Recovery of Contractors Head Office Overheads

Compensation required by the contractor for extended or additional head office overhead can be one of the more controversial issues faced on construction projects. One of the less understood elements in construction damage claims is the head office overhead that is incurred when a project is delayed. However it is compensable and there is no doubt that head office overhead is an entitled expense of the contractor. However, the approaches for the calculation of the expense incurred have been widely debated as well as the circumstances under which the methodology should be applied.

There are many studies attempt to manage the HOOH claim effectively and quantify the unrecovered of HOOH during the project prolongation situation due to the client cause delays. Cateret Work Uniforms (1954), Eichleay Corporation (1960), Manshul Construction crop (1981), Finnegan Ltd (1989), Alfred McAlpine Heads North Ltd (1995) are some of contracting firms developed formulas to recover the HOOH loss. Meanwhile, Fordham (1995), Zack (2001), Tamm and Singh (2003) are most recent researchers on this area. They pointed out that the “HOOH costs are hard to calculate" (Zack, 2001), “obtaining a 100% accurate estimate of head office expenses is practically onerous" (Tamm & Singh 2003, p.234).

There are several issues are affecting the HOOH claim during the stages of initiation, quantification and evaluation. These issues generally restrain the HOOH claim and make dead lock. Specially, it is known that the reasonable choice of a quantification system will lead to the less disputes in this claim area. If a wrong quantification, may cause loss to one party and profitable to another party. This unrecovered HOOH is an actual loss to contractor, therefore the contractor shall claim with the actual cost he incurred during the delay. Consequently the selection of most suitable recovery or calculation method is critical for both clients and contractors.

To explore the HOOH claim process model, primarily this study identifies and analyse the existing HOOH claim related areas at the current. This session one reviews the construction cost and the taking part of the HOOH within it. The second section focuses on the unrecovered HOOH in detail manner and the chapter ended up with the review of formula approach to recover HOOH loss and the general summary.

1.2 Background

In the construction industry, where contract documents define rights, obligations, and procedures, a claim is a request by the contractor for an extension of time and/or additional cost and can evolve into a disagreement that may not be amicably resolved by the parties concerned (Clough & Sears, 1979; Jervis & Levin, 1988; Barrie & Paulson, 1992 cited in Abdul Malak et al, 2002). In any construction project, significant additional costs can be experienced by the contractor, the owner, or both, due to the actions of the other party or parties involved.

A major criticism facing the Sri Lankan construction industry is the growing rate of delays in project delivery. However in countries such as United State of America (USA), United Kingdom (UK) and Western Germany, Mobbs (1982) found that ‘construction time’ is better.

Even if just a few delay costs are exist, a variety of problems incur on contractors’ overhead costs both site overhead and head office overhead (Ibbs & Nguyen, 2007). An overhead cost can be defined as a cost that cannot be identified with or charged to a construction project or to a unit of construction production (Coombs & Palmer 1989 cited in Hobson & Holland, 1999). Overhead costs generally are divided into two categories (Peurifoy & Oberlender, 1989), such as job overhead costs or site overheads and general overhead costs or head office overheads. Head office overheads are usually posted to accounts that are not project related, and lumped together; they are called the head office overhead “pool" (Irwin, 2005). In normal practice, it is how this pool is allocated amongst the projects using some basis and varies from contractor to contractor.

The problem is that the site overheads are associated with the contractor’s individual projects but the head office overhead costs are not associated with any particular projects (NCHRP Synthesis 315, 2003). If one project is delayed such that no work is performed and no income from billings are received during the month and additional expense incurred when the completion of a project is prolonged beyond its scheduled completion date then a certain percentage of the business’s overhead expense is unrecovered and can presumably be attributed to the delay. This is called “unrecovered head office overhead." (Gregory et al, 1997).

In compensable delay cases, the contractor has the right to claim head office overhead loss or overburden (Taam & Singh, 2003; Scott, 1997). Many contract conditions like JCT98 clause 4.11(need to consider online artical http://books.google.co.uk/books?id=7eLWYZTltakC&pg=PA279&lpg=PA279&dq=jct+clause+4.11&source=bl&ots=yorhm9rb9Q&sig=PmkXhk7_x6X0J_qUjveX1ThWYLE&hl=en&ei=3OTsTMuAHMXLhAe828zODA&sa=X&oi=book_result&ct=result&resnum=8&ved=0CEsQ6AEwBw#v=onepage&q=jct%20clause%204.11&f=false), ICE 5 clause 1(5), FIDIC and ICTAD published conditions of contact are supporting to the above statements. The recovery of head office overhead from compensable delay is not new to law. Zack (2001) stated as far back as 1941 Federal courts awarded recovery of head office overhead to a contract for a government - caused delay.

