Should Overhead Recovery Be Limited to a Percentage of Cost?

When the construction performance period is extended beyond the original schedule, a contractor incurs overhead costs. The time in the field, with its associated costs, is extended. Additionally, contract payments are spread over a greater period of time, reducing the rate at which the contract absorbs its share of fixed home office expenses. If the extended performance period was the responsibility of the project owner, the contractor will want compensation. How should that compensation be calculated?

In a recent federal court case, a contractor had encountered undisclosed site conditions and faulty design documents. These problems had caused the public project owner to issue a series of contract modifications, changing the work, increasing the compensation to pay the direct cost of that work, and extending the performance period. The contractor wanted to calculate its overhead costs using the so-called “Eichleay formula,” which is used to measure unabsorbed home office overhead. This would have produced a rather generous recovery.

The contractor was stymied, however. Under federal contracting law, when the performance period is extended by compensable extra work, extended overhead must be calculated as a percentage of the direct cost of that work. The percentage should be consistent with the overhead markup the contractor carried in its bid. The markup is presumed to cover extended overhead in the field. It is also presumed to absorb the contract’s share of home office overhead during the extended performance period. The recovery is far less generous than what would be produced by the Eichleay formula.

Is this rule – which has not necessarily been adopted in the state courts – fair? What if the changed work directed by the project owner increases the direct cost of contract performance by one percent but extends the performance period by 20 percent? Will a percentage of the increased direct cost compensate the contractor for its extended field overhead and extended absorption of home office expenses? I welcome your comments.

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Comments

[Scott Piper]

I believe it depends on who's schedule you are using. Assume a retail client wants a store complete by Nov. 1 for the holiday season and the contractor intends to hit the job hard and get in and out before Oct. 1. Should the contractor get more overhead if the owner makes changes that force an extra month of work (but still gets everything complete by the Nov. 1 date)? In this instance I think the Owner's schedule has been mantained so the contractor is not due any additional overhead. If the Owners changes prolong the project past the original owner established completion date then the addtional overhead is legitimate.

[Ron Cilensek]

There are 2 components of a contractor's overhead; field overhead and home office (general & administrative or G&A) overhead. Field overhead is genearlly a function of project duration, so if the project performance period is extended, the field overhead should be extended accordingly. Home office overhead is a completely different matter; it is a relatively fixed cost that is recovered by allocation against the total cost of all work, including contract changes. This allocation of home office expense is expressed as a percentage compared to the cost of all work, and does not increase with extended performance of any one particular project. Therefore, the application of a percentage amount for home office overhead to the direct cost of the change work is appropriate.

[Michael Peters RA Esquire]

Ron, I agree; but isn't the Eichleay formula essentially the most widely accepted mathematical expression of the principle you describe (though not perfect in all situations)? And if so, the court said that in this situation (which was hardly unique, we're going to use a different (and less widely-accepted) calculation.

[GC]

It sounds to me as if the contractor had selected the option of percent of work for overhead cost allocation instead of per diem. This is a selection made at the time of submission of the offer in response to the solicitation. Selection of the per diem method allows for actual costs of onsite overhead associated with compensible delays and does not address unabsorbed home office overhead. I have never understood why any contractor would want to select percent of work for the overhead associated with delays for the very reason pointed out: cost of work in place and duration are not always related. Some delays have no additional scope of work involved, but are purely delays.

[Matt]

A clear objective understanding of the Context within which all the events leading up to the Claim for additional overhead is paramount for all parties to the agreement.

Assuming the Contractor is never at fault, it is fair to say that Overhead and General Conditions Costs are not typically identical from month to month over the projects natural progression. It is also fair to say that time extensions for one aspect of newly added scope may in fact have the exact same time duration and schedule overlap that a second scope addition may also have. In essence, if the superintendant and trailer is going to be there an extra month for Contract Amendment One, the superintendant and trailer are still there for concommittant work being done by Change Order 33. From an Owner perspective Overhead and General Conditions should not be paid for twice.

Being fair and honest with all parties is the real goal in resolving these matters. Having a listing of the various general conditions and overhead costs as a part of the original Agreement can be very helpful to all of us. Owner's should be advised to maintain appropriate contingent budgets for such items. Contractors should help the Owner Team understand the importance of and penalties associated with the lack of timely decisions. Courts and Attornies are the bain of our society. When we cooperate and work together we do not need them.

[MD]

Ron, I don't completely agree with your premise that HOOH is a set percent of the contract amount. For most subcontractors, particularly those with labor intensive work, the majority of home office costs are in administrative costs. Preparing invoices, inputting and processing payroll, etc. As well as the cost to track payments on invoices, call and hound GCs for payment on those invoices. All of these processes take basically the same amount of time/cost monthly whether they are for small amounts or the larger, expected amounts. Therefore, more/smaller invoices and more weeks of payroll cost more to process than less/larger ones even if the final total is the same.