A Grand Contractor Scam, Figment of Imagination, or Instead a Provable Element of Money Damages Recovery in Project Delay, Disruption, Acceleration, Extended Performance, and Owner Work Suspension Construction Claims?

 

As a construction engineer, construction claims expert consultant and former Government general construction contractor it’s amazing to see how much misinformation exists about a contractor’s unabsorbed overhead (some call it “G&A”; general and administrative) costs on a delayed, disrupted or suspended contract.

Recently Bruce Jervis, in his forum “ConstructionPro Network”, posed a question about this controversial element of contractors’ claims and invited responses from readers. See: http://constructionpronet.com/Content_Free/2016-01-29CPW.aspx . The first person to respond, Mr. James Mills, stated:

“I don’t believe in the under-absorbed overhead costs based on mathematical formulae. I have been a Contract’s Administrator with the Public Transit Industry for 30 years and have had to negotiate Eichleay based claims numerous times. The Contractor should be required to support delay cost impacts the way Transit Owners have to support their basis for liquidated damages- pre-bid.”

One might easily infer that Mr. Mills not only believes the mere calculation of under-absorbed overhead damages by means of the Eichleay formula poisons the contractor’s entitlement, but that maybe he also thinks contractors’ unabsorbed G&A does not even exist. However, that would be unfair. I will assume he merely means that the use of the Eichleay formula to quantify the damages nullifies the contractor’s otherwise clear entitlement to the damages.

The Eichleay Formula is not financial magic. It is merely a means to prorate – allocate – the contractor’s home-office overhead pool funding to its various projects, including the disrupted project. The driver of the amount to be allocated to the disrupted project is the ratio of the disrupted project’s total billings after completion to the total contract billings for all the contractor’s projects …. within the overall period of performance of the disrupted project.

As for the contractor being “required to support delay cost impacts the way Transit Owners have to support their basis for liquidated damages- pre-bid”, I know of no precedent or basis for such, legal or otherwise. And I feel sure there is none. As to whether or not liquidated damages, as stated in a construction contract, can be legally imposed, Williston enumerates a three-step test:

Under the fundamental principle of freedom of contract, the parties to a contract have a broad right to stipulate in their agreement the amount of damages recoverable in the event of a breach, and the courts will generally enforce such an agreement, so long as the amount agreed upon is not unconscionable, is not determined to be an illegal penalty, and is not otherwise violative of public policy.

See: Williston on Contracts § 65:1 (4th ed.). Clearly, the method of proof of whether a contract’s liquidated damages are legal is completely unrelated as a means to measure a contractor’s alleged home office overhead damages in a claim. Conversely, Eichleay has been the standard for half a century and California has now adopted it (Mr. Jervis in his statement for discussion). And:

“Under Federal case law, the Eichleay formula is the exclusive measure of unabsorbed overhead”

(Col. David Anderson, Esq. in his reply). And of course no contractor holding a newly signed contract on a brand new “bell-cow” project with an owner with which he hopes to establish long lasting relationships is ever going to initiate any such discussions about “claims”, the possibilities thereof, how to quantify their value …..etc. Nor or the owner’s representatives likely to initiate talk about such in this moment of cordiality.

A contractor’s home office G&A consists of facilities (office, shops, yards, overhaul space, etc.); people (officers, managers, estimators, secretaries, mechanics, parts managers, etc.), expendables (copy paper, oxy- acetylene, welding rods, etc.), insurance, medical and retirement plans, utilities and rent (or depreciation). The contractor’s home office produces no income. Unlike the contracts, it has no customers to invoice. G&A is a “dead horse”; its cost must be funded by a “fee”, a cost bid into each of the business’ contracts as there is no other means of funding it.

Only the most imprudent, naïve contractor will not include in each bid for a new contract an allowance for home office G&A.

