Completing the publication of its 2024 suite of contracts, the Joint Contracts Tribunal's (JCT) Target Cost Contract 2024 has now been released along with the target cost sub-contract and respective guides.
In this article, we explore the operation of the payment mechanism in the JCT Target Cost Contract, draw some comparisons with the New Engineering Contract (NEC) form of target cost contract and highlight some key considerations for using this contract in practice.
Under the JCT Target Cost Contract, the contractor is paid ‘allowable cost’, the ‘contract fee’ and any sum payable in respect of the ‘difference share’. These terms are considered in more detail below. The ‘difference share’ is what readers might know as a “pain/gain” share and the essence of the contract is that the parties agree a target cost, with the contractor sharing in any under or overspend in pre-agreed sums or percentages.
Like the JCT 2024 Design and Build Contract, the JCT Target Cost Contract:
JCT users will be familiar with many of the substantive provisions of the JCT Target Cost Contract which generally align with the JCT Design and Build Contract with the exception of the principle of target cost, however the structure of the JCT Target Cost Contract differs in places. For example, loss and expense provisions and the provisions relating to changes, which are contained in the main body of the conditions in the JCT Design and Build Contract, are instead contained in schedules to the JCT Target Cost Contract.
Our earlier article “JCT Design & Build Contract 2024 released: A summary guide for Employers and Contractors” gives a useful commentary on the specific clauses of the Design and Build Contract.
The target cost is the parties’ agreed total of the cost of carrying out and completing the works based on the information available at the time of entering into the contract. Schedule 1 sets out the circumstances in which the target cost may be adjusted (for example, for changes, fluctuation provisions and entitlement to loss and/or expense).
In response to the employer’s requirements, the contractor provides the contractor’s proposals and a target cost analysis. The target cost analysis is the pricing document for the JCT Target Cost Contract. It is important that the target cost analysis is as accurate as possible and sufficiently detailed as the stated rates and prices are used to calculate the adjusted target cost value of work completed for each interim payment and if selected, the ‘difference share’ paid in interim payments (see further below).
Schedule 2 sets out the items comprising allowable cost which includes the contractor’s management and design staff on site and the contractor’s direct workforce; details of which are required to be stated in the contract particulars. The parties may also agree lump sums, all-rates/ prices and maximum amounts for additional items stated in the contract particulars which are used instead of the actual cost of such items to calculate the allowable cost.
In the NEC4 Engineering and Construction Contract (NEC ECC), a similar concept is used (‘defined cost’). Where either of payment options C,D or E are used, the ‘defined cost’ comprises items stated in the ‘schedule of cost components’ less ‘disallowed cost’.
Unlike the NEC suite of contracts, with its concept of disallowed cost, the JCT Target Cost Contract does not contain an equivalent definition for that term. Rather, it lists costs which are not included in allowable cost. In the JCT Target Cost Contract (as is the case in the NEC ECC (options C,D and E)) the contractor is not entitled to payment of:
Discounts received (or which ought to be received) by the contractor and costs incurred by the contractor failing to comply with obtaining consent to, and conditions of, sub-contracting obligations are also excluded from allowable cost in the JCT Target Cost Contract. In the NEC ECC (Options C,D and E) all recoverable “discounts, rebates and taxes” are already deducted from the ‘defined cost’ instead of being stated within the definition of ‘disallowed cost’ which effectively achieves the same outcome.
The agreed ‘contract fee’ is inserted in the contract particulars as either a fixed sum amount or percentage of allowable cost.
If the contract fee is a fixed sum, there is a mechanism for the sum to be adjusted to reflect adjustments to the target cost (unless otherwise stated in the contract particulars). If the difference between the target cost and the adjusted target cost is equal to or above a stated percentage threshold, the contract fee is adjusted.
The percentage threshold above which the adjustment to the contract fee applies is stated by the parties in the contract particulars. If the parties do not state a percentage threshold, the default percentage threshold is zero. This means that there will be an adjustment to the contract fee for any changes to the target cost. Note that the contract fee can be increased or decreased, in line with the corresponding adjustments to the target cost. The higher the stated percentage threshold, the less the adjustment to the contract fee will be whether up or down.
Where the contract fee is defined as a percentage of allowable cost, there is no mechanism for adjustment, as the contract fee (calculated on a percentage basis) would automatically increase or decrease in line with allowable cost.
The parties share cost overruns and cost savings. In the JCT Target Cost Contract this is known as the “difference share”. The NEC equivalent is the “contractor’s share”, colloquially known as the “pain/ gain” mechanism. The agreed share percentages, bands or monetary sums are stated in the contract particulars. If none are stated, a default 50/50 percentage share applies.
Interestingly, the JCT Target Cost Contract allows the difference share to be assessed and applied to monthly interim payments as an alternative to just being calculated at final payment (or termination payment) stage, provided that the parties indicate this is to apply in the contract particulars. This reflects the JCT's intention in the 2024 contract suite to contractually encourage collaboration between the parties. Picking up any overspend early in a project should assist the parties to manage and mitigate further overspend. If no option is selected in the contract particulars, the difference share is calculated at final payment.
How does the calculation work in the two scenarios?
In the reverse of the scenarios above (i.e. where such total amounts exceed the adjusted target cost value of work completed or final adjusted target cost (as appropriate)), the parties share the cost overrun.
By comparison, in the NEC ECC (options C, D and E), the contractor’s share is preliminarily calculated on completion of the works and then finally assessed at final payment stage. There is no provision for calculation at interim payment stages.
The JCT Target Cost Contract is a welcome addition to the JCT's suite of contracts and a useful alternative to the NEC target cost ECC and likely to be embraced by those who want a target cost contract but have more familiarity with the JCT suite of contracts. The ability to reconcile the savings / overspend on an interim basis is also a useful option.
For more information, please contact Lois Putnam.
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