Various formulae for compensation against construction claims/costs incurred
IRFAN MOHAMMAED AMEER MERZA AMEER ATHAM ALI MERZA
FRICS, FCIArb, PQS, LLM
The formulas for compensation against EPC (Engineering, Procurement, and Construction) claims can be categorized into several types, each addressing a different aspect of the costs incurred due to delays or disruptions in the project. Here are the various formulas:
Direct Costs Formula
The Direct Costs Formula is used to calculate the direct costs incurred due to delays or disruptions in a construction project. Direct costs are expenses that can be directly attributed to a specific activity or a specific cost center within a project. These costs are typically itemized and tracked with a high level of accuracy. Direct costs are essential for determining the actual cost of construction and for assessing the financial impact of changes, delays, or disruptions.
Examples of direct costs in construction claims include increased labour hours, overtime pay, and additional equipment rental.
To calculate the compensation for direct costs, the formula is as follows:
Compensation = Direct costs incurred due to delays or disruptions
The compensation sought through this formula may include additional labour, equipment, materials, and subcontractor costs directly attributable to the delays. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
Extended Overhead Formula
The Extended Overhead Formula is used to calculate the extended overhead costs incurred during the period of delay in a construction project. Extended overhead costs are the ongoing overhead expenses, such as office rent, utilities, and administrative staff salaries, that continue to accrue during the delay.
A well-recognized method of proving extended job site overhead is to derive a daily rate by dividing the total job site overhead costs by the total number of days of performance and then multiplying the daily rate by the number of days of delay.
This method is also used to calculate extended general conditions or field overhead associated with a delay.
To calculate the compensation for extended overhead, the formula is as follows:
Compensation = Extended overhead costs incurred during the period of delay
The compensation sought through this formula may include ongoing overhead expenses that continue to accrue during the delay, such as office rent, utilities, and administrative staff salaries. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
Total Cost Formula
The Total Cost Formula is used to calculate the total cost of a project or product, taking into account both fixed and variable costs. In the context of construction claims, the Total Cost Formula is used to calculate the compensation sought by the contractor for delays or disruptions in the project. The formula compares the total cost of the project with the delays to the cost that would have been incurred if there were no delays. The difference is the compensation sought.
The formula for the Total Cost is as follows:
Total Cost = Total project cost - Cost without delays
The compensation sought through this formula may include all costs incurred due to delays or disruptions, including direct costs, extended overhead costs, and other costs. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
Home Office Overhead Formula
The Home Office Overhead Formula is used to calculate the proportion of home office overhead associated with the delayed project and apply it to the delayed job costs. Home office overhead costs are the expenses involved in generally running a business and are not attributable to any one construction project. These costs may include executive salaries, administrative personnel, general insurance, rent, utilities, telephones, advertising, and interest on loans.
The formula for the Home Office Overhead is as follows:
Compensation = (Total home office overhead / Total job costs) x Delayed job costs
The compensation sought through this formula may include the proportion of home office overhead associated with the delayed project and apply it to the delayed job costs. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
Different ways for calculating head office overheads and profit:
The Hudson Formula is a method used to calculate home office overhead costs in delay claims.
The formula is as follows:
H1 x H2 / H3 x H4 = H5
Where:
However, the use of the Hudson Formula is not supported by the Society of Construction Law (SCL) Delay and Disruption Protocol. This is because it is dependent on the adequacy or otherwise of the tender in question, and because the calculation is derived from a number which in itself contains an element of head office overheads and profit, so there is double counting.
In the limited circumstances where a formula is to be used, the SCL Delay and Disruption Protocol prefers the use of the Emden and Eichleay formulae. The Emden Formula allocates to the delayed project a portion of the contractor’s total overhead based on a historical average, while the Eichleay Formula allocates overheads based on the proportion of the contractor’s total turnover attributable to the delayed project.
The Corrected Hudson Formula is a variation of the Hudson Formula, which is a method used to calculate home office overhead costs in delay claims. The Corrected Hudson Formula is used to remove the double counting of overheads and profit in the original Hudson Formula.
The Corrected Hudson Formula consists of two parts:
(1) CH2 x (1 - CH1) = CH3
(2) CH1 x CH3 / CH4 x CH5 = CH6
Where:
The compensation sought through this formula may include the proportion of home office overhead associated with the delayed project and apply it to the delayed job costs. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
The Corrected Hudson Formula is a variation of the Hudson Formula, which is a method used to calculate home office overhead costs in delay claims. However, the use of the Hudson Formula is not supported by the Society of Construction Law (SCL) Delay and Disruption Protocol. This is because it is dependent on the adequacy or otherwise of the tender in question, and because the calculation is derived from a number which in itself contains an element of head office overheads and profit, so there is double counting.
