Recovery of Overheads and Profit When Delay Occurs

7/25/2019 Recovery of Overheads and Profit When Delay Occurs

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When a Contractor has established a right to an extension of time which also carries a right

to reimbursement of costs for the delay to his Works, then subject to the terms of the

contract, they may be able to recover as part of a claim all the losses which have been

incurred as a result of being delayed. This can be considered and referred to as part of a

loss of opportunity cost. The key element of this concept is that there must be a direct link

between the lost opportunity and the project works.

The first hurdle for a Contractor to overcome is the obligation to demonstrate that he was

unable to recover or make up the loss with other work. In other words, where the claimant

cannot evidence he was unable to recover head office cost elsewhere, there would be no

right of recovery in respect of the delayed contract.

For example, if the claimant was incurring costs associated with back officecosts, which

could include buying costs, estimating staff costs and accounting staff costs, then unless he

can demonstrate that the profitability of the company was materially affected by the delays

or, to put it another way, that there was a direct link between the delays and the deployment

of the above-mentioned costs, the prospects of recovery are remote.

Because of the complication of assessing these costs with any degree of certainty or as the

courts would say on the balance of probability, a recognisable mechanism is needed to

identify the correct figure a claimant would be entitled to recover. This is where the use of

formula comes into its own.

Using formula to justify such a claim was given a boost and approved by the courts in 1989

in the case of J F Finnegan v Sheff ield Coun ty Counci l. Although the judge referred to

Hudson formula in his judgment he actually used the Emden formula to assess the

Contractors losses.

Further endorsement of the use of formula was given in 1997 in the matter of Norwest

Holst Constru ct ion L td v Co-Operat ive Wholesale Society Ltd. Amongst other matters,

Judge Thornton considered CWSs right to recover overheads arising out of delays by

Norwest Holst. He laid down certain rules concerning recovery of overheads which still hold

Recovery of Overhead and Profit when delay occurs


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good today and said to qualify for recovery of overheads, the following issues must beaddressed:

If the Contractor had earned additional money through variations any losses may be

recovered by the overhead recovery on those variations.

If the Contractor could have made up the loss by way of obtaining additional work

elsewhere the loss would have been made good.

Referring back to the Hudson formula, which the judge in the Finnegan case thought he was

using in 1989, this uses the assumption that the Head Office Overheads and Profit

percentage allowed in the tender is also what the Contractor's business would lose because

of the delay.

The Hudson formula is:

Contract Profit Percentage x Contract Sum

Contract Period (weeks)

= Value of recovery of overheads per week

For example

15% x 100,000 / 12 weeks = 1,250.00

So for every week the contract overruns the Contractor can argue he is losing 1,250.00 byway of a lost opportunity claim.

The courts endorsed the right of the Contractor to recover such sums in the matter of

Beechwood Development Company (Scotland) Ltd v Stuart Mitchell t/a Discovery

Land Surveys in 2001.

In this case, the builder's turnover for the year was to be 1.4m. Beechwood's average

charge for overhead and profit in the previous two years was 14.7%. On this basis and using

the relevant data the Contractor claimed 3100 a week for 22 weeks. The judge said the

Contractor was entitled to a 10 week extension of time with costs and awarded 31,000.


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Including other heads of claim, Mitchell, the defendant, was found liable for 60,000. It is

worth bearing in mind that Beechwood didn't really lose its overhead and profit at all.

Recovery was delayed so instead of earning that money at a particular time as the contract

originally envisaged, it earned it 10 weeks later. However, since Beechwood did one job at a

time, its next job was delayed by the same 10 weeks. Only one short sentence in the

judgment deals with this: "There is nothing to suggest the lost time was ever made up." The

logic of the decision in this case was that the expected recovery reduced the companys

return for the year by 10 weeks in a 52 week year.

Before us English folk rely on this case too heavily, please bear it in mind that it is a Scottish

case which means it has only passing relevance in English law.

