Recovery of Overhead and Profit when delay occurs

Transcription

1 Recovery of Overhead and Profit when delay occurs When a Contractor has established a right to an extension of time which also carries a right to reimbursement of costs for the delay to his Works, then subject to the terms of the contract, they may be able to recover as part of a claim all the losses which have been incurred as a result of being delayed. This can be considered and referred to as part of a loss of opportunity cost. The key element of this concept is that there must be a direct link between the lost opportunity and the project works. The first hurdle for a Contractor to overcome is the obligation to demonstrate that he was unable to recover or make up the loss with other work. In other words, where the claimant cannot evidence he was unable to recover head office cost elsewhere, there would be no right of recovery in respect of the delayed contract. For example, if the claimant was incurring costs associated with back office costs, which could include buying costs, estimating staff costs and accounting staff costs, then unless he can demonstrate that the profitability of the company was materially affected by the delays or, to put it another way, that there was a direct link between the delays and the deployment of the above-mentioned costs, the prospects of recovery are remote. Because of the complication of assessing these costs with any degree of certainty or as the courts would say on the balance of probability, a recognisable mechanism is needed to identify the correct figure a claimant would be entitled to recover. This is where the use of formula comes into its own. Using formula to justify such a claim was given a boost and approved by the courts in 1989 in the case of J F Finnegan v Sheffield County Council. Although the judge referred to Hudson formula in his judgment he actually used the Emden formula to assess the Contractor s losses. Further endorsement of the use of formula was given in 1997 in the matter of Norwest Holst Construction Ltd v Co-Operative Wholesale Society Ltd. Amongst other matters, Judge Thornton considered CWS s right to recover overheads arising out of delays by Norwest Holst. He laid down certain rules concerning recovery of overheads which still hold

2 good today and said to qualify for recovery of overheads, the following issues must be addressed: If the Contractor had earned additional money through variations any losses may be recovered by the overhead recovery on those variations. If the Contractor could have made up the loss by way of obtaining additional work elsewhere the loss would have been made good. Referring back to the Hudson formula, which the judge in the Finnegan case thought he was using in 1989, this uses the assumption that the Head Office Overheads and Profit percentage allowed in the tender is also what the Contractor's business would lose because of the delay. The Hudson formula is: Contract Profit Percentage x Contract Sum Contract Period (weeks) = Value of recovery of overheads per week For example 15% x 100,000 / 12 weeks = 1, So for every week the contract overruns the Contractor can argue he is losing 1, by way of a lost opportunity claim. The courts endorsed the right of the Contractor to recover such sums in the matter of Beechwood Development Company (Scotland) Ltd v Stuart Mitchell t/a Discovery Land Surveys in In this case, the builder's turnover for the year was to be 1.4m. Beechwood's average charge for overhead and profit in the previous two years was 14.7%. On this basis and using the relevant data the Contractor claimed 3100 a week for 22 weeks. The judge said the Contractor was entitled to a 10 week extension of time with costs and awarded 31,000.

3 Including other heads of claim, Mitchell, the defendant, was found liable for 60,000. It is worth bearing in mind that Beechwood didn't really lose its overhead and profit at all. Recovery was delayed so instead of earning that money at a particular time as the contract originally envisaged, it earned it 10 weeks later. However, since Beechwood did one job at a time, its next job was delayed by the same 10 weeks. Only one short sentence in the judgment deals with this: "There is nothing to suggest the lost time was ever made up." The logic of the decision in this case was that the expected recovery reduced the company s return for the year by 10 weeks in a 52 week year. Before us English folk rely on this case too heavily, please bear it in mind that it is a Scottish case which means it has only passing relevance in English law. The real snag in the Hudson formula is that it is almost impossible for a Contractor to prove his tender actually would have achieved a particular return. This is what many commentators have said is the failing in this formula compared to the Emden Formula. For this reason the eleventh edition of Hudson's Building and Engineering Contracts and the sixth and later editions of Keating on Building Contracts will show that the modern description of the Hudson Formula does not necessarily involve the tender head office and profit percentage. The thinking is now to use 'a fair annual average' for head office and profit percentage. The Emden Formula was devised by Alfred Charles Richard Emden a barrister and County Court judge. This calculates the average head office overhead and profit percentage that was achieved overall in the Contractor's business and applies it to the reimbursable period of delay. Like the Hudson Formula, it assumes that the average weekly contract turnover anticipated at the outset of the Works would also be true during the period of delay. This is unlikely but as the burden of proof is on the balance of probability it is a good enough assessment. Duplicated recovery may occur in the use of formula, especially if there has been additional work that has been valued and paid as such payments would, in most cases, include the head office overhead and profit percentage which was inherent in the Contractor's pricing of the variation.

4 The Emden Formula looks like this: *Company Overhead and Profit Percentage x Contract Sum Contract Period (weeks) = Value of recovery of overheads per week 10% x 100,000 / 12 weeks = The company profit percentage would be taken from the audited accounts of the company in the relevant account reporting period in which the additional (delay) occurred. Slightly different is the formula developed by the Eichleay Corporation in America. This assumes an average weekly turnover, but this time it is derived in part from the Contractor's head office and profit percentage for his whole business and in part a proportion of the delayed contract value. It is possible to weed out the complicating factors in all these formulae but if done properly it is a time-consuming exercise for all but the simplest of projects. The reality is that none of the formulae will give even an approximation of the true loss of head office and profit percentage in most prolongation situations. Other ways of calculating losses have been attempted and some cases have succeeded and some have failed. For example, in Tate & Lyle v GLC (1983), a case which concerned the building of a wharf in the Thames, the plaintiff claimed 2.5 per cent on prime cost for managerial time. This sort of mark-up is used in admiralty cases. The court accepted that additional costs caused by the inefficient use of managerial time caused by a matter for which the other party is contractually responsible was admissible; however it was held that managers had to keep time records of their activities. The 2003 case of Euro Pools v Clydeside Steel Fabrications Ltd concerned delays to a swimming pool in Surrey. The court decided that the Claimant was entitled to recover staff costs arising out of delay +350% (for overheads) +50% for directors. Some contracts take a particular hard line on the right of recovery of losses arising out of delayed contracts. For example, the GC/Works family of contracts talks about the Contractor s right only to recover Expenses i.e. excluding the Contractor s right to losses.