In the limited circumstances where a formula is to be used, the SCL Delay and Disruption Protocol prefers the use of the Emden and Eichleay formulae. The Emden Formula allocates to the delayed project a portion of the contractor’s total overhead based on a historical average, while the Eichleay Formula allocates overheads based on the proportion of the contractor’s total turnover attributable to the delayed project.
The Emden Formula is a method used to calculate home office overhead costs in delay claims. It is named after the Emden Company, which was the first company to use this method in a legal case.
The formula is as follows:
(EM1 / EM2) x (EM4 x EM6) / (EM5 x EM3) = EM7
Where:
The compensation sought through this formula may include the proportion of home office overhead associated with the delayed project and applies it to the delayed job costs. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
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Before it can recover unabsorbed overheads and lost profit, the Contractor must be able to demonstrate that it has failed to recover the overheads and earn the profit it could reasonably have expected during the period of prolongation, and been unable to recover such overheads and earn such profit because its resources were tied up by Employer Risk Events. The Contractor should make all reasonable efforts to demonstrate through records the head office overheads that it has failed to recover and the profit it has been deprived of earning. If it is not otherwise feasible to quantify the unabsorbed overheads and lost profit, formulae may be used (with caution) to quantify unabsorbed overheads and lost profit once it has been successfully demonstrated that overheads have remained unabsorbed and there is a lost opportunity to earn profit as a result of an Employer Risk Event. The burden of proving that it has unabsorbed overheads and lost profit always rests with the Contractor. A formula just serves as a tool for the quantification of the loss.
The Eichleay Formula is a method used to calculate home office overhead costs in delay claims.
The formula is as follows:
(1) EI1 / EI2 x EI3 = EI4
(2) EI4 / EI5 x EI6 = EI7
Where:
The compensation sought through this formula may include the proportion of home office overhead associated with the delayed project and applies it to the delayed job costs. The specific calculation may vary depending on the terms of the contract and the specific circumstances of the delay or disruption.
It is important to note that before a contractor can recover unabsorbed overheads and lost profit, they must be able to demonstrate that they have failed to recover the overheads and earn the profit they could reasonably have expected during the period of prolongation, and been unable to recover such overheads and earn such profit because their resources were tied up by Employer Risk Events. The contractor should make all reasonable efforts to demonstrate through records the head office overheads that they have failed to recover and the profit they have been deprived of earning. If it is not otherwise feasible to quantify the unabsorbed overheads and lost profit, formulae may be used (with caution) to quantify unabsorbed overheads and lost profit once it has been successfully demonstrated that overheads have remained unabsorbed and there is a lost opportunity to earn profit as a result of an Employer Risk Event. The burden of proving that they have unabsorbed overheads and lost profit always rests with the contractor. A formula just serves as a tool for the quantification of the loss.
Standby Costs Formula
Standby costs refer to the costs incurred by a contractor for maintaining idle equipment or labour during a delay. Contractors can seek compensation for these costs by using the Standby Costs Formula. The formula calculates compensation based on the actual costs incurred by the contractor for maintaining idle equipment or labour during the delay period.
Compensation = The hourly standby rate is calculated as the hourly depreciation cost plus the hourly cost of facilities capital plus the hourly indirect costs.
The calculation of standby rates is not standardized across the industry, and some DOTs have certain ways of reimbursing contractors for their equipment on standby. However, one suggested way to calculate standby rates is to use a cost recovery tool such as the Rental Rate Blue Book. The Rate Element Table provides critical information such as percentages for depreciation, overhaul, cost of facilities capital, indirect costs, and fuel that vary for each type of equipment. Contractors can add the percentages for depreciation, cost of facilities capital, and indirect costs to obtain a total percentage of the Blue Book rate applicable for standby allowance.
It is important to note that standby costs can also refer to the charges paid by a borrower to a lender to compensate for the lender's commitment to lend funds. Additionally, standby rates are tariffs designed to recover the costs incurred by electric distribution utilities to provide service to those customers who use a utility's service as a backup.
Lost Profit and Opportunity Costs Formula
Lost profit and opportunity costs refer to the profits that a business misses out on when choosing to pursue one business venture over another. Contractors can calculate the potential profit that could have been earned from other projects or opportunities during the delay period and include it in the claim. The calculation of lost profit and opportunity costs can be done using the following formula:
Opportunity Cost = Return on Most Profitable Investment Choice - Return on Investment Chosen
Where:
The formula for calculating opportunity cost is simply the difference between the expected returns of each option.
