Calculation of Head Office Overheads Entitlement for Delays
Employer delays or delay resulting due Employer assumed issues is common within the construction industry. Delays may have many sources, including directed or constructive changes, delays in furnishing Employer issue equipment or materials, differing site conditions, slow approval of Contractor shop drawing submittals or requests for information, etc.
Despite the number of reasons for Employer related delays, the end result is almost always the same. The Contractor typically submits a loss and expenses claim request an equitable adjustment to the contract amount to compensate the Contractor for both time and cost. It is often difficult for Employer or the Employers Contract Administrator and Contractor to reach agreement on the causes of delay. Contractors tend to view most delays as the responsibility of the Employer. Employers, on the other hand, often try to label such delays as either third party-caused or concurrent delay, either of which results in excusable, non-compensable delay. Delay analysis usually sorts out this argument one way or the other.
Once agreement is reached between the Contractor and Employer concerning the causes of the delay, the argument then turns more technical attempting to establish the extent of the delays. Due to the complexity of modern-day scheduling and multiple ways to perform delay analysis, negotiations over the extent of a delay are often protracted. Delay analyses performed by two different parties, on the same incident, can yield results substantially at odds with one another. Generally, however, if both the owner and the contractor stay focused on resolution, some agreement can be reached on both the extent of delay and quantification.
The argument now turns to financial impact as a result of the delays. Provided that the Contractor maintains reasonably good job cost records, determining daily field office overhead costs should not prove terribly difficult to an experienced Contractor. However, in Employer instigated delay situations, Contractors frequently seek recovery of extended or unabsorbed head office overhead cost. This is where negotiations often reach a deadlock as there is no industry accepted way of calculating these costs. Most Contractors want to use formulas to calculate their damage. Most owners, on the other hand, want to see the so-called real damage based on some sort of audit and seek the Contractor to prove his additional cost.
Before examining the options available for recovery of Head Office Overheads we should define what are Head Office Overheads and typical costs which maybe included within them.
Head Office Overheads can be defines as company costs incurred by the Contractor for the benefit of all the projects in progress and is deemed the actual cost, which is an essential part of the cost of doing business.
These are costs should not be directly attributable to a specific project.
Examples of Head Office Overheads would normally be:
Executive and Administrative Salaries
Legal and Accounting Expenses
Head Office Rent and Expenses
Utilities, Telephone, Fax and Computers
Head Office Equipment Costs
Human Relations Costs
Interest on Company Borrowings
Travel for Head Office Staff
Depreciation of Company Assets
The Contractors has two avenues open to him in respect to claiming for overhead costs he may adopt either an actual cost approach or a lost opportunity approach.
The lost opportunity approach is made on the premise that because of the delay the contractor’s organization is unable to move on to another project and earn the combined profit and head office overheads so the opportunity to earn elsewhere is lost.
The actual cost approach is simply the identification and cost of the head office overheads affected by the delay.
The lost opportunity approach is by far the most popular with contractors, for two reasons. Firstly, because the actual costs are extremely difficult to identify and prove, and secondly, because the lost opportunity approach uses a formula for its calculation. Contractors generally prefer to use a formula to calculate head office overhead costs and it is easy to see why. The formula calculation approach is simple, cheap and quick whilst at the same time produces an entitlement with minimal effort.
The two formulae commonly adopted by Contractors for such calculations are the Hudson’s formula and the Emden formula. The Hudson’s formula was first produced by Mr. Duncan Wallace and published in Hudson’s Building and Engineering Contracts.
The Head Office Overhead percentage adopted in the Hudson’s formula has received judicial support in a number of cases. However the formula is criticised by many principally because it adopts the head office overhead percentage from the contract as the factor for calculating the costs, and this may bear little or no relation to the actual head office costs of the Contractor. In an attempt to improve upon the Hudson’s formula an alternative was published in Emden’s Building Contracts and Practice.
The Emden formula of Head Office / Profit percentage is Head Office percentage, arrived at by dividing the total overhead cost and profit of the Contractor’s organization as a whole by the total turnover had the advantage of using the contractor’s actual Head Office / profit percentage rather than the one contained in the contract and has received judicial support in a number of cases.
These two formulae were used extensively until the use of formula, and indeed the opportunity costs approach in general fell out of favour following the case of Tate & Lyle where the court would not accept a calculation of head office overheads based upon a simple percentage, and stated that it was necessary to prove actual additional costs incurred rather than the approach of a hypothetical loss of opportunity. Many in the industry considered that the ruling in this case would bring an end to the recovery of head office overhead claims based upon the loss of opportunity by use of a formula. However, the difficulties of proving the actual additional costs incurred in respect of head office overheads led the courts yet again towards adopting formula to establish head office overheads on the lost opportunity principle.
Contractors have thus continued to use of the Hudson’s and Emden’s formulae for the preparation of claims for head office overheads, provided of course the Contractor can prove that due to the delay he has in some way lost the opportunity to fully earn the head office overheads on other projects. Where the Contractor cannot prove such, then he will need to revert to actual cost approach.
A third formula with its origins rooted in American is the Eichleay formula and the courts have taken account of this approach where the contractor is unable to prove lost opportunity but has to revert to actual cost. This formula is calculated by comparing the value of work carried out in the contract period for the project with the value of work carried out by the Contractor as a whole for the contract period. A share of head office overheads for the contractor can then be allocated in the same ratio and expressed as a lump sum to the particular contract. The amount of head office overhead allocated to the particular contract is then expressed as a weekly amount by dividing it by the contract period. The period of delay can then be multiplied by the weekly amount to give a total sum claimed.
The use of formula to calculate head office overheads is succeeding and gaining the courts approval with the adoption of the Hudson’s formula or more commonly the Emden’s formula where the Contractor can prove some lost opportunity to recover contributions to head office overheads from other projects, and the Eichleay formula can be adopted where a claim based on actual costs is more appropriate.
Finally there are a number of other formula which have been proposed for use in the calculation of Contractors Head Office Overheads, namely Enrstrom Formula, Carteret Formula and Allengheny Formula. We have not addressed these in this article as these have not really been adopted to any great extent within the Industry.