Within the past four decades from the Eichleay formula development the construction industry has being filled up with more than thirteen formulas. Each approach is based on several assumptions and on the other hand they have several obvious and signification flaws (Kenyon, 1997). The alternative methods have similarities and significant differences. The utilisation of these methods to recover the unrecovered head office overhead creates many questions in application. Most of the contractors and clients still have the low confidential step in quantifying such head office overhead claims.

A need for an overall step-by-step procedure for HOOH claims analysis and administration is therefore crucial for achieving proper resolutions and for preventing claims from developing into disputes. The foremost step to develop this claim process tracking model, the current main issues of HOOH claim stages have to be identified. Further the causes and effects related to this HOOH claim initiation, quantification and evaluation stages need to be identified in order to establish a HOOH claim tracking model.

1.3 Construction Costs and Overhead Components

1.3.1 Construction Costing

The terms direct costs, indirect costs, job overhead, and general overhead are varying in meaning from construction firm to construction firm. Ahuja and Campbell (1988) define, that the construction costs into two classifications: direct and indirect. Direct costs are considered to be the costs for labour, materials, production equipment, and supplies that must be incorporated into a distinct feature of the completed work. Indirect costs include other items that are not made a part of the completed work such as contractors’ overheads, profit, contingencies, escalations, and interest during the construction period.

From the issues of direct verses indirect cost, the indirect construction cost can be defined as a cost that can be identified with a construction project but not a specific unit of production. The distinction between overhead costs and indirect costs is blurred further by their usage in the literature. One source uses the term ‘job overhead’ and ‘indirect costs’ for project overhead (Neil, 1981). Another source equates job overhead with general conditions and/or direct overhead (Dagostino, 1993).

Finally, this research defines that the direct costs is labour, material, production equipment, and subcontract cost, which is identifiable with a construction activity however the indirect costs cannot be related with the construction activity directly.

1.3.2 Overhead Costs

Overhead costs are those charges that cannot be attributed exclusively to a single product or services (Tipper, 1996), or the summary of expenses that benefit more than one cost objective (Fultz, 1980). Another definition states that the OH costs are costs meanwhile are not a component of the actual construction work but are incurred by the contractor to support the work (Cilensek, 1991). Pulver (1989) states that total overhead costs may vary from 8 to 30% of the sum of materials, labour, and equipment costs or from 12 to 50% of the labour costs, depending on the project characteristics.

Although overhead costs are extremely important in construction estimation, they can be easily overlooked. In fact, neglecting overhead has forced some contractors out of business because these costs constitute a significant portion of total construction costs. Furthermore, overhead costs rise continuously and never go down on their own, producing even higher production costs (Snodgrass, 1999).

1.3.2.1 Composition of Overhead Component

There are two major types of overhead costs in construction: HOOH costs and SOOH costs.

Figure 2.1- Overhead Components

1.3.2.2 Site Office Overhead

SOOH (project overhead) must be distributed over the associated project, since it cannot be allocated to specific work packages (Neil, 1981). SOOH costs include items that can be identified with a particular job, but are not materials, labour, or production equipment. SOOH includes expenses that cannot be charged directly to a particular branch of work, but are required to construct the project (Dagostino, 1993). Standard Method of Measurement of Building Works and ICTAD prepared Method of Measurement of Building Works (SLS 573) illustrates the comprehensive list of site office overhead items. The few of typical site office overheads are listed below as example;

Site office supply

Temporary telephone and the paying of all charges

Maintenance of site office, etc.

1.3.2.3 Head Office Overhead

HOOH is also called general and administrative OH and includes all costs incurred by the construction firm in maintaining the firm in business and supporting the production process, but are not directly related to a specific project (Adrian, 1982). HOOH costs vary considerably from time to time but range from 8 to 15% of the total construction volume (Pulver, 1989). This component can vary from every organization depending on the size, efficiency of the management, diversity of business taken, branches of the organization etc. HOOH normally consists of the fixed costs and time related costs of operating a head office. According to the Mccaffer et al (1994, p.164), Carr (1989, p.5), Damayanthi (1994, p.16) and NCHRP Synthesis 315 (2003, p.4), the typical items of HOOH are listed below;

Rents & Utilities

Auto mobile maintenance and travel costs

Other staff professionals’ fees and registration

Mortgage cost

Real estate taxes

Advertising costs

Non project related bond or insurance expenses

Depreciation of equipment and other assets

Office equipment & supplies

Interest payments

Legal services

Support and clerical staff not assigned to the field

Marketing costs

This Typical HOOH items were categorized into eight foremost HOOH categories with the base of ‘MAC Model Contract’ (MAC, 2008) and modified by brainstorming approach for application among the Sri Lankan contractors. The followings are identified as HOOH categories and all the HOOH items can be located within those appropriately.

