It is bound to happen occasionally. A perfectly timed construction project hits an unexpected snag, leading to major financial repercussions. When an owner causes the delay, the parties may wind up in court to determine how to allocate damages — no easy task when a contractor’s costs span multiple projects. This article reviews two ways to determine overhead allocations and discusses other damages contractors may seek.
How is Overhead Allocated?
Construction companies rarely segregate their overhead by project. This makes it tough when a delayed contractor seeks damages to cover some of its overhead costs.
Two types of overhead costs will require cost segregation or job-specific allocations:
- Cost of Doing Business
These costs include salaries (for company officers, estimators, accounting staff and others not assigned to a specific project), general and administrative costs, insurance, and taxes. Generally, these are among the most contentious points of construction litigation. Disagreements often stem from the fact that construction companies cannot directly charge these items to a specific project and, unlike overhead related to the job-site, indirect overhead items generally aren’t directly increased by a project delay. However, slowdowns can impede the contractor’s ability to generate revenue. As a result, project delays can negatively impact profitability and lead to reduced margins.
- Job-Site/Extended Field Overhead
This comprises costs that contractors need to support job-site work and can directly charge to a specific project. These costs represent expenses associated with the project and can increase because of delays. They include the costs for project managers, supervisors and office workers, as well as office supplies, equipment rentals and utilities at the job-site. This can also include field office vehicles. Generally, contractual damages for these costs include only the job-site overhead costs necessary to support the project for the expected project completion timeline. When contractor employees (such as supervisors) work on multiple job-sites, determining a reasonable method to allocate the costs to various job-sites or projects can be challenging. Also note that, when a delay creates the need for additional supervision, equipment, reporting, quality control and scheduling, cost allocation will also be necessary.
So what formulas do courts use to allocate costs? The “Eichleay” formula is probably the most common method. Under this method, a contractor must establish that 1) a compensable delay occurred, 2) the construction company was working on standby, and 3) the business couldn’t take on other projects.
What About Other Damages?
Depending on the circumstances, a contractor could pursue damages for productivity losses and damages for escalation. Although a contractor typically assumes the risks related to the costs of labor, equipment and materials during the course of a project, contractors may be entitled to damages that result from increased production times resulting from such delays.
For example, a construction company might postpone a materials purchase because of the delay. If the materials cost more when purchased later, the owner could be liable for the difference in costs.
If, however, the contractor went ahead and bought the materials within the original period, it could seek damages to reimburse it for storage costs incurred because of the delay. In addition, the construction company could demand compensation for costs associated with idle labor and equipment.
Courts expect parties to make reasonable efforts to mitigate their losses. For example, a court can limit damages to the extent that a contractor failed to take steps to minimize damages once it knew about the delay.
Owner-caused construction delays and their resulting damages are bound to sometimes happen. When they do, hire a qualified financial expert to help you determine reasonable damages, along with the appropriate overhead allocation and reimbursement of legitimate charges under the contract. Understanding how to allocate costs reasonably and correctly will be invaluable if the dispute proceeds to litigation. Review your construction contracts to be sure they cover delay damages; better safe than sorry.
If you have any questions, please contact Anita Wescott at [email protected], or call her at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.