Using cost saving proposal mechanisms in Hong Kong SAR NEC4 contracts

The cost saving proposal mechanisms are beneficial to both contractors. Regardless of the mechanisms, approval is usually achieved through negotiation between the contractor, the project manager and the client, reflecting the central theme of NEC contracts of collaboration and partnering between contracting parties.

Under the standard form Hong Kong edition of NEC4, a contractor can submit a cost saving proposal through two different clauses, Core Clause 16 and Option Clause X21.

Additionally, the DevB has developed a library of standard amendments and additional contract clauses for incorporation into the standard NEC contracts, called the Standard Additional Conditions of Contract (ACC). Clause VII:2 within the ACC provides another mechanism for a contractor to propose a cost-saving design.

These clauses incentivise contractors to propose value engineering solutions and cost saving designs, but can result in practical issues arising.

Read more on the use of NEC4 contracts in Hong Kong SAR

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• Allocating the risk of physical conditions under NEC4 construction contracts
• Understanding Hong Kong SAR NEC compensation events ‘crucial’ to projects’ success
• Optional clauses in Hong Kong SAR NEC forms can boost construction project outcomes
• Hong Kong SAR NEC forms hold limits to instructing changes to construction works’ scope
• Hong Kong SAR NEC forms encourage proactive communication
• Impact of potential variations of scope in Hong Kong SAR NEC forms must be thoroughly assessed
• Clarity on compensation events in Hong Kong SAR NEC forms can help to avoid construction disputes
• Using the NEC4 standard form contract for construction projects in Hong Kong SAR

Core Clause 16: cost saving proposals

Under Core Clause 16, a contractor can make a cost saving proposal (CP) to the project manager that changes the scope of work, resulting in a reduction of the amount the client pays. After the submission, the project manager has four weeks to either accept or reject the proposal, or to inform the contractor that the client is still considering the submission and request the contractor to submit a quotation for consideration. There is no obligation on the project manager to accept the proposal, nor to provide reasons for not accepting it.

If the CP is accepted, it becomes a compensation event, rewarding the contractor depending on which main option is adopted.

If it is a lump sum model (i.e. Option A or B is adopted), the cost saving is shared between a contractor and the client according to the value engineering percentage prescribed in the contract data. The default value in the Hong Kong edition of NEC4 is 50%, which means the client and the contractor split the savings evenly and the contactor bears the risk of whether the CP can produce the expected savings once the quotation is accepted.

If a target cost model is used (i.e. Option C or D is adopted), the price remains unchanged when the CP is accepted. Whether a contractor is ‘rewarded’ for the CP ultimately depends on whether the final “Price for Work Done to Date” as assessed upon completion, is less than the contract price, taking into account of the CP and any other factors; as well as the contractor’s “pain/gain” share percentage prescribed in the contract data. As a result, the risk of whether the CP can produce the expected savings is shared by the client and the contractor, depending on the “pain/gain” share percentage.

ACC Clause VII: cost saving design proposal

The CP provision of the standard form Hong Kong edition of NEC4 is usually amended by ACC in two ways:

• another mechanism for a contractor to submit a cost saving design proposal (CSDP), in addition to Core Clause 16, is amended into Clause ACC VII; and

• Core Clause 16 is amended by adding a sub-clause 16.1A which states that Core Clause 16 does not apply where a contractor’s proposal amounts to a cost saving design under ACC VII:2.

Some NEC projects in Hong Kong SAR do not have sub-clause 16.1A, resulting, in theory, the contractor being able to choose between submitting a CP under Core Clause 16 or a CSDP under ACC Clause VII:2.
ACC Clause VII:2 allows a contractor to submit a CSDP for the project manager’s review and the client’s approval where: construction costs are reduced by a lump sum; the time for completion of the entire or a section of the project is reduced; operations and maintenance (O&M) cost is reduced; efficiency or value to the client of the works can be improved; construction productivity is increased; manpower required is reduced; or the proposal provides any other social benefits.

This mechanism avoids the complexity of navigating multiple clauses by incorporating a proposal and its cost-saving assessment in one single clause.
Using this mechanism, the contractor bears the liability for any changed design. In comparison, under Core Clause 16.1, it is not expressly stated who bears the design risk for a CP if the contractor proposes a change to the client’s and the project manager’s design.

The project manager, after receiving the CSDP and consulting with the client, has six weeks to accept or reject it, unless the contractor has agreed to a longer period.

When considering the CSDP, the client bears any costs that arise as a result. However, the contractor must reimburse the client for the project manager’s costs even if the CSDP is rejected, as well as any increase in future O&M. This is in contrast with a CP under Core Clause 16.1, which does not expressly address these points. Considering this, contractors should give due regard to the quality and feasibility of their proposal before submitting it for the project manager’s review and the client’s approval.

