disallowed Costs.
Collaboration with the Project
Manager:
Maintain a cooperative relationship
with the Project Manager and be ready
to discuss and clarify any potential
Disallowed Costs. Promptly address
any concerns or issues raised.
Early Warnings and Compensation
Events:
Be proactive in using early warning
notices to report issues that may lead
to Disallowed Costs. Also, understand
the impact of compensation events
and how they relate to cost
assessments.
Contractual Compliance:
Ensure that you follow all contractual
and procurement procedures to the
letter. Avoid any actions that might
lead to the disallowance of costs and
focus on compliance with the
contract's intentions.
Financial and Project Control:
Understand that NEC Option C and D
contracts are not just about
recovering your costs. Sound
financial and project management is
crucial to ensure the project's overall
commercial success.
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E. Disallowed Cost vs Breach of Warranty

Disallowed Costs

A “disallowed cost” is a defined term in the contract.

When using a target cost approach under ECC option C or D, the basic principle is that a
target cost is agreed, and the Contractor is reimbursed for costs spent undertaking the work
throughout the course of the project. Payments to the Contractor are based on their
accounts and records, which the project manager must has access to inspect at any time.

Disallowed Costs steps away from the general principle – it is a cost that the Client will not
reimburse the Contractor for because the Contractor incurred the costs under one or more
of the circumstances stated in Clause 11.2(60) ECC option C.

Breach of Warranty / Breach of contractual obligation

A "contractual warranty" represents a legally binding commitment made within a contract.

Clause 20.2 in the EEC option C, for instance, asserts that the Contractor guarantees the
fitness for purpose of the design documentation they prepare. In simpler terms, the
Contractor promises that their design will work as intended. However, if the Contractor's
lack of skill or expertise results in the design falling short of this standard, it's considered a
breach of this promise. In such cases, the Client has the right to reject the costs incurred
by the Contractor to generate the defective design and the cost to rectify the design.

Additionally, there's the concept of an "implied warranty," which serves as an unwritten

assurance that products or services will perform as expected, even when the contract
doesn't explicitly state it.

For example, in EEC Option C's clause 20.5, it is stipulated that the Contractor is obligated
to supply materials and construct the works according to "Good Industry Standards." These
standards encompass practices, methods, and procedures in alignment with Australian
laws and regulations, along with the level of skill and care that one would reasonably expect
from a skilled and experienced Contractor.

Essentially, this means that the Contractor is inherently expected to adhere to commonly
accepted industry practices for (but not limited to) safety, durability, and quality, including
using appropriate materials, complying with building codes, and ensuring the structural
integrity of the project. Under Clause 40.3 in EEC Option C, if the Project Manager instructs
the Contractor to rectify a failure to meet quality standards, the Contractor cannot claim
costs for correcting these failures.

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