It’s 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. Here’s what you need to know before litigation starts.
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 may require cost segregation or job-specific allocations:
1. “Cost of doing business” overhead items. 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 can’t directly charge these items to a specific project and, unlike overhead related to the jobsite, 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.
2. Jobsite/extended field overhead. This comprises costs that contractors need to support jobsite 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 jobsite. This can also include field office vehicles. Generally, these costs include only the jobsite overhead costs necessary to support the project for the expected project completion timeline.
When contractor employees (such as supervisors) work on multiple jobsites, determining a reasonable method to allocate the costs to various jobsites 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 may 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.
Depending on the circumstances, a contractor could pursue damages for productivity losses and damages for escalation. Although a contractor may assume the risks related to the costs of labor, equipment and materials during the course of a project, contractors may need to consider costs 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 contractor may need to recoup the difference in costs.
If, however, the contractor went ahead and bought the materials within the original period, it could seek reimbursement for storage costs incurred because of the delay. In addition, the construction company could incur costs associated with idle labor and equipment.
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 and consult with legal counsel to be sure they cover delay damages; better safe than sorry.