Staff’s and Labours’ (Head Office) salaries and wages

Equipment and Plants related costs

Materials related costs

Charges (Head Office)

Insurance (Head Office)

Fee Schedule Constituent

Vehicles and travelling expenses

Miscellaneous Items (Others)

Identification of Typical HOOH Items in HOOH Pool

Staff’s and Labours’ (Head Office)

Wages and Salaries

Payments to people for

Bonuses and incentives

Overtime

Allowance for working in special circumstances

Other special allowance

Absence due to sickness and holidays

Statutory severance

Payments made in relation to employees

Travel

Subsistence and lodging

Relocation

Medical examinations

Passport and visas

Death benefit

Occupation accident benefits

Medical aid

Vehicle

Equipment and Plants related costs

Equipment maintenance

Unallocated plant

Equipment damage/ repair costs

Depreciation and maintenance of equipment

Materials related costs

Material yard maintenance

Payments for

Purchasing materials

Delivery to yard and removal from the yard

Samples and tests

Charges (Head Office)

Payment for

Leasing costs

Compensation for loss of crops or buildings

Inspection certificates

Advertising, leaflet drops and the like in connection with the services

Payment for

Specialist services (Advices etc)

Payment for

Head office building rental

A/C, sanitation, power, lighting and water

Depreciation and interest of capital assets

Supplies and consumable stores

Cleaning and maintenance

Telephone, telex, fax, post and electronic mail

Security

Copying

Computing

Stationeries

Recruitment and training of staff

Marketing and other external expenses

Refreshments and food

Insurance (Head Office)

Head office related resources ( including employee, equipments, assets etc) – premiums

Fee Schedule Constituent

Payments for

Franchises, Royalties, Licences

Accounting and Auditing

Research and Development

Publicity, Marketing

Entertainment

The amount of any excess borne by the contractor in respect of any claims under Employer’s liability

Finance and Interest charges

Quality assurance

Health and safety

Training

Tendering

Supply chain (LC)

Legal costs

Vehicles and travelling expenses

Vehicle maintenance

Vehicle damage and repair

Fuel charges

Parking charges and fines

Miscellaneous Items (Others)

1.3.3 Allocation of Head Office Overheads to Projects

1.3.3.1 HOOH Cost within the Tender Sum

Tender sum derived from all the costs which incur when carrying out the contract.

Figure 2.2 – Tender Sum Components (Source: Jasitha, 2001)

The HOOH cost percentage of the contractors are estimated based on the annual turnover and the total overhead cost and added within the tender sum through mark up.

1.3.3.2 Methods of Including HOOH Cost within the Tender Sum Formation

Include as a percentage in the unit rates of the BOQ

All the HOOH costs are included in the unit rates.

Front loading – Add more HOOH cost to early stage billing work items.

Back loading - Add more HOOH cost to end stage billing work items.

Smooth distribution – Equal distribution among work items.

Added as a amount within the tender sum

In this case the estimated HOOH cost id inserted within the tender sum as lump sum amount and no allocations within the rate.

1.3.3.3 Allocation Base of Head Office Overhead

There are seven possible bases that can be used to estimate the amount of HOOH that has to be allocated to a project at hand. The allocation bases are listed below.

Project duration

Number of projects

Project bid value

Material cost

Material and labour cost

Material, labour and equipment cost

Direct cost including project OH

Fixed amount is added (Source: Al Shahri et al, 2000; Pulver, 1989)

1.3.3.4 Factors Affecting the Magnitude of Head Office Overhead Allocations

In many instances, the top managers in contracting companies not consider the actual figures coming from the estimators, but insert the HOOH cost as lower or higher values. Contractors may choose to do so because of;

The nature and type of the contract

Project complexity, location and size

Need for work

Payment schedule

Contractor’s cash availability

Client’s strictness and nature

Percentage of subcontract work

Number of competitors (Source: Al Shahri et al, 2000; Pulver, 1989)

1.3.3.5 Reasons for Increasing Head Office Overhead Costs

This question investigates the potential causes for increased HOOH costs. Knowing the major sources of high HOOH costs helps in concentrating efforts towards specific causes. Seven potential causes were identified from the literature. It should be noted that some causes of increased HOOH costs are inter-related, which makes it difficult to evaluate them individually. For example, a decision to expand the company, which stands as a cause of increased HOOH costs by itself, involves also marketing costs and constitutes an inter-organization mistake if taken at the wrong time. The main causes for increased HOOH are listed follows.

