Prolongation Cost Claims – An eye for detail

Once a Contractor has secured an extension of time and relief from liquidated damages,
thoughts will quickly turn to recovery of the costs incurred due to the delayed completion date –
i.e. “Prolongation Costs”.

Ask an Employer’s QS how such costs should be determined and the answer is often an
unequivocal statement that the rates and prices from the Preliminaries BOQ shall be divided by
the original contract duration and the derived daily rate for preliminaries shall then be applied to
the extended duration. The sharp witted Employer’s QS may even refine this logic with the
caveat that the BOQ rates and prices should first be adjusted to remove fixed costs,
mobilization and demobilization costs, overheads and profit.

Whilst both answers are quite wrong, these approaches are often used in order to achieve an
expedient, albeit inaccurate answer. The problem is that neither approach attempts to address
the underlying question of what costs / losses were actually incurred by the Contractor as a
consequence of the delaying events for which the Employer was responsible. The answer to
this question cannot be found in the BOQ, but can (and should) be found in a detailed analysis
of the Contractor’s cost records The express wording of the contract will dictate which heads of
claim are admissible, but in general terms an accurate understanding of Prolongation Cost
entitlement can be derived by application of the following basic principles:

-Identify the events that gave rise to the extension of time – as it is the cost / loss arising
from these events that the Contractor is entitled to recover;

-Identify the point in time that the delay occurred – a common mistake is to identify the
costs that were incurred over the extended duration at the end of the contract period. This is
incorrect. The delay may have occurred prior to full mobilization and thus the actual costs
incurred at that time may be lower;

-Identify the direct costs that follow from the compensable delay events – the Contractor
is not entitled to costs arising from delay events for which it is responsible. Separation of the
two can defeat arguments that the claim is global and includes elements of the Contractor’s
own culpability;

-Assess only time related costs and not one off capital costs – time related costs are those
which necessarily arise as a consequence of additional time spent on the project and would
typically include staff salaries; insurance, rents, utilities, bonds, accommodation, office
services, car leases & running costs, etc. but would not include purchase costs of offices,
photocopiers, vehicles etc.

-Exclude task related costs – a common mistake is to include task related costs (e.g. labour,
plant hire or scaffolding costs) that would have been incurred in any event. These costs may
only have been incurred at a later point in time and are therefore not additional. Such costs
would need to be separately recovered through a properly formulated disruption cost claim;

-Exclude profit – the purpose of the claim is to put the Contractor back into the position it
would have been, but for the delay. ‘Profit’ is not ‘cost’ and thus any claim for profit can only be
by way of a ‘loss of opportunity’ claim – which may be expressly precluded by the wording of
the contract and would in any case have to be proved, i.e. that opportunities did in fact present
themselves and were refused because key resources could not be released from the delayed
project;

-Allow for off-site costs – costs incurred in the Contractor’s head office (and elsewhere) may
be as a direct result of the project delay. The fact that these costs were incurred off site does
not mean that the Contractor is not entitled to receive them;
-Avoid formulae for determining overheads (e.g. Hudson’s, Emden’s etc.) – unless you are
a Contractor and you fully understand the basis of your ‘loss of opportunity’ claim and how to
present it! By indentifying actual incurred overhead costs rather than rely on theory based
formulae that commonly produce high assessments;

-Interest / Finance Charges – remember that charging interest on a debt may be prohibited in
your jurisdiction or by your contract. Most interest or finance claims suffer from a lack of facts
and are commonly: unsupported, theoretical assessments of loss. However, a skilled claimant
can often find ways to lend credibility to this type of claim.

Hudson Formula and Extension of Time Claims

The payment of additional monies in respect of Head Office overheads and profit is the subject
of much debate and discussion. Views range from a categorical denial that such items can ever
comprise direct loss or expense to the blanket application without recourse to the facts of a
formula for calculating recovery.

Head office, Central Stores, Fabrication facilities and the like are offsite costs. Duncan Wallace
the author of Hudson's Building and Engineering Contracts tenth edition states on page 598,
that "offsite overheads are usually known in the (construction) industry as ‘Head Office
Overheads". This cost is usually allowed for in the tender by means of a percentage on the
value of the Contract.