It is important to note that the calculation of lost profit and opportunity costs is based on estimates and assumptions, and there is no way of knowing exactly how a different course of action may have played out financially.
Therefore, to determine lost profit and opportunity costs, a company or contractor must project the outcome and forecast the financial impact. This includes projecting sales numbers, market penetration, customer demographics, manufacturing costs, customer returns, and seasonality.
In summary, the Lost Profit and Opportunity Costs Formula is used to calculate the potential profit that could have been earned from other projects or opportunities during the delay period. The formula calculates the difference between the expected returns of the most profitable investment choice that was not chosen and the investment that was chosen instead. The calculation is based on estimates and assumptions, and projections of sales numbers, market penetration, customer demographics, manufacturing costs, customer returns, and seasonality are required.
Liquidated Damages Offset Formula
The Liquidated Damages Offset Formula is used to calculate compensation based on the reduction of liquidated damages already paid by the contractor. Liquidated damages are funds covering the costs for each day the project continues past the agreed-upon date of completion.
The formula calculates the amount of compensation that can be sought by the contractor by subtracting the amount of liquidated damages already paid from the total amount of damages incurred due to the delay.
It is important to note that liquidated damages are presented in certain legal contracts as an estimate of otherwise intangible or hard-to-define losses to one of the parties.
The ultimate purpose of a liquidated damages provision is to allow the parties to agree, at the outset of their relationship, on a fair and reasonable estimate of damages that might otherwise be difficult or impossible to calculate.
The calculation of liquidated damages can be tricky, depending on the project. The owner must prove how they arrived at the figure they included in the liquidated damages provision in the contract
In summary, the Liquidated Damages Offset Formula is used to calculate compensation based on the reduction of liquidated damages already paid by the contractor. The formula calculates the amount of compensation that can be sought by the contractor by subtracting the amount of liquidated damages already paid from the total amount of damages incurred due to the delay. Liquidated damages are presented in certain legal contracts as an estimate of otherwise intangible or hard-to-define losses to one of the parties, and the calculation of liquidated damages can be tricky, depending on the project.
Acceleration Costs Formula
The Acceleration Costs Formula is used to calculate compensation based on the costs incurred to accelerate the project to make up for the delay. If the contractor is required to accelerate the project to meet the original completion date, they can seek compensation for the additional expenses incurred. The calculation of acceleration costs can be done using the following steps:
Identify the work items: The contractor must identify the work items that need to be accelerated to meet the original completion date.
Determine the original duration: The contractor must determine the original duration of the work items before acceleration.
Determine the new duration: The contractor must determine the new duration of the work items after acceleration.
Calculate the acceleration cost: The acceleration cost is calculated by subtracting the original cost of the work items from the new cost of the work items after acceleration.
Add other costs: The contractor must add other costs incurred due to acceleration, such as additional labour, equipment, and materials.
Subtract savings: The contractor must subtract any savings achieved due to acceleration, such as reduced overhead costs.
It is important to note that the calculation of acceleration costs can be complex and may require the assistance of a construction claims consultant or expert. Additionally, the contractor must provide detailed documentation to support their claim for acceleration costs, including daily reports, schedules, and invoices.
In summary, the Acceleration Costs Formula is used to calculate compensation based on the costs incurred to accelerate the project to make up for the delay. The formula involves identifying the work items, determining the original and new duration, calculating the acceleration cost, adding other costs incurred due to acceleration, and subtracting any savings achieved due to acceleration. The calculation of acceleration costs can be complex and may require the assistance of a construction claims consultant or expert.
Performance Efficiency Formula
The Performance Efficiency Formula is used to calculate the contractor's performance efficiency during the delay period. The formula is calculated by dividing the actual output rate by the standard output rate and multiplying it by 100%. The formula can be expressed as follows:
Performance Efficiency = (Actual Output Rate / Standard Output Rate) x 100%
The actual output rate is the actual number of units produced during the delay period, while the standard output rate is the expected number of units that should have been produced during the same period if there were no delays. The performance efficiency formula is used to determine how efficiently the contractor performed during the delay period.
It is important to note that the performance efficiency formula can be applied in various industries, including manufacturing, construction, and service industries. In manufacturing, the formula can be used to calculate the efficiency of a machine or production line. In construction, the formula can be used to calculate the efficiency of a crew or subcontractor. In the service industry, the formula can be used to calculate the efficiency of a team or department.
In summary, the Performance Efficiency Formula is used to calculate the contractor's performance efficiency during the delay period. The formula is calculated by dividing the actual output rate by the standard output rate and multiplying it by 100%. The formula can be applied in various industries, including manufacturing, construction, and service industries.