Disallowed cost

Under cost reimbursable contracts, the contractor is paid actual costs – a calculation based on their accounts and records, rather than a pre-determined rate or price. However, not all costs can be accurately determined on a project-specific basis – some costs have only been incurred due to the contractor’s inefficiency, and not all costs are recoverable under the contract.

Options (C, D, E and F) of the New Engineering Contract (NEC) and Engineering and Construction Contract contract (EEC), describe the costs that can be recovered by the contractor as the ‘defined cost’, whereas the costs that cannot be recovered are described as the ‘disallowed cost’. The disallowed cost does not have to be paid by the employer and so is borne by the contractor. As a result, this is a common area of dispute.

Very broadly, the defined cost includes payments due to subcontractors and the cost of components for other works (such as plant, equipment and people), minus the disallowed cost.

The disallowed cost may include costs that appear to fall within the definition of defined cost, but that have been incurred as a result of the contractor’s failure or default.

This includes:

• Amounts that should not have been paid to a subcontractor.
• Amounts that are not justified by the contractor’s records.
• Resources that were not used.
• Costs incurred because the contractor did not follow the proper procedure.
• Failure to give early warning of anything that may delay the works, or increase costs.
• Defects corrected after completion.
• Preparation for adjudication.

Some defects corrected before completion are not disallowed. However, if a target cost (pain/gain) contract is being used, this will increase the defined cost, and so the potential ‘gain’ for the contractor is reduced, and the likelihood of ‘pain’ is increased. As a result, the contractor may in fact still end up paying for some of the costs of the defect.

The project manager decides whether a cost is disallowed. This must be done in accordance with the contract, and a reason must be given for each disallowed cost through the certification process.

[edit] Related articles on Designing Buildings Wiki:

• Atkins v Secretary of State for Transport.
• Alternative Dispute Resolution legislation.
• Compensation event.
• Contract conditions.
• Cost reimbursable contract.
• Defect.
• Defined cost.
• Delay damages.
• NEC3.
• NEC contract change management systems.
• NEC early contractor involvement.
• Outturn cost.
• Period for reply.
• Target cost.
• Time Risk Allowance TRA.