Like any other element of the bid, the G&A cost element should be based upon a sound estimate. Successful contractors rely in-part upon their cost and accounting records to arrive at an average figure to apply in a new bid to cover G&A. A Contractor’s annual CPA reviews (or audits) reveal the total G&A expenditures, and the total billings … both for the same period. Thus the G&A figure initially appropriate for the new bid is: (total annual G&A ÷ total annual billings (sales)). Of course before bid time this figure should be modified by the contractor’s bid manager(s) to reflect any specific potential contract problems; high river stages, winter weather, the owner’s performance period too short (with potential LDs accruing), the available record of the owner’s litigious inclination, as opposed to negotiations and settlement, etc.

Suppose a contractor’s G&A history averages 15 percent. The contractor has three $1.0 million contracts and one $3.0 million contract currently underway. Initially, conditions and production is good and steady. The three jobs monthly billings average $100,000 each, while the large project is averaging $300,000 per month. Altogether, the contracts are thus funding the home office G&A to the tune of $90,000 per month ($100k * 3 + $300k) * 0.15 = $90,000). Suddenly winter storms arrive prematurely, before the contractor can get the large project’s substructure up from the river bed, producing 50-year flood conditions. The contact contains a clause by which the owner is expected to suspend work without penalty under such conditions, but it refuses. Instead the owner drives the contractor ahead with threats of default termination and by withholding portions of earned funds. Next, heavy snow melt from the mountains arrives, in conjunction with large spring and summer water releases from an upstream dam for irrigation, prolonging dangerously high river working conditions.

The contract ends up a year later complete but three months late, with the owner in possession of $500,000 of the contractor’s earnings. This happened by way of a combination of liquidated damages at $4,000/day and other wrongfully withheld earnings, with the final cost about $1.0 million over budget; and the contractor needing $750,000 just to be dead broke.

Much more could be told but two things become painfully obvious:

  • Almost immediately the contractor’s G&A funding began burning down at the rate of 50% of the required level; all cash available went to enlarged payrolls, extra materials, extra special equipment and to keep subs working.
  • In a disrupted contract entailing extended performance, damage to a contractor’s G&A funding begins when the disruption begins and never stops until the extended performance ends.

This brings me to Col. Anderson’s position on his test for whether a contractor is even permitted to recover for unabsorbed or under-absorbed G&A – even if it experiences delay, disruption, work suspension or extended performance, or all of the above –  attributable to the owner. His position seems clear that if government fact analysis of those conditions shows that the contractor performed “less work”, then compensation for unabsorbed G&A meets the test for entitlement; anything otherwise it does not, and if so the contractor will not be compensated.

I must respectfully disagree. I cannot reconcile this with my own experience. Far more importantly, I cannot reconcile it with the case law as stated by the California Appeal Court, quoting the U.S. Federal Circuit Court of Appeals for Federal case law:

As explained by the Altmayer court:

“Home office overhead costs are those that are expended for the benefit of the whole business, which by their nature cannot be attributed or charged to any particular contract. [Citation.] In contracting with the government, a company necessarily includes a portion of home office overhead expenses, which it calculates based on the contract’s duration, in its estimate of costs to perform the contract. [Citation.] When the government delays or disrupts contract performance, ultimately requiring that it be extended, the contractor’s stream of income from the government for the direct costs it has incurred under the contract is reduced or interrupted. [Citation.] However, home office overhead continues to accrue throughout both the original and extended performance periods, regardless of direct contract activity. [Citations.] This, of course, results in a reduction or interruption of payments for overhead, especially when, as here, the contractor has prepared a critical path schedule, for any delay along the critical path results in the delay of the overall project. (Altmayer, supra, 79 F.3d at p. 1132.)”

JMR CONSTRUCTION CORP. v. ENVIRONMENTAL ASSESSMENT and REMEDIATION MANAGEMENT, INC., and SURETEC INSURANCE COMPANY, Calif. Ct. of Appl., 6th Dist.; Quoting: Altmayer v. Johnson (Fed.Cir.1996) 79 F.3d 1129, 1132-1133. See: http://www.courts.ca.gov/opinions/ documents/ H039055.PDF  , p. 26-27

Glen L. Eaton

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