By Bruce Jervis
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.