Lack of new projects (recession)

Cost inflation

Delayed payments

Government regulation

Increased marketing cost

Client related reasons

Firm's growth

Other (internal mistakes)

1.3.4 Head Office Overhead Practice in the Local Contractors

1.3.4.1 Head Office Overheads of the Contractors

All local contractors have the clear idea on the HOOH and they included certain amount as overhead expenditure within the mark up percentage. Head office expenditures differ from contractor to contractor however this differentiation is in low level between same grade contractors and more between different grade contractors (Damayanthi, 1994). The way of identification of the HOOH items also differ from contractor to contractor.

It was identified that within the HOOH items the highest proportion of the HOOH is for directors salaries and the second is staff salaries (Damayanthi, 1994). It is clear that each and every department of the firm involves different level within the particular project and incurs the expenditure. The total HOOH cost for the particular project has to feed all the departments in a proportional way.

1.3.4.2 Quantification of Head Office Overheads

The most commonly used allocation mechanism is to total all HOOH costs for a given accounting period (fiscal year) and scale them against the total direct costs for the same period, which gives the percentage of HOOH costs that can be applied to forthcoming projects (Adrian, 1982; Frank, 1984). After the overhead rate is calculated, it is added to the total estimated direct costs of the projects in hand.

This quantification calculated form the past accounts data related to turnover and the HOOH cost.

The expected adjustments are made to the past data on behalf of inflation, recession in construction market and the resource recruitment within the company etc by the contractor. If the contractors may reduce the HOOH through proper utilization, they can enter into better competitive bid.

1.3.4.3 Allocation and Recovery of Head Office Overheads

The contractor needs to recover these costs by allocating these costs to the projects it performs. In construction contracting, the HOOH is normally added to the bid or contract price as a percentage of the direct cost amount. The number of projects that a contractor has during a given period affects the markup percentage that he would allocate to any given project. The existing studies (Damayanthi, 1994.) shows that the Sri Lankan contractors do not have the proper check before the end of the financial year whether they have recovered the amount of HOOH for the year or not. That study further stated that the contractors wait until the end of project to monitor the HOOH recovery from the particular projects.

1.3.5 The Government Directives Concerning on Overhead in Sri Lanka

The government of Sri Lanka has issued several directives relation to construction overheads development, inclusion and recovering. The “Financial regulations of Ceylon" published during the colonial era and the “Financial manual of Sri Lanka" stipulates that the overhead components should be included within the BOQ item rates. This implementation cut off the requirement of separate preliminary section in the BOQ. In 1972 the General Treasury has issued a circular pointing out that the State Engineering Cooperation of Sri Lanka entitled to add 35% of the basic cost as overhead and profit component. The Sri Lankan construction consortium classified the Local construction organizations as class A, B and C. According to grade the contractors were allowed to insert overhead and profit component as 35%, 30% and 25% respectively. The fixed overhead concern replaced in 1988 with the ICTAD. They implemented the pricing of primary bill separately. This has to be cost with important site overhead items by respective tenderers. The ICTAD recommendations and implementation mandated in 1990 for state projects (Damayanthi, 1994).

1.4 Unrecovered Head Office Overheads due to Compensable Delay Events

1.4.1 Delays and Construction Costs

Contract delays are common to construction industry. They occur with exceptional frequency and with virtually every contract change. Consequently, when a delay occurs that increases a contract’s performance time and the contractor’s costs of performing that contract. Because the construction costs are time dependent.

Table 2.1 - Delays Categorisations (Source: Niesse, 2004)

Delay Type

Responsible Party

Time Extensions

Monetary Compensation

Excusable

Neither

Yes

No

Excusable/ Compensable

Owner

Yes

Yes

Non Excusable

Contractor

No

Noa

Critical Concurrent

Both

Yes

Nob

a - Owner may assess liquidated damages, b – For concurrent period

The above table shows the delay categories and the entitlements of the parties in each category. Specifically the HOOH claims falls within an excusable and compensable delay can be defined as a delay caused by an owner’s actions or failure to act, which entitle a contractor to additional time and compensation (Braude, 1997).

Fordham (1995) explains the unrecovered overhead as follows. Every contract usually requires a contractor’s commitment of resources such as facilities, equipment, machineries and personnel. During the early stage of the projects the commitment of these resources is minimal but it increases as performance continues and level off or reduce with contract performance close. Commonly, the firm must allocate adequate resource capacity to perform at the maximum level of required effort. Once that peak has achieved, the firm must relocate the excess resources according to the requirements. At the end of the project stage the firm may invest those resources within the next project.

The consequence of delaying all or some part of the contract work is generally to reduce the amount of planned contract activity in the original performance period and delays not only cause performance of the work to occur in later time periods but the company must also retain the resources in the certain level of effort necessary to complete the contract over a longer period of time. This situation increases the contractors’ costs.

