Let’s say you have a six-month job that gets stretched out to one year with no added work. You may have claims for labor costs caused by stop-and-start performance and out-of-sequence work. To support these claims, you may use a comparison of planned versus actual labor costs or some form of labor productivity analysis, but what about the indirect impact to your business for the elongated performance period?
The argument is that you expected this six-month job, together with other contracts you had, to help pay for your home office overhead. The expression used is that all of those jobs combined are responsible for “absorbing” your overhead expense. Where one job is delayed, a portion of your overhead will not be absorbed because the income from that delayed job is smaller per month than expected while your overhead costs continue unabated.
To account for the elusive cost of unabsorbed home office overhead, the Eichleay formula has been used extensively. However, recent court decisions have greatly curtailed its continued use.
So-called “unabsorbed” overhead can be encountered with any delay, including total suspensions of work as well as by delayed completion caused by owner or contractor inferences and change orders. The rationale for recovering extended home office overhead is the same for all of these events, but with federal government contracts, the Eichleay formula applies only to work suspensions.
The formula is simple: (1) take the ratio of billings for the delayed project to billings for all jobs during this same period, (2) multiply that ratio by total overhead for that period, and (3) divide that allocated overhead by the number of days used for the problem job. The result is a per diem amount to apply to each day of delay. In this way, a job representing 25 percent of your billings should theoretically pick up 25 percent of your overhead.
This gross measure assumes that the contractor’s billings and overhead remain fairly constant year by year. Any major fluctuation in either one will skew the Eichleay calculation.
The formula also makes no accommodation for the type of work being performed. Because billings are the foundation for the calculation, a material/equipment-centered job will count the same in the formula as a labor-only job. To account for this problem, some contractors have misused Eichleay by inserting labor billings, rather than total billings, for the calculation. Although this labor approach may make sense, it is simply not permitted.
Either Eichleay or nothing
The Eichleay formula is the only one acceptable for federal government contracts. A variety of proposed alternatives have all been rejected. Eichleay is so ingrained in federal contracts that, as one judge has observed, it would require an act of Congress to change it.
Not only is Eichleay the only formula for computing unabsorbed overhead, but in many instances, it cannot be used at all.
If a change order, for example, results in a time impact to job completion, it would seem logical that extended overhead for the extra time could be calculated using the formula. It cannot.
The legally binding assumption by the federal courts and boards of contract appeals is that the markup for overhead used in the change order is complete compensation for that element of contract damages. The same is true for a markup on the recovery of a claim.
As a result, a change order that has no time impact, no matter how large in dollar amount, will be treated the same as a change order that has a 30-day impact. In both instances, the markup is deemed to cover all related overhead.
For years, attorneys and claims consultants have used Eichleay whenever there was a delay claim, arguing that, if the work disruptions, suspensions or interferences stretched out project duration, the total billings for the work may remain unchanged, while the extended home office overhead remains unabsorbed. This argument is no longer valid.
If there were any questions about whether Eichleay could be used for a general delay claim, it was put to rest by the U.S. Court of Federal Claims in The Redland Co. v. United States.
The sweeping decision in Redland
These are the Redland criteria. The third “prerequisite” is the death knell to many delay claims: “[A] plaintiff must meet three prerequisites in order to establish a prima facie case of entitlement to compensation for unabsorbed overhead. First, there must be a government-caused delay of uncertain duration … . Second, the delay must have extended the period of performance beyond what was originally anticipated … . Finally, the contractor must have been required to remain on standby during the period of delay.”
Redland involved a road contract, but it is equally applicable for electrical installations. In that case, the government suspended performance for four years, but it was not canceled. The contractor argued that, under the circumstances, it had to be ready to resume at any time during this suspension period. This “stand-by” status affected its willingness and ability to bid other work. These were all good arguments, but unsuccessful.
Redland now defines the “stand-by” status, which is critical in establishing a right to use Eichleay: “[I]n order to be on standby, ‘the contractor must be required to keep at least some of its workers and necessary equipment at the site, even if idle, ready to resume work on the contract ... .’ ”
What can you do?
Home office overhead is a loosely defined cost item. Certainly the term applies to the cost of doing business and would include office rent, utilities, staff and officer salaries and benefits, and other general and administrative expenses.
On any given project, home office personnel, such as estimators, engineers and project management, may have limited but direct involvement with the job. For some electrical contractors, there may also be labor for assembly of equipment or devices at their home base prior to shipment to the project, and there may be purchasing staff, schedulers and other semidirect involvement with your home office staff members.
Many contractors select whom they consider to be key home office support personnel and have them keep time sheets for each job that requires their involvement. Arguably, these can be considered “direct” costs in the event of a change order or claim but with limitations.
The federal government has audit guides (e.g., the Defense Contract Audit Agency manual) that helped define what should be treated as overhead and what can be a direct job cost. It is also not uncommon, particularly for cost reimbursable contracts, for these activities to be expressly defined as direct costs as opposed to being part of the markup. These guides are worth reviewing, even for nongovernmental work.