English
Spend enough time on projects -be it as part of an Employer/Client team, a Consultant team or a Contractor team- and you will get familiar with claim situations. Claim situations in themselves can be quite frustrating for all involved but one of the least understood subcategories that may even top that frustration is probably the one of Unabsorbed Home Office OverHead (UHOOH). We all know that all contractors relative to their size and capability have a Home Office OverHead (HOOH). And based on their size and capability this can range anywhere from just cousin Vinnie with a pocket calculator in the garage to a compilation far exceeding an engineering office, utility bills, telephone bills, computer costs, HR costs, rental of office space, interest on company borrowings, extra travel for home office staff, …
As a basic principle, it is all really easy: A Client based delay has occurred resulting in a forced standby that makes it impossible for the Contractor to take on new work due to the unknown duration of the delay as also preventing the performance other meaningful work on the project to support UHOOH costs and thus resulting in a substantial reduction in project cash flow for the Contractor. Great!
But now comes the hard part… how does one quantify that UHOOH?
A lot of the work done on this topic actually stems from North of the Atlantic Ocean. Before World War II unless expressly permitted by the contract the Contractor often would have no option to recover damages in government contracts. The government considered it had paid for the rights to alter the contract at their sole discretion. However, in recognition of this very unfair situation the Federal Court of claims put a stop to this extremely lopsided situation and open the door for later mitigations. The most famous and well-known mitigation that would later on stem from this would become known as the Eichleay Equation, Formula or Method. The method is named after the company Eichleay Engineers who back in 1954 was under contract to the United States government to construct three NIKE missile sites in Pennsylvania. As the project went on there were numerous changes to the scope of work and delays to the detriment of Eichleay. Eichleay always claimed they had maintained overhead costs during the suspension period that had occurred. Finally, back in 1960 the US Armed Services Board of Contract Appeals ruled that a Contractor should be entitled to compensation for unabsorbed overhead resulting from owner (Client) caused delay, and as there was, at the time, no accepted method of allocating home office overhead to a particular contract to determine the amount of compensation the formula as put forward by Eichleay would be used to work out the compensation due to the Contractor.
In essence the formula or method tries to determine the Whole office overheads that is allocated to the particular project relative to the entire whole office overhead. From this it then distils a daily, weekly or monthly Home Office OverHead (HOOH) delay component, which is then multiplied by actual Delay time or suspension time to give you the Unabsorbed Home Office OverHead (UHOOH) due to the Contractor. Over its many years of application, the methods have been repeatedly both in and out of favor. One of the main criticisms against the methodology is its accuracy. Several have argued that the methodology results in over-estimates whilst others have argued the results in an under-estimate. It remains however an impossibility to finally determine the actual accuracy of it in any given case as that woods dictate an absolute an internal knowledge of the actual costs that have occurred. This also directly leads us to the second and possibly most prevalent argument against the use of the formula, namely that a given contractor when standby occurs will already be compensated for home office overheads in his markup of direct costs on changes in the works and variations. There are however several issues with the latter arguments. A contractor may not receive any variations for the delay or following the delay. You will however if the variation does occur receive the markup on that variation regardless of whether the variation past the delay to begin with or tried to remedy it. Furthermore, it is also possible that when actual costs are fairly straightforward to determine by all involved, that the contractor will be compensated for those but not receive any Markup and that for sure would likely then remain to be compensated for through the HOOH spent during the period of delay or suspension.
Attempts to find better alternatives to the Eichleay method have been made and thus various other approaches have at some time been used by other authors and courts. A broad but by no means exhaustive selection is given below:
- Allegheny Method
- Stems from the manufacturing and supply industry and actually dates back initially to 1953 and a claim and appeal filed by Allegheny Sportswear Company against the US Army.
- Burden Fluctuation Method
- Aims to determine the increase in overall OH and then reassign that to the delayed project.
- Canadian Method
- At times also referred to as the Emden Method is a creation from the Canadian courts.
- Direct Method
- A simple method that opts for applying a listed HOOH value that stems for example from an industry governing body, leading authority or peer reviewed sector journal.
- Modified Eichleay Method
- Total Direct Cost Allocation Method I
- Takes abstraction form what has been billed or performed and instead uses the direct cost quoted/incurred.
- Total Direct Cost Allocation Method II
For a better understanding on how they work in some more detail in order to get to the HOOH and to allow the reader to play a bit with the various methods an Excel sheet is provided here. The numbers used are obviously purely fictional and for illustrative purposes only. As mentioned before the list is by no means exhaustive and numerous other methods exist. As to the question which one of the above approaches is the better one, one would be wise to have a look at the summary numbers given at the end of the Excel sheet. Particular attention is drawn to the percentage standard deviation and the difference in mean and medium. All methods are in essence trying to ascertain the same, however it is clear from this exercise that even with small variations in the approach taken there can be wide swings in the final outcome. And that is all together not illogical as they each are delivering an estimate based on a series of assumptions and incomplete data.
In conclusion, it would appear more than fair to say there it is quite impossible to come up with a singular best method for quickly and fairly determining the UHOOH. Nevertheless, it would appear prudent to as much as possible always opt for a method that is as straightforward as possible and in addition to that do try and pre-empt post-dispute discord and an explicit listing of the HOOH taken up in the contract could go a long way to addressing prolonged wrangling when unexpectedly one finds oneself in a dispute.
For those interested in finding out more on the subject I would like to refer you to a few very useful publications on the subject:
- Groseth R. F. (1986) A formula for use in unabsorbed overhead claims in government contracts, Thesis, Air Force Institute of Technology Air University, AFIT/GLM/LSQ/86S-30, 88p
- Taam, T. and Singh, A. (2003) Unabsorbed Overhead and the Eichleay Formula. J. of Professional Issues in Engineering Education and Practice, 129(4), Oct. 234-245
- Trauner T. Jr. (1990) Construction Delays: Documenting Causes, Winning Claims, Recovering Costs. R. S. Means Co. ISBN 978-0876291740, 200p
What, might some be wondering, would be the most appropriate approach in case of disruptions though instead of a straight-out delay? Well, we’ll leave that for a next installment….