1.4.2 Compensable Damages

Compensable damages are damages that compensate the claimant for losses or costs incurred because of a breach or a wrong committed by another party within the contract. A category of compensable damages is ‘‘consequential damages’’ that flow from a breach of contract but are not the direct result of it. The damage arises not as a result of ordinarily predictable factors but from the intervention of circumstances not directly involved in contract performance. For example, the resultant effect of a delay in the completion of a project for a contractor, the resultant effect of a similar event would be unrecovered, extended, or increased HOOH or SOOH expenses. When a compensable delay occurs, damages usually result in five different areas. These areas are an increase in labour costs, material costs, equipment cost, SOOH expenses, and HOOH expenses. HOOH damages due to delay are a very controversial issue and is an area that is difficult to understand. Yet, in many cases, it can be the largest component of the delay claim (Taam & Singh, 2003).

1.4.3 Unrecovered Head Office Overhead

1.4.3.1 What is Unrecovered HOOH?

The concept of unrecovered HOOH as an item of damages arises at least in part from the basic accounting concept that all business costs are incurred to support ultimate, specific revenue generating objectives and therefore should be allocated to these objectives. HOOH costs do not directly benefit any specific objective; therefore, the overhead is referred to as ‘‘indirect’’ costs.

If the delay is attributable to extra work, the contractor may receive HOOH compensation from the markup on a change order. If there is no extra work and project experiencing delay, then the contractor face under recovery of HOOH from the particular project. In general, if a project is suspended or delayed, the contractor experiences extended HOOH. Contractors may or may not incur additional expenses. However, since it is very difficult to determine extra resources used in the head office, courts have allowed contractors to claim for unrecovered HOOH, regardless of actual expenses (Taam & Singh, 2003).

Effects of Delay on Contractors’ HOOH

Shortfall of turnover

Displaced turnover

Figure 2.3 Illustration of Delay Effect on HOOH (Source: Kulatunga, 2001)

Project turnover

Short fall in turnover caused delay

Displaced turnover due to delay

Line ‘a-a’ represents the contractors’ anticipated or actual HOOH. Line ‘b-b’ represents the contractors’ anticipated turnover on all projects. Profile ‘c-c’ represents the contractors’ anticipated turnover on the particular project. Profile ‘d-d’ represents the contractors actual turnover on the present (delayed) project. Profile ‘e-e’ represents the contractors’ actual turnover on all projects.

There is a time dependent relationship between the contractor’s costs and its contracts. The cost allocation structures of the most firms are based on this concept. An example of such a performance based allocation system is overhead cost allocation. In such allocation structures, the consequence of a delay is to reduce the planned pattern of fixed overhead cost allocation (recovery) for the delayed contract.

The result is that overhead costs are misallocated to other contracts. This misallocation of indirect cost has been termed "unrecovered HOOH".

1.4.3.2 Unrecovered Head Office Overhead Claim

An element of contractors’ claims which can prove particularly problematic for those charged with ascertaining the same is that relating to the recovery of HOOH and loss of profit. It is now accepted practice, on the grounds that it is settled law, that the recoveries of HOOH are allowable heads of claim (Hackett & Trickey, 2001).

Reimbursement of the HOOH costs is the important element in a prolongation claims when a project delayed. However such a claim, and the basis upon which it is made, is often misunderstood. In simple terms a contractor may seek reimbursement of its HOOH costs in one of the two alternative ways (Molloy, 2001):

As lost opportunity costs; or

As additional overheads actually expended as a result of the delay

In case of lost of opportunity cost due to delay arises from the inability of the contractor's organization to free move to another project and earn the combined profit and HOOH of which it is reasonably capable. In order to pursue the HOOH claim on the base of opportunity costs approach it is necessary for the contractor to prove the following:

That the HOOH represents a reasonable one by reference to audited accounts for the appropriate period.

Prove on the same level of HOOH recovery was available during the period of delay.

That the method of working of the Contractor was suitable for this approach. This can be proved by showing that the Contractor is actively seeking extra work during the period of delay, and by providing details.

The best a contractor has to do is to be aware of the need for such evidence and ensure that records of how delays are affecting HOOH.

Whilst the opportunity costs approach provides a straightforward and easy method of calculation, and whilst it is probably easy in principle to prove an entitlement to opportunity costs, the reality is that evidence will be far from easy to provide.

However, in the more recent construction cases, the court affirmed that there was no objection in principle to a claim for extended HOOH, and further that there was no objection in principle to such a claim being calculated by reference to a formula. Here it should be noted however that in this case the court in fact refused to adopt such an approach principally because it was the contractors’ working arrangement that they only ever undertook one construction project at a time and did not undertake another until the project was complete. It was therefore inappropriate to use opportunity costs as the basis of calculation (Molloy, 2001).

