El Niño and the NEC contractual phenomenon

“Fenomeno del Niño” is the name given to an unpredictable weather event specific to the eastern side of the Pacific Ocean. Historically, this phenomenon has brought catastrophic effects to the Peruvian population located in certain areas of the Andes of Peru and in the coastal zones around the river mouths. Devastation as a result of these events comes in the form of floods and mud slides, with a huge impact on infrastructure and housing. The impact of climate change over the past few decades has magnified the effects of fenomeno del Nino. Hence, economic losses brought by fenomeno del Niño in 2017 is estimated in the region of US$3,100 million. Future fenomenos del Niño will make flooding more likely in Peru which, in turn, will increase all consequential losses.

As a result of a number of corruption investigations in the construction sector, under the so-called “Lava Jato” scandal, the Republic of Peru explored the alternative government to government bidding process for significant infrastructure works. Taking inspiration from the 2019 Pan-American Games, the Peruvian government in office has decided to implement the same procurement process for the purpose of the reconstruction works in the north of Peru, devastated by El Niño (the “NRC Project”). The NRC Project, orchestrated in conjunction with the UK government, entails an investment for these works of nearly US$2,000 million to be spent building/reconstructing hospitals, schools, riverside protections, amongst others.

A significant benefit is the opportunity to utilise alternative contractual arrangements. Indeed, the traditional Peruvian contractual arrangements for construction works were awarded on a lump sum basis, determined at the time of entering into the contract for the works, with budget increases effected through amendments to the initial contract. However, such practice has been fraught with issues, as it has been the tool used to reimburse illicit contributions. This brings a perverse incentive to local contractors, who sacrifice quality in order to keep within the initial budget.

On the contrary, UK expertise brings different contractual formulas such as NEC contracts (New Engineering Contract), which could offer a positive cultural change to the contractual mind set in the Peruvian construction sector. For the purposes of the remainder of this article, we shall assume that the intention is to utilise an unamended form of NEC4 on the NRC Project.

The overarching philosophy of the NEC suite of contracts (NEC) is clarity – it seeks to allocate risk fairly between the parties and remove much of the complex terminology and phrasing common to other types of contract. It intends to act as a stimulus to good management, as a contract that is constantly used as a reference point, rather than relied on only in dispute situations.

Risk allocation is dealt with very clearly, with the risks to be borne by both the client and the contractor specifically listed. For example, unforeseen ground conditions and incorrect assumptions are risks for the client, and when such risks come to fruition, NEC allows for contractors to apply for an extension of time and additional costs. There is a greater emphasis on the programme than in other standard form contracts and NEC is prescriptive as to what the programme should contain, perhaps because the programme acts as a basis on which compensation will be considered.

NEC employs early warning notices – issues must be notified as they are discovered, so the contractor cannot hold back on claims until the end of the project. Any matter that could cause a delay or increase prices must be notified, as well as defects and compensation events.

Collaboration is another key principle actively promoted by NEC - all parties are to act both as stated in the contract and “in a spirit of mutual trust and co-operation”. In essence, this is a good faith clause. The project manager holds a stronger role than in other standard forms, as a party who is intended to encourage and facilitate co-operation.

We at Kennedys, with our London and Lima offices, duly supported by the Latin American hub located in Miami, which is co-led by one of our construction experts at the firm, are in a privileged position to provide the necessary advice and assistance from a UK and Peruvian standpoint in negotiating and administering the NEC suite of contracts. Kennedys are able to provide a legal understanding that identifies and understands the relevant challenges faced by the UK and Peruvian parties who will be involved in the NRC Project. This is the first in a series of articles on the NEC suite of contracts. In subsequent articles, we will touch upon, and offer advice on, those challenges, in a straightforward, direct manner. Kennedys style.