Acceptance of a CSDP under ACC VII:2 is not a compensation event, unlike a CP, so the value of engineering percentage in the contract data is irrelevant. How a contractor is rewarded for the CSDP depends on which main option is adopted:

• if it is a lump sum model (i.e. Option A or B is adopted), the cost savings are shared between the contractor and the client equally;

• if it is a target cost model (i.e. Option C or D is adopted), the mechanism for CSDP is similar to that for CP, with reference to the ‘pain/gain’ share percentage in the contract data.

The completion date may also be adjusted on acceptance of the CSDP, subject to agreement between the client and the contractor.

Option Clause X21: O&M cost reduction

Under Option Clause X21, a contractor may submit a proposal to the project manager which reduces the project’s O&M costs.

Any proposal should include a quotation which includes a description of the suggested work, the forecast reduction in O&M cost, risk analysis, changes to the price and a revised programme showing the change of completion date and key dates for the project manager’s consideration. The project manager should then reply within the “period of reply” specified in the contract data.

If the quotation is accepted, the scope, price, completion date and key dates will be changed accordingly, noting that the change to the scope due to acceptance of the quotation for reduction of a whole life cost is not a compensation event. The contractor will be rewarded based on the quotation submitted and accepted by the project manager.

Where the standard form Hong Kong edition of NEC4 is amended to include ACC VII:2, the DevB’s Practice Note on NEC suggests that it is not necessary to include Option Clause X21 as the scope of CSDP includes a proposal for reduction of O&M cost.

Practical issues

If the contract does not contain sub-clause 16.1A requiring a cost-saving design proposal to be submitted as a CSDP under ACC VII:2, the contractor, in theory, has a choice of submitting the cost-saving proposal as a CP under Core Clause 16 or as a CSDP under ACC VII:2. Although in practice, this is likely to be subject to negotiation with the project manager and the client.

Considerations for which approach to choose include:  

Benefits of the proposal

The proposal may simply reduce the amount the client pays; or it may include other benefits such as improved productivity, reduction of construction time and O&M savings. If the proposal offers benefits other than just reducing construction costs, this should be submitted as a CSDP under ACC VII:2.

Contactor reward

Where lump sum model (i.e. Option A or B) is adopted, the contractor’s reward may differ if the proposal is accepted as a CP or as a CSDP. For Core Clause 16.1, the reward of a CP depends on the value engineering percentage prescribed in the contract data and the reward / savings for a CSDP under ACC VII:2 are shared equally.

Design responsibility for proposed changes

Core Clause 16.1 is silent on design responsibility even though a CP may involve amendment to the design of the works. Nevertheless, this is likely to be a point for negotiation with the project manager and the client, and a contractor may be required to bear responsibility as a condition of approval. By comparison, it is made clear that a contractor shall bear the design responsibility for a CSDP under ACC VII:3.

Regardless of the approach, where a proposal involves amendment of the client’s permanent works design, contractors should carefully and clearly delineate the scope of the design change so that there is a clear boundary of design responsibilities.

Extent of cost saving

There is no limit to the scope of the cost savings for a CP or CSDP before it can be approved. As a result, even relatively trivial cost saving may be considered and accepted.

Compensation of the project manager’s cost for reviewing the proposal

Core Clause 16.1 does not expressly require the contractor to compensate the project manager for their review costs. However, this is likely to be negotiated with the project manager and the client, and a contractor may be required to bear the cost as it is required to do under ACC VII:2. 

Where a contractor is required or obliged to compensate the project manager’s cost for reviewing the proposal, the contractor may be able to limit exposure by negotiating and agreeing a fixed lump sum fee or a fixed percentage of fees dependent on the expected cost saving of the proposal.

Where a CP or CSDP also amounts to acceleration or mitigation of delay

In principle, a proposal with the primary objective of accelerating or mitigating delay, without involving any reduction of construction cost, should be submitted under Core Clause 36.

Where the proposal involves a reduction in construction costs but also reduces construction time or enhances productivity, such savings can also be considered in a CSDP under ACC VII:2 and a CP under Core Clause 16.1, subject to the comments above regarding sub-clause 16.1A. Although not expressly provided for, a CP can, in theory, include a reduction in construction time or improvement in efficiency as a consequence of the implementation of the proposal.

Approval process and procedure

Both Core Clause 16 and ACC VII:2 expressly provide a timeframe for the project manager to make a decision regarding the CP or the CSDP or request further information for the CP.

The nature and scope of the proposed cost-saving proposal may mean that the project manager cannot decide within the stated period. Nevertheless, the mechanism for requesting further information under Core Clause 16 or to request a contractor agrees to extend the timeline under ACC VII:2 should not be used to delay the decision-making process.

Co-written by Kingston Yeung of Pinsent Masons.