Accordingly Molly (2001), the second method of calculating a HOOH claim is the actual costs approach. The basis of this claim is that the prolongation has resulted in the contractor allocating more overhead expenditure to the project than was originally contemplated at the date of the contract.

1.4.3.3 Contractual Provisions for Head Office Overhead Claims

Conditions in JCT Contracts (internet article to consider, http://goliath.ecnext.com/coms2/gi_0199-2007323/Changes-to-the-JCT-Standard.html)

In JCT 80 the clause 26 permits claims for both disruption and delay (prolongation). Clause 26.1 refers to ‘the regular progress of the works or any part thereof materially affected by anyone or more of’ the matters listed in clause 26.2, which, it is said, means that it is only delay in progress which can be compensated and that the effect upon the progress is to be equated with ‘delay’, that ruling out any claim for loss of productivity.

Conditions in FIDIC Contract

FIDIC fourth edition mentions the compensable delay situation very clearly. FIDIC provisions are less problematic to practice because it has clearly defined the adjustment of price by stating the cost and profit provisions (refer Table 2.2).

Conditions in ICTAD (SBD 2)

In Sri Lanka the most popular form is ICTAD conditions of contract. This form was developed based on FIDIC third edition. In this form some clauses are not directly expressing the time extensions and the compensations (refer Table 2.3).

Table 2.2 - HOOH Claims Provisions in Fourth Edition of FIDIC Conditions of Contract

Clause Number

Employer - Caused Delay

Adjustment to Contract Price

5.2

Ambiguities in documents

T + C

6.3

Drawing delay

T + C

12.2

Physical conditions

T + C

17.1

Setting out

P + C

20.3

Repairs and employers risks

P + C

36.5

Tests

P + C

40.2

Suspension

T + C

42.2

Late possession

T + C

52.1

Variations

P + C

69

Default by the employer

T + C

(C-Cost, T-Time, P-Profit) (Source: Caulton, 1991)

[Table – 2.3 - HOOH Claim Provision in ICTAD Conditions of Contract

No

Head of Claim

Original Clause

Claim Clause

Time Clause

Payment Clause

1

Ambiguties, descrepancies in contract document

5.2

5.2

44

52.5

2

Late issue of drawings

6.4

6.4

44

52.5

3

Errors in setting out due to incorrect information by engineer

17

17

44

52.5

4

Suspension of work

40

52.4

44

52.5

5

Failure to give possession of site in due time

42

42

44

52.2

6

Variations

51

52.4

44

52.2

7

Nominated sub contractors

59

29.4

44

52.2

8

Payment due to default of employer

69

65.8

(Source: Upul Shantha, 1992)

1.5 Current Head Office Overhead Recovery Techniques

Eichleay Formula

The Eichleay Formula originated from a decision by the Armed Services Board of Contract Appeals in 1960, Eichleay Corporation v. United States case. In its appeal before the Board, the Eichleay Corporation proposed a formula for calculating the damages. The Board accepted this formula as a reasonable method for calculating the damages (Trauner, 1990).

Contract Billings x Total Company Overhead = Overhead

Total Billings for During Actual Contract Allocable to

Actual Contract Period Period Contract

Allocable Overhead = Overhead Allocable to Contract / Day

Actual Days of

Contract Performance

Daily Overhead Rate x Days of Owner-Caused = Head Office Overhead

Delay Owed

The Eichleay Formula first determines the allocation of HOOH for a particular project. Next, it takes a portion of the allocation and applies it to the total days of performance, which results in a daily HOOH cost. Finally, the Eichleay Formula calculates compensation due to a contractor for an owner caused delay by multiplying the daily HOOH rate with the days delayed. The formula is an attempt to provide a realistic basis for allocating HOOH costs.

2.0 Modified Eichleay Formula – Variation 1

The first modification to the Eichleay Formula is set forth below:

Contract Billings x Total Company Overhead = Overhead

Total Billings for During Original Contract Allocable

Original Contract Period Period to Contract

Allocable Overhead = Overhead Allocable to Contract/Day

Original Days of

Contract Performance

Daily Overhead x Days of Owner-Caused = Head Office Overhead

Delay Owed

This formula attempts to allocate HOOH for the original contract period first to the project and then on a daily basis to determine the compensation owed. However, it assumes that the HOOH rate from the original contract period should hold the same even during the delayed period.

