If you are a contractor and having a delayed project (presumably not solely caused by you!), Head Office Overheads Contributions may be in your list for Loss and Expense claims. It is common for contractor to adopt the simplest and so called ‘accepted’ method of calculating such expenses hoping the other side will accept it too.
So, the Hudson’s, Eichleay or Emden’s formulae will be in mind to choose from. Among these 3 formulae, I found out from experience that the Hudson’s is the all time favourite!
Why choose Hudson’s? There are 2 other alternatives normally discussed in textbooks i.e. Eichleay & Emden. Not only that there are many more formulae available such as the Ernstrom Formulae, Manshul Formulae, Carteret Formulae, Allegheny Formulae to name few and all these formulae were created from various Court cases. I have no answer to this, perhaps our industry is comfortable using it and maybe there were success stories heard and passed from one generation to the other.
However, recently I found that many attempts to use Hudson’s formulae failed and been rejected outright! Even JKR banned the use of such formulae or alike to be applied in assessing loss and expense in their projects. Many Contractors expressed their dissatisfaction over this matter and blaming Employers being unreasonable, inconsiderate, and not professional in their conduct and what not. Some cases resort to arbitration or litigation with significant claims for head office & overheads.
Now having practiced as a Claims Consultant for more than 15 years, I found that there is lacked of understanding on what need to be demonstrated first before any claim of this kind can survive and also the premise of when Hudson’s formula can be used. Mere application and misuse of the formulae will surely attract rejection as it doesn’t comply with business common sense!
So, let’s be clear now that the subject we are discussing now is the claim for overheads and profit contribution that is expected from a particular contract to the contractor’s head office. This is different from a pure prolongation cost the contractor suffered as a direct result of the Employer’s caused delay.
Claims for loss of contribution to head office overheads are frequently contested in principle and continue to be the subject of much debate. Despite this, such claims have found favour with the courts.
The case of J F Finnegan V Sheffield City Council (1988) 43 BLR 124 is one instance. Sir William Stabb QC sitting as Official Referee stated;
“It is generally accepted that, on principle, a contractor who is delayed in completing a contract due to the default of his employer; may properly have a claim for head office or offsite overheads during the period of delay, on the basis that the work-force, but for the delay, might have had the opportunity of being employed on another contract which would have had the effect of funding the overheads during the overrun period.”
On this point Sir William Stabb QC also referred to the unreported case ofWhittal Builders Company Limited V Chester-le-Street District Council (1985), Mr Recorder Percival QC in
passing judgement said
“…I come to overheads and profit. What has to be calculated here is the contribution to offsite overheads and profit which the contractor might reasonably have expected to earn with these resources if not deprived of them.”
Now let’s look at the formulae. The Hudson formulae, is expressed as follows;
H.O. profit percentage/100 x contract sum/contract period (weeks) x delay (weeks)
The head office/profit percentage applied is that percentage to cover both head office overheads and profit as built into the tender.
Let’s look at few points that will explain why it failed most of the time;
1. First and foremost, most contractors failed to clearly demonstrate causes of delay and determine who is responsible for it. This applies to all cases when the cost claim relates to delayed contract. In most cases delays were caused by both parties. So, if a project has been delayed for 4 months, who attributed to the 4 months delay must be analysed. Without proper and systematic delay analysis, one will not be able to identify critical delays affecting the completion date & who is responsible for it. Concurrency issue will also be a plausible defence for the Employer if not analysed properly. Look at it this way, when both parties attributed to the delay and the contractor is not able to show who caused it and how long of delay been caused by the respective parties, it’s unlikely that any Employer will consider paying him for the extra time taken. Time=Money for both parties!
2. The Hudson’s formulae evolved during the 60’s at the time of high economic activity and assume the existence of a favourable market where certain % overhead & profit can reasonably be earned in most contracts and that another contract can be easily secured after completion of the other with more or less the same % for overhead & profit. Just consider our construction industry market currently since the fall in mid 90’s. It’s not favourable at all. Projects were given to big companies (on the assumption that they are able to sustain and finance the project) on slim profit margin or none at all. Subcontractor’s prices were pressed so low that they themselves accept the contract for survival only. The chances of immediately securing a contract after another also in reality are not a norm now days.
3. The Hudson’s formula integrates head office overheads and profit and assumes that both are inseparable. It also assumes the contractor will price for its overheads & profit this way which is not true in practice. The head office expenses bear no direct relation with the contract sum. A huge contract sum does not necessarily result in a proportionally huge overhead, especially when subcontracting system is the norm now days. Profit level also varies significantly and commonly dealt with separately from overheads.
4. The Hudson’s formulae assumes that the % allowed in the tender for overheads and profit be automatically applied irrespective of whether such % allowed can be achieved in reality or otherwise. There is an element of uncertainty here, it can be in reality a –ve %, 0% or the full 15% earned. Why should the Employer agree to any %?
5. The Hudson’s formulae also assumes that all the contractor’s resources will be prolonged and utilised in that particular contract and that he will not be able to undertake work elsewhere until he is released from this delayed contract. This is again not in line with current industry practice where most companies will manage its financial risk by discharging un-utilise and under utilise resources. Not only that, if this assumption is allowed, it goes against the principle of law requiring a party to mitigate his losses.
6. Following point no. 5 above, it is against common sense and business sense for companies to claim that they had to decline works just because of limited resources (human, plant, machineries and equipments) as pools of resources are available during this not so good economic times.
7. When claiming for loss of contribution based on the Hudson’s formula and at the same time prolongation cost is claimed, duplication must be avoided. Most contractor failed to convince a clean claim is been submitted which led Employer to believed duplication has not been dealt with properly.
8. In essence, most contractors failed to show he could have obtained other profitable works but was unable to because his resources were tied up on the delayed contract.
Posted by SUAZ Consultancy & Solutions
Quite interesting topic, especially on the formulae used to calculate HO Overheads.