The real snag in the Hudson formula is that it is almost impossible for a Contractor to prove

his tender actually would have achieved a particular return. This is what many commentators

have said is the failing in this formula compared to the Emden Formula. For this reason the

eleventh edition of Hudson's Building and Engineering Contracts and the sixth and later

editions of Keating on Building Contracts will show that the modern description of the

Hudson Formula does not necessarily involve the tender head office and profit percentage.

The thinking is now to use 'a fair annual average' for head office and profit percentage.

The Emden Formula was devised by Alfred Charles Richard Emden a barrister and County

Court judge. This calculates the average head office overhead and profit percentage that

was achieved overall in the Contractor's business and applies it to the reimbursable period

of delay. Like the Hudson Formula, it assumes that the average weekly contract turnover

anticipated at the outset of the Works would also be true during the period of delay. This is

unlikely but as the burden of proof is on the balance of probability it is a good e nough

assessment.

Duplicated recovery may occur in the use of formula, especially if there has been additional

work that has been valued and paid as such payments would, in most cases, include the

head office overhead and profit percentage which was inherent in the Contractor's pricing of

the variation.


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The Emden Formula looks like this:

*Company Overhead and Profit Percentage x Contract Sum

Contract Period (weeks)

= Value of recovery of overheads per week

10% x 100,000 / 12 weeks = 833.00

The company profit percentage would be taken from the audited accounts of the company in

the relevant account reporting period in which the additional (delay) occurred.

Slightly different is the formula developed by the Eichleay Corporation in America. This

assumes an average weekly turnover, but this time it is derived in part from the Contractor's

head office and profit percentage for his whole business and in part a proportion of the

delayed contract value.

It is possible to weed out the complicating factors in all these formulae but if done properly it

is a time-consuming exercise for all but the simplest of projects. The reality is that none ofthe formulae will give even an approximation of the true loss of head office and profit

percentage in most prolongation situations.

Other ways of calculating losses have been attempted and some cases have succeeded and

some have failed. For example, in Tate & Ly le v GLC (1983),a case which concerned the

building of a wharf in the Thames, the plaintiff claimed 2.5 per cent on prime cost for

managerial time. This sort of mark-up is used in admiralty cases. The court accepted that

additional costs caused by the inefficient use of managerial time caused by a matter for

which the other party is contractually responsible was admissible; however it was held that

managers had to keep time records of their activities.

The 2003 case of Euro Pools v Clydeside Steel Fabricat ions Ltdconcerned delays to a

swimming pool in Surrey. The court decided that the Claimant was entitled to recover staff

costs arising out of delay +350% (for overheads) +50% for directors.

Some contracts take a particular hard line on the right of recovery of losses arising out of

delayed contracts. For example, the GC/Works family of contracts talks about the

Contractors right only to recover Expensesi.e. excluding the Contractors right to losses.
http://www.constructionguy.com/litigation/eichleay.htmhttp://www.constructionguy.com/litigation/eichleay.htm


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The NEC suite is very prescriptive in its approach to the valuation of Compensation Events

which effectively excludes any right to the recovery of head office cost and profit. True, there

is the right to recover a fee on any costs found in the Schedule of Cost Components, but I

doubt this is enough to recover losses as would be recovered under the Hudson or Emden

formula. Put very simply, if the schedule of cost components produces a value of say 5,000

per week and the fee is stated as 10% then the recovery of head office and profit would

amount to only 500 per week; whereas formula recovery would have allowed recovery of

some 1,000.

Another case which confirmed a Contractors right to recover overheads was Alfred

McAlpine Homes North Ltd v Property and Land Contractors Ltd 1995 . This involved a

JCT 1980 Contract to build 22 houses in Shipton. McAlpine gave PLC an instruction to

postpone the Works. The matter was first addressed by an arbitrator, a Mr Rawson, who

found that PLC was not entitled to recover loss of overhead and profit under the Emden

Formula, but was entitled to recover on the basis of overhead actually expended and not

recovered during the period of delay. However In his second interim award, Mr Rawson

awarded PLC the sum of 59,661.68 as additional head office overheads incurred and notrecovered elsewhere. The matter was referred to the Court of Appeal which held that in

general terms, the formulae are appropriate in some circumstances, but the formulae do not

relieve the Contractor of the need to show that he has suffered at least some loss in terms of

overheads and profit by reason of a delay.