3.0 Modified Eichleay Formula – Variation 2

Eichleay Formula a later variation of the follows:

Contract Billings x Total Company Overhead = Overhead

Total Billings for During Original Contract Allocable

Original Contract Period Period to Contract

+ Contract billings for

Extended Period

Allocable Overhead = Overhead Allocable to Contract / Day

Original Days of

Contract Performance

Daily Overhead x Days of Owner-Caused = Head Office Overhead

Delay Owed

Like the first variation to Eichleay, this formula attempts to allocate HOOH for the original contract period first to the project and then on a daily basis to determine the compensation owed. It adds into the calculation the value of contract billings during the extended period in an attempt to compensate for overhead costs spread over a longer period of time.

4.0 Hudson Formula

The Hudson Formula is set forth below:

Planned Head Office x Original Contract Sum = Allocable Overhead

Overhead & Profit % Original Contract Period Per Day

Allocable Overhead x Period of Owner-Caused = Head Office

Per Day Delay Overhead Owed

This formula was created by the courts in the United Kingdom and later exported to Canada. It derives its daily HOOH rate on the basis of the as-bid calculations and assumes that the bid rate should hold constant throughout the life of the project.

5.0 Ernstrom Formula

The Ernstrom Formula can best be explained with the following formula.

Total Overhead for Contract

Period (All Projects) = General Labour / Overhead Ratio

Total Labour Costs for Contract

Period (All Projects)

Labour / Overhead Ratio x Labour Costs During Delay = Overhead Allocable to

Delay

This formula rests on the theory that there is a direct relationship between overhead costs and labour costs that can be calculated and applied to a delay situation. That is, as labour costs grow so do the corresponding HOOH costs. Thus, by calculating this ratio and applying it to the amount of labour expenses incurred during a delay period, the amount of damages due to the delay can also be calculated. Since this is a ratio formula, it does not develop a daily HOOH cost but rather calculates a lump sum cost.

6.0 Manshul Formula

The Manshul Formula is shown below:

Cost of Work Performed x Contract Cost % = Direct Cost

During Delay Period Cost + Mark Up %

Direct Cost Incurred x Head Office = Head Office Overhead Owed

During Delay Period Overhead %

This formula has also been referred to as the Direct Cost Allocation Method. It is a creature of the courts in the State of New York. When New York courts rejected Eichleay, they were challenged to pose a substitute method of calculating overhead and created this formula. It does not arrive at a daily overhead rate. Rather, it uses the as-bid HOOH rate times the cost of work performed during the delay period to determine the overhead used.

7.0 Carteret Formula

The Carteret Formula is displayed below:

Actual Overhead Rate during - Normal Overhead Rate = Excess

Delay Period Overhead Rate

Excess Overhead Rate x Total Cost of Work during = Head Office

Delay Period Overhead Owed

Carteret is a formula that comes out of the manufacturing sector, but some have attempted to apply the formula to construction delay cases. It assumes that there is a differential in overhead rates during a delay period and calculates this difference. The formula then multiplies this rate differential times the cost of work performed during the delay period. Since this is a cost-based formula, like Manshul, it does not derive a daily rate. The problem with this approach is that if no rate differential can be shown, then no HOOH is owed.

8.0 Allegheny Formula

The Allegheny Formula is set forth below:

Actual Overhead Rate during - Actual Overhead Rate during = Excess

Delay Period Entire Project Performance Overhead

Period Rate

Excess Overhead Rate x Contract Base Cost = Head Office Overhead

Rate Owed

Like Carteret this formula comes to the construction industry from the manufacturing sector. And, like Carteret and Manshul it is cost based, not time based. Thus, it does not derive a daily overhead rate but calculates overhead from the rate differential times the base bid cost. Again, if no rate differential can be demonstrated, then no HOOH is owed, even if owner caused delay is present.

9.0 Emden Formula

The Emden Formula is displayed as follows:

Total Overhead & Profit * / Total Company Turnover ** x

100

Gross Contract Sum x Owner-Caused Delay Period = Head Office

Overhead Owed

Planned Contract Period

* Total company overhead and profit during contract period

** Total company revenue for contract period

This formula is a creature of the Canadian Courts. Its approach is similar to Eichleay in that it attempts to allocate total HOOH to a project on first a proportionate basis and then a daily basis. It utilizes both overhead and profit costs as a part of the calculation and then multiplies the result times the amount of owner-caused delay incurred.

10.0 Burden Fluctuation Method

This method determines unrecovered HOOH by finding the increase in the absorption rate and allocating that increase to the non contract work, which was forced to bear more than its fair share of HOOH expenses. The burden fluctuation method has been used by courts and boards to calculate manufacturers’ unrecovered HOOH claims.

Total Billings - Contract Billings = Other Contract Billings

Actual Overhead Rate - Potential Overhead Rate = Burden Fluctuation

Burden Fluctuation x Other Contract Billings = Unrecovered Overhead Claim

11.0 The Canadian Method

This method is used extensively in Canada (Trauner, 1990). The Canadian Method uses the contractor’s actual markup for overhead in its calculation. This markup is based on bid documents or audit records. An audit of the contractor’s records will determine a percentage based on history.

