Understanding Unabsorbed Home Office Overhead

It is readily apparent that – if a project is delayed – the contractor is losing money.  The increased direct costs associated with the labor and equipment on site are obvious. The more complex question arises when considering the effect a delayed project has on a contractor’s recovery of its home office overhead, where “home office overhead” is defined as the cost of the contractor’s main office including, but not limited to, rent, utilities, executive and management salaries, staff, office equipment, office supplies, taxes, insurance, etc.  Everyone intuitively understands that a delayed project increases such costs in the same manner that that delays increase the project’s direct costs but increases in home office overhead cannot be directly correlated to any one project because a contractor typically has several projects with overlapping schedules underway at any given time.  Over the years, courts have attempted to determine the damages necessary “to compensate a contractor for its indirect costs that cannot be allocated to a particular contract for the period during which the government has made contractual performance impossible.”  Charles G. Williams Constr., Inc. v. White, 326 F.3d 1376, 1380-1381 (Fed. Cir. 2003).  “As a result, there are at least nine formulas that have been used, with varying degrees of success, in litigation in the United States and Canada.”  Zack, Jr., James G., Calculation and Recovery of Home Office Overhead, CM eJournal, August 2001.

The most well known and widely accepted approach for determining compensable unabsorbed overhead is the Eichleay formula.  “[T]he Eichleay formula . . . relies on a daily allocable overhead rate, as an alternative to the fixed-percentage method.”  M.E.S., Inc. v. McHugh, 502 Fed. Appx. 934, 938 (Fed. Cir. 2013).  The theory is that each day the revenue from all the projects upon which the contractor is working will combine to, among other things, cover the costs associated with its home office overhead.  When a project is delayed, however, the delayed project fails to produce its share of the daily home office overhead and the contractor suffering damages because, in theory, the contractor would have moved on to its next project by the time it actually performs the delayed work resulting in a lost opportunity cost that is never recovered.

In light of the foregoing, “unabsorbed overhead is recoverable if the delay prevented the contractor from obtaining contracts during the delay period that would have ‘absorbed’ the ongoing overhead expense.”  Yacht West, LTD v. Christensen Shipyards, LTD, 464 Fed. Appx. 626, 629 (9th Cir. Or. 2011).  In other words, a contractor that can find replacement work, which allows his labor and equipment to keep working during the owner caused delay, has suffered no damages that are determinable using the Eichleay formula.  Of course, once a contractor commits to a project, it is typically impractical (if not impossible) for it to find replacement work – especially if the delay in question is of short duration.

Furthermore, “[i]t is inappropriate to use the Eichleay formula to calculate home office overhead for contract extensions because adequate compensation for overhead expenses may usually be calculated more precisely using a fixed percentage formula.”  Redondo Constr. Corp. v. P.R. Highway & Transp. Auth. (In re Redondo Constr. Corp.), 678 F.3d 115, 124 (1st Cir. P.R. 2012).  In negotiating additional work and/or a contract extension, a contractor is in the same position as when it is bidding on a project in the first place. When bidding on a project, a contractor typically adds a percentage to its calculated job cost to cover overhead and profit so there is no reason to believe that adding a percentage to the cost of change order work is not the most appropriate way to address home office overhead in that situation (although, in today’s competitive environment, contractors have been forced to bid work at cost and hope it can make up the overhead and profit by increased production and/or an aggressive buy-out).

In Connecticut, the state Supreme Court has “approved the general concepts used in the Eichleay formula without citing the case or adopting its rigid prerequisites . . . The Court observed that while other methods of computation might have been acceptable, alternative methods of determining damages for breach of contract may be employed to meet the exigencies of any given situation.  The test is the reasonableness’ of the method used.”  Paragon Constr. Co. v. Dep’t of Pub. Works, 2013 Conn. Super. LEXIS 789, 29-31 (Conn. Super. Ct. Apr. 5, 2013).  In light of the disparate results from the formulas that have been accepted by different courts, a contractor that has suffered delay damages in Connecticut (or any state that has yet to endorse any specific method for determining unabsorbed home office overhead) should carefully consider its options before submitting a delay claim.  See Calculation and Recovery of Home Office Overhead, supra.

If you have been delayed on a project and need assistance determining the best approach to calculate the value of your claim, please give me a call.

Scott Orenstein
(860) 760-3317

 

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