5 The NEC suite is very prescriptive in its approach to the valuation of Compensation Events which effectively excludes any right to the recovery of head office cost and profit. True, there is the right to recover a fee on any costs found in the Schedule of Cost Components, but I doubt this is enough to recover losses as would be recovered under the Hudson or Emden formula. Put very simply, if the schedule of cost components produces a value of say 5,000 per week and the fee is stated as 10% then the recovery of head office and profit would amount to only 500 per week; whereas formula recovery would have allowed recovery of some 1,000. Another case which confirmed a Contractor s right to recover overheads was Alfred McAlpine Homes North Ltd v Property and Land Contractors Ltd This involved a JCT 1980 Contract to build 22 houses in Shipton. McAlpine gave PLC an instruction to postpone the Works. The matter was first addressed by an arbitrator, a Mr Rawson, who found that PLC was not entitled to recover loss of overhead and profit under the Emden Formula, but was entitled to recover on the basis of overhead actually expended and not recovered during the period of delay. However In his second interim award, Mr Rawson awarded PLC the sum of 59, as additional head office overheads incurred and not recovered elsewhere. The matter was referred to the Court of Appeal which held that in general terms, the formulae are appropriate in some circumstances, but the formulae do not relieve the Contractor of the need to show that he has suffered at least some loss in terms of overheads and profit by reason of a delay. Other cases which have addressed the issue of overhead recovery include: St Modwen Developments v Bowmer & Kirkland (1996) which concerned the construction of an office block. This case followed the general principle that overhead and profit are recoverable. Babcock Energy v Lodge Sturtevant (1994) Here, Babcock was in a strong position in that it had kept very good records of the additional hours spent by head office staff in connection with the delayed matters. Babcock had also produced evidence to show that its order book was full, that work had been farmed out and that agency staff had been employed. This was good enough for the Official Referee. Turning the argument around in favour of the Contractor he held: "The plaintiffs might have provided an alternative quantification by reference to the additional cost to them of employing others, but I do not consider that they

6 are obliged to do so if they can satisfactorily demonstrate the cost to them of time unnecessarily spent and therefore lost. It is for the defendants to show that the losses prima facie incurred are not the correct measure of damage and this (the defendants) failed to do". The most recent case to come before the High Court is Walter Lilly & Company Limited v (1) Giles Patrick Cyril Mackay (2) DMW Developments Limited. In their claim, Walter Lilly sought to recover overheads where the agreed contract was the JCT standard form of contract. Walter Lilly s claim used the Emden formula. This was accepted by the judge. In allowing this claim, the judge reviewed the authorities on delay related loss of head office overheads and profit claims. The judge made the following observations: A Contractor can recover head office overheads and profits lost as a result of delay caused by factors which entitle it to loss and/or expense; The Contractor has to prove, on the balance of probabilities, that if there was no delay that it would have secured other work which would have produced a return over and above cost, representing a profit and/or contribution to head office overheads; The use of a formula, such as Emden or Hudson, is a legitimate and helpful way of ascertaining, on a balance of probabilities, what that return can be calculated to be; The ascertainment process under clause 26 of the JCT does not mean that it must be certain (i.e. sure beyond reasonable doubt) that the overheads and profit has been lost. Assessment is part of the ascertainment process and all that is required is confidence that the loss and/or expense being allowed had been incurred owing to delay factors under Clause 26. Further, in allowing this claim, the Judge reviewed the parties evidence. In particular, the Judge took into consideration the following evidence presented by Walter Lilly: Walter Lilly s business model was to use only directly employed staff in lead roles when undertaking contracts; Walter Lilly would identify suitable contracts to tender which would commence at the time appropriate staff became available (i.e. following completion of their current contracts or when their expertise was no longer required on a particular project);

7 The future tender strategy and staff availability was reviewed at weekly meetings, at which directors would accept or reject tender opportunities depending on resource availability; Walter Lilly s tender success rate was 1 in 4 between January 2006 and December 2008 (the extended/delayed period) and during that period Walter Lilly declined a number of tendering opportunities owing to the delays on this project (as recorded at the weekly meetings); The market for the type of projects constructed by Walter Lilly was buoyant in the 2006 and 2008 period (the extended / delayed period). Having regard to the fact that the Employer caused delay and the above matters, the Court accepted Walter Lilly s evidence and was satisfied that, if the management team from this project had been available, more tenders would have been submitted and that 1 in 4 additional tendered projects would have been secured. Accordingly, the Court held Walter Lilly s claim was established in full and allowed the amount claimed. In summary the Court found that, on a balance of probabilities, had delays not occurred the Contractor would have secured work elsewhere and that the use of a formula, such as Emden or Hudson, is a legitimate and helpful way of ascertaining the loss of contribution to head office overheads. The key principle which came out of these cases was that good record keeping showing the impact of delays on a company s performance and also records addressing the inability of a company to take on more work because of delays on a contract that are tying up key head office resources, will greatly assist in the recovery of head office overheads and profit. Paul Lomas-Clarke FRICS, FCIOB, FCIArb paul.lomas-clarke@jrknowles.com