Other cases which have addressed the issue of overhead recovery include:

St Modwen Developments v B owm er & Kirkland (1996)which concerned the construction

of an office block. This case followed the general principle that overhead and profit are

recoverable.

Babco ck Energy v Lod ge Sturtevant (1994)Here, Babcock was in a strong position in that

it had kept very good records of the additional hours spent by head office staff in connection

with the delayed matters. Babcock had also produced evidence to show that its order book

was full, that work had been farmed outand that agency staff had been employed. This was

good enough for the Official Referee. Turning the argument around in favour of the

Contractor he held: "The plaintiffs might have provided an alternative quantification byreference to the additional cost to them of employing others, but I do not consider that they


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are obliged to do so if they can satisfactorily demonstrate the cost to them of time

unnecessarily spent and therefore lost. It is for the defendants to show that the losses prima

facie incurred are not the correct measure of damage and this (the defendants) failed to do".

The most recent case to come before the High Court is Walter Li l ly & Company Limited v

(1) Giles Patrick Cyril Mackay (2) DMW Developments Lim ited. In their claim, Walter Lilly

sought to recover overheads where the agreed contract was the JCT standard form of

contract. Walter Lillys claim used the Emden formula. This was accepted by the judge.

In allowing this claim, the judge reviewed the authorities on delay related loss of head office

overheads and profit claims. The judge made the following observations:

A Contractor can recover head office overheads and profits lost as a result of delay

caused by factors which entitle it to loss and/or expense;

The Contractor has to prove, on the balance of probabilities, that if there was no

delay that it would have secured other work which would have produced a return

over and above cost, representing a profit and/or contribution to head office

overheads;

The use of a formula, such as Emden or Hudson, is a legitimate and helpful way of

ascertaining, on a balance of probabilities, what that return can be calculated to be;

The ascertainment process under clause 26 of the JCT does not mean that it must

be certain (i.e. sure beyond reasonable doubt) that the overheads and profit has

been lost. Assessment is part of the ascertainment process and all that is required is

confidence that the loss and/or expense being allowed had been incurred owing to

delay factors under Clause 26.

Further, in allowing this claim, the Judge reviewed the parties evidence. In particular, the

Judge took into consideration the following evidence presented by Walter Lilly:

Walter Lillys business model was to use only directly employed staff in lead ro les

when undertaking contracts;

Walter Lilly would identify suitable contracts to tender which would commence at the

time appropriate staff became available (i.e. following completion of their current

contracts or when their expertise was no longer required on a particular project);


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The future tender strategy and staff availability was reviewed at weekly meetings, at

which directors would accept or reject tender opportunities depending on resource

availability;

Walter Lillys tender success rate was 1 in 4 between January 2006 and December

2008 (the extended/delayed period) and during that period Walter Lilly declined a

number of tendering opportunities owing to the delays on this project (as recorded at

the weekly meetings);

The market for the type of projects constructed by Walter Lilly was buoyant in the

2006 and 2008 period (the extended / delayed period).Having regard to the fact that the Employer caused delay and the above matters, the Court

accepted Walter Lillys evidence and was satisfied that, if the management team from this

project had been available, more tenders would have been submitted and that 1 in 4

additional tendered projects would have been secured. Accordingly, the Court held Walter

Lillys claim was established in full and allowed the amount claimed.

In summary the Court found that, on a balance of probabilities, had delays not occurred the

Contractor would have secured work elsewhere and that the use of a formula, such as

Emden or Hudson, is a legitimate and helpful way of ascertaining the loss of contribution to

head office overheads.

The key principle which came out of these cases was that good record keeping showing the

impact of delays on a companys performance andalso records addressing the inability of a

company to take on more work because of delays on a contract that are tying up key head

office resources, will greatly assist in the recovery of head office overheads and profit.

Paul Lomas-Clarke FRICS, FCIOB, FCIArb

[email protected]

Documents

Recovery of Overheads and Profit When Delay Occurs