[Percentage Markup (from bid docs or audit) x Original Contract Sum] ÷

Original Number of Days in the Contract = Daily Overhead Rate

Daily Overhead x Number of Days of Compensable Delay = Compensation for

HOOH

12.0 Total Direct Cost Allocation Method

The Total Direct Cost Allocation Method allocates the direct costs incurred to calculate the overhead rather than what has been billed (Hewitt, 1986). The calculation for the method is as follows.

x

=

Overhead Applicable Disputed Contract Direct Costs Total Company

to the Disputed Contract All Other Contract Direct Costs Overhead

(OHDC)

Daily Overhead Rate (DOR) = OHDC ÷ Days of Contract Performance (less delay

days)

HOOH Cost Claim = DOR x Days of Delay

13.0 Specific Base Allocation Method (SBAM)

SBAM is a substantially accurate allocation approach, but is also considered the most complicated and expensive to use (Hewitt, 1986). SBAM allocates overhead costs based on the specific characteristics of a job and each overhead cost element. SBAM would only be a practical approach if the methodology for collecting data was already in place or when the claim amount can justify the analysis expense. The method involves creating indirect cost pool accounts and a basis for allocating the accounts to each contract. This involves developing, comparing, and establishing cost relationships for all elements. The costs for overhead items are allocated to each job based on the established percentages of the overall item cost. Of the various established techniques, SBAM comes closest to counting the dollars in detail the exact way they are allocated.

Allocation Basis (AB) = Allocation Item Cost on Disputed Jobs

Allocation Item Cost on All Jobs

Allocated Overhead of Pool Account (AH) = Pool Account Cost x AB

Average Daily Overhead (ADOH) = AH ÷ Total Contract Days

Claimed Overhead Costs = ADOH x Days of Delay

14.0 Calculation Based on Actual Records

In the calculation of damages based on actual records, the contractor needs to provide detailed accurate records of his HOOH expenses that will support his claim. In providing the records, the contractor will need to determine the percentage of effort expended for this project performance period or during the delay period. This percentage can be applied to the fixed HOOH costs, which will result in an allocation

for the particular project (Trauner, 1990). This procedure requires detailed accounting procedures, from a record-keeping standpoint, which can be quite onerous. However, the effort may produce substantial benefits to the contractor, which might otherwise not be realized (Ernstrom & Essler, 1982). This method is very accurate if used precisely, and requires no formulas, which is a welcome benefit.

1.6 Critical Review on HOOH Claim in Local Context

There are some recovery of contribution to HOOH in owner caused delay claims has been come up and claimed with some formula approaches such as Hudson, Emden and Eichleay formulas. They do not, however, take particular account of the differing natures of the key players in the market, and the variable added value that each contributes to final output.

The pilot study stipulates the several conflict concepts between the contractor and the consultant in relates to unrecovered HOOH in owner caused construction projects. From the contractor’s perspective, delay (owner caused) and unrecovered HOOH can significantly affect the cash flow of the contractor. The reduction in the stream of income from the project causes the substantial reduction on contractor’s cash flow. In short, the owner’s perspective tends to be that a contractor has agreed to construct a project for a set of unit prices, or even a lump sum, no matter when that construction occurs. Here the owners see the contractor’s HOOH as a constant expense unaffected by when the construction delayed.

In Sri Lanka most owners recognize that contractors are generally entitled to additional compensation when a delay is caused by the owner however they are frustrated with the contractors’ claim procedures and the quantification approaches. Therefore the unrecovered HOOH becomes an issue that has great potential for conflict, such conflict could become more extreme in cases where unrecovered HOOH claim is the only vehicle, from the contractor’s perspective and that are not allowed because of other contract provisions and employers’ evaluations.

1.7 Summary

This literature survey was done with the intention to derive three main outcomes such as deriving a typical HOOH items for the contractors, identifying the current HOOH quantification techniques and strengthen the back ground of this research with available literature. The typical HOOH items were identified and categorized under eight main cost items based on ‘MAC Model Contract’ (MAC, 2008) and brainstorming, further it is tested on the cross case analysis session among the contractors. Meanwhile the literature survey also identified the current unrecovered HOOH quantification techniques in the whole construction industry. There were fourteen techniques has been identified among several countries and illustrated with the explanations in the literature body. The formula approach and actual method are currently practicing in Sri Lankan construction industry, even though the most contractors want to use formulas to calculate their damage but on the other hand most clients want to see the actual damage. On this point the reasonable claim process tracking frame work to calculate and claim the unrecovered HOOH cost is very useful to avoid HOOH claim from dead lock.