Mike Kenyon examines contractor's claims for loss of contribution to head office overheads.

Contractor's claims for the reimbursement of loss and/or expenses arising from prolongation frequently provide for the recovery of loss of contribution to head office overheads.

Head office overheads, by definition, include those costs of the contractor's business that cannot be charged to a particular contract without the need to employ costly and complex accounting procedures. Items forming the head office overhead typically include:-

• Head office maintenance and running costs
• Mortgage or rent and rates of offices, plant and yards
• Wages of head office supervisory, estimating, surveying, administrative and accounting staff
• Depreciation costs
• Legal Fees
• Interest

It is common practice to distribute head office overhead costs to all contracts in progress. The overhead is ascertained from company accounts and adjusted for the forthcoming year. The contractor will estimate his turnover for the year and determine what percentage of turnover is required to contribute to the head office overhead cost. From this the estimator will be able to establish that percentage which must he added to the estimated cost of a contract to cover the head office overhead contribution. This percentage contribution is typically spread across all items in a contractor's tender submission. Despite being common estimating practice this process does fail to recognise that head office overhead is as much a function of time as it is of cost.

Claims for loss of contribution to head office overheads are frequently contested in principle and continue to be the subject of much debate. Despite this, such claims have found favour with the courts. The case of J F Finnegan V Sheffield City Council (1988) 43 BLR 124 is one instance.
Sir William Stabb QC sitting as Official Referee stated;

"It is generally accepted that, on principle, a contractor who is delayed in completing a contract due to the default of his employei; may properly have a claim for head office or off-site overheads during the period of delay, on the basis that the work-force, but for the delay, might have had the opportunity of being employed on another contract which would have had the effect of funding the overheads during the overrun period."

On this point Sir William Stabb QC also referred to the unreported case of Whittal Builders Company Limited V Chester-le-Street District Council (1985), Mr Recorder Percival QC in passing judgement said
"...I come to overheads and profit. What has to be calculated here is the contribution to off-site overheads and profit which the contractor might reasonably have expected to earn with these resources if not deprived of them."

At this point it is worth stressing that claims for loss of contribution to overhead are not the same as claims seeking to recover the actual overhead expended by the contractor in relation to the contract during the prolongation period.

If a contractor is to make a successful claim for lost overhead contribution, then in common with other prolongation claims, it is necessary to establish that the period of prolongation for which the loss of contribution is claimed arose as a consequence of those relevant events provided for under the contract. It must not be forgotten that the principle behind loss of contribution claims is, that but for the delay the contractor would have generated overhead contributing turnover on other contracts. As a consequence, the contractor must establish that other work was available which, but for the delay, would have been secured. The contractor must also quantify the actual loss of contribution.

Contractors frequently adopt a formula approach to quantify of claims for loss of contribution to head office overheads. The formula approach is subject to considerable criticism, not least that it fails to recognise the actual loss. Despite this, the formula approach has found favour with the courts. Judgements in both Finnegan and Whittal Builders accepted, or were prepared to apply, a formula approach to quantifying the lost contribution. Three formula methods are in common usage Hudson, Emden and Eichleay. However, it is only Emden that has met with judicial approval.

The Hudson formula, is expressed as follows;
H.O. profit percentage/100 x contract sum/contract period (weeks) x delay (weeks)

The head office/profit percentage applied is that percentage to cover both head office overheads and profit as built into the tender. A proper appraisal of the formula does reveal flaws and the following points are worthy of note when considering its application: -

It provides for overhead and profit on a contract sum that already includes for overhead and profit

• It assumes that the overhead and profit percentage was capable of being earned by the contractor elsewhere
• The formula links together overheads and profit which in reality are separate issues
• That the overhead and profit percentage was reasonable
• The percentage is based on a tender estimated that may not have been achieved in reality

The Emden formula is similar to Hudson. However, the Emden formula provides for a percentage to be applied in respect of overhead only. This percentage is derived by dividing the total overhead cost of the organisation by the total turnover. This is more realistic than the approach adopted by Hudson as it is based upon an actual percentage achieved and will at least be supported by audited accounts. Despite this benefit the Emden formula should be used with similar caution to Hudson.

A flaw common to both is that they do not take into account any additional overhead that may have been recovered through additional works in the period of prolongation. They also work on the premis that overhead is purely a function of time, which is not necessarily correct. Furthermore, too liberal an application of both Hudson and Emden can lead to a situation where the overhead contribution claimed exceeds the actual overhead cost recorded in the company accounts.

The Eichleay, judicially recognised in the USA, corrects the flaw in Hudson and Emden in that it makes allowance for the recovery of overheads that may have arisen from the execution of additional works. Eichleay also overcomes some of the other concerns of the above methods, not least that when used correctly the overhead claimed will not exceed the actual total company overhead. The Eichleay formula is as follows:

1. Contract turnover/total company turnover x company H.O. overhead = allocable overhead
2. Allocable overhead/contract duration = daily overhead allocable to contract
3. Daily overhead x prolongation period = loss of contribution to H.O. overhead

Overhead

Eichleay, though recognising additional works contribute to overhead, does not consider the timing of such works (in that it averages out the overhead contribution from the additional works over the full contract period).

Accordingly, the Eichleay will in many instances inaccurately state the lost contribution during the period of prolongation.

While no formula is ideal for quantifying the actual lost head office overhead contribution they do have a part to play, not least as a first stage tool in quantifying a potential loss of contribution. Contractors relying on nothing else, other that a formula to support lost contribution of head office overheads, must accept that such claims will meet with little chance of success if put to strict proof. Contractors should at the very least expect to provide accounts, tender breakdowns, internal head office and job records. This information should cover the whole period of the contract in dispute and not just the period of prolongation. Further and in addition to the above, the contractor must prove that he would have secured other work in the period of prolongation.

Those in receipt of claims supported in this way, while not representing the actual loss, should not dismiss them totally out of hand, should give serious consideration to making some contingent allowance in the event that such a loss of contribution can be ascertained.

Proving the actual loss of contribution is difficult and will necessarily involve a wholesale review of the contractor's trading position over the duration of the contract. The success of any review will be dependent upon the quality and accuracy of the contractor's records and accounts. An overhead formula will be no substitute for the hard work required to prove the actual loss of contribution.