ConstructionPro Week, Volume: 5 - Issue: 4 - 01/29/2016

Are “Unabsorbed” Office Costs Real Damages?

By Bruce Jervis

The Eichleay formula, used for calculating and recovering home office overhead in a delay situation, has long been controversial. Critics say these general and administrative expenses are fixed; a delay or suspension of work in the field does not increase them. However, delay in performance results in delay in payment. If periodic progress payments are extended over a longer period of time, the contract does not cover, or absorb, fixed costs at the rate anticipated when the contract was bid. That is why these damages are interchangeably referred to as extended, unabsorbed or under absorbed home office overhead.

The Eichleay formula was born in the federal construction contracting arena. The federal courts have sanctioned the formula and refined its permissible use. State courts have been slow to authorize the use of Eichleay, although there has been a reluctant trend over the past several decades. It was therefore a big deal when, on December 30, a California appellate court, for the first time, expressly sanctioned the use of the Eichleay formula for calculating and recovering unabsorbed home office overhead.

What is your opinion of contractor recovery of unabsorbed overhead? Is this an actual cost item to contractors or just a way to inflate claims? Do you encounter the Eichleay formula being used in pricing claims? The California court, in authorizing its use, noted it had long been used in the negotiation, mediation and arbitration of claims in that state. Your comments are welcomed.

COMMENTS

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.
Posted by: James Mills - Friday, January 29, 2016 10:11 AM

I believe a contractor should be able to allocate home office expense based solely from his work load. Meaning the home office overhead is a fixed cost regardless of income and should be able to charge a customer for lost opportunity and costs resulting from delays because his workforce, equipment and home office overhead are all affected by project delays that result from delays and changes in the work and the contractors ability to Bond additional work as he may not have additional capacity to bond the work or have time to procure new work as the changes and delays were not timely.
Posted by: Michael Larsen - Friday, January 29, 2016 2:16 PM

A delay may or may not cause unabsorbed overhead. It depends on the facts. Where delay results in a contractor performing less work, the overhead that the lost work would have absorbed is “unabsorbed.”

It is, however, a question of fact whether a particular delay actually results in the contractor performing less work. In many instances, a delay does not. For example, the delay may have freed the contractor to perform substitute work. Moreover, many delays just affect the timing of the work -- not overall amount of work performed. A delay may cause less work during the period in which the delay occurs but then more work in the period following the delay. The two often offset.

Turning to the Eichleay formula. Under Federal case law, the Eichleay formula is the exclusive measure of unabsorbed overhead. The accuracy of the Eichleay formula, however, depends on the validity six assumptions. When in a particular case anyone of these assumptions proves invalid, the Eichleay formula overcompensates the contractor. This is why, under Federal case law, it is now very difficult for a contractor to establish entitlement to unabsorbed overhead.

I have written extensively about unabsorbed overhead and the issues concerning its recovery. See: “Recovery of Indirect Costs in the Pricing of Equitable Adjustments and Terminations for Convenience” (ABA, 1989); “Feature Comment: Federal Circuit Limits Entitlement to Eichleay Damages” (THE GOVERNMENT CONTRACTOR, July 23, 2003); Unabsorbed Overhead–the Federal Circuit Continues the Confusion with its June 25, 1998 Decision West v All State Boiler, Inc. (NASH & CIBINIC REPORT, September 1998); and “Practitioner’s Viewpoint, Federal Circuit Creates an Invalid Legal Test for Determining Entitlement to Unabsorbed Overhead (PUBLIC CONTRACT LAW JOURNAL, Spring 1997).

Posted by: David Anderson - Friday, January 29, 2016 3:50 PM

I feel compelled to respectfully disagree with two responders, completely with one and in part with the other. Contractors’ home office overhead (G&A, general and administrative) expense is a real cost; the office and its people from president to janitor, the “yard” and storage-staging area, the repair and overhaul facility, not to mention insurance, medical and retirement plans, etc. It seems Mr. Mills believes the mere calculation of contractors’ G&A damages by means of the Eichleay formula poisons the contractor’s entitlement. That’s amply dispelled in Mr. Jervis’ explanation, as well as by Mr. Anderson: “Under Federal case law, the Eichleay formula is the exclusive measure…. .” Mr. Mills’ proposed method of testing G&A damages entitlement seriously misinforms as well. The test for a contract’s liquidated damages legality is “the amount agreed upon is not unconscionable, is not determined to be an illegal penalty, and is not otherwise violative of public policy”. Williston on Contracts § 65:1 (4th ed.). In comparison, the G&A of a contractor without contracts is simply an unfunded pool of ongoing expenses. G&A, unlike contracts, has no customer to invoice. Instead, it must “invoice” the contracts. The test for reasonableness of G&A quantum in a claim is whether it is fairly in the range of the contractor’s previous year’s average G&A overall experience, as a percent of sales. This can be determined by audit. Only the most reckless contractor will not bid a similar percentage into each bid for a new contract. To understand G&A one need only understand that and the following concept. A contractor has 3 contracts underway, one for $2 million, the others $1 million each. The owner suspends indefinitely the $2 million contract. The contractor immediately looses one-half the total funding planned for the entire G&A pool. This swiftly burns down the G&A funding of the other two, then begins to burn down any profit the other two have or hope to.

As for entitlement to recover G&A damages, Mr. Anderson appears to state that if fact analysis shows that the contractor performed “less work”, then the test for unabsorbed G&A entitlement is met; anything otherwise it is not, and if so the contractor will not be compensated. I can’t reconcile that with the recent finding by the California Appeal Court: “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….” See: http://www.courts.ca.gov/opinions/ documents/ H039055.PDF , p. 26-27.

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.

I have given this subject a little more in-depth treatment the routing to which is posted on my Linkedin account, https://www.linkedin.com/in/glen-l-eaton-bb310b50

Glen L. Eaton

Posted by: Glen L. Eaton - Sunday, March 20, 2016 8:46 PM