"As regards head-office overheads, these essentially represent, firstly, generally administrative
costs incurred by the organisation in setting up and running the contract, which are increased if
there is any delay or disruption; and secondly, loss of profit the organisation could have made
in the relevant period, had they been free to take on other jobs. Inevitably, they are virtually
impossible to calculate precisely, since the time spent by each individual on each contract is not
recorded separately."

Accordingly, when it is necessary to claim head office overheads for a period of delay a
calculation is adopted as follows:

Dividing the total overhead cost and profit of the organisation as a whole by the total turnover of
the organisation normally arrives at the head office percentage. The formula set out above thus
notionally ascribes an amount in respect of overheads and profit proportional to the relation
which the value to the total turnover of the organisation. This formula is now known as
Hudson's formula and is generally accepted as a recognised method for calculating the
additional cost payable for head office and other off site overheads.

Loss on Overhead recovery might be difficult to calculate with precision on any one Contract; it
is nevertheless real. The Hudson Formula does certainly provide a simple solution to calculate
such a loss in relation to an extension of the project duration. Our extension of time template
recognises this entitlement and sets out the recovery in a logical and correct manner when
making such claims - Refer to our Contractual Management Package.

One of the principal elements of a claim for loss and expense or costs due to the prolongation
of the works is a claim for the costs of head office overheads. Such claims are made under two
quite distinct bases, either an actual cost approach or a lost opportunity approach.
The lost opportunity approach is made on the premise that because of the delay the
contractor's organization is unable to move on to another project and earn the combined profit
and head office overheads of which it is reasonably capable, i.e. the opportunity to earn
elsewhere is lost.
The actual cost approach is simply the identification and cost of the head office overheads
affected by the delay. The lost opportunity approach is by far the most popular with contractors,
for two reasons. Firstly, because the actual costs are so difficult to identify and prove, and
secondly, because the lost opportunity approach uses a formula for its calculation. Contractors
love to use a formula to calculate head office overhead costs and it is easy to see why. A
formula calculation is simple, cheap, quick and produces a reasonable sum of money for very
little effort.

There are two formulae commonly used for such calculations, the Hudson's formula and the
Emden formula. Hudson's formula was first produced by Mr. Duncan Wallace (purportedly upon
the advice of a quantity surveyor) and published in Hudson's Building and Engineering
Contracts.
Basically there are three quantity surveying formulas which are used to calculate the head
office overhead.

Hudson's formula

Hudson's formula is Head Office Contract overhead Percentage 1 x Sum x Period of 100
Contract Delay Period. The Head Office Overhead percentage in the Contract and it has
received judicial support in a number of cases.

The formula is criticised by many principally because it adopts the head office overhead
percentage from the contract as the factor for calculating the costs, and this may bear little or
no relation to the actual head office costs of the contractor. In an attempt to improve upon the
Hudson's formula an alternative was published in Emden's Building Contracts and Practice.

Emden's formula

Emden's formula is Head Office Contract Overhead Percentage2 x Sum x Period of 100
Contract Delay Period
 The HO/Profit percentage is head office percentage, arrived at by dividing the total overhead
cost and profit of the Contractor's organization as a whole by the total turnover. This formula
has the advantage of using the contractor's actual head office/ profit percentage rather than the
one contained in the contract and has received judicial support in a number of cases.

These two formulae were used for many years until the use of formula, and indeed the
opportunity costs approach in general fell out of favour following the (non construction) case of
Tate & Lyle

Where the court would not accept a calculation of head office overheads based upon a simple
percentage, and stated that it was necessary to prove actual additional costs incurred rather
than a hypothetical loss of opportunity approach. Many felt that this case sounded the death
knell for head office overhead claims based upon the loss of opportunity approach and in
particular by the use of simple formula. However, the difficulties of proving the actual additional
costs incurred in respect of head office overheads (and possibly of judges in assessing them)
have recently led to the courts taking a more relaxed view of the degree of proof necessary to
prove that the delay had caused the contractor to lose the opportunity to fully earn its head
office overheads elsewhere, and in a number of cases claims using the loss of opportunity
approach and a formula are re-appearing.

So there seems to be a swing back to accepting the use of Hudson's or Emden's formulae for
the assessment of head office overheads, provided of course the contractor can prove that due
to the delay he has in some way lost the opportunity to fully earn the head office overheads on
other projects. Where the loss of opportunity cannot be proven, and an actual cost approach is
necessary there is however a formula that may be appropriate. This formula is the American
Eichleay formula and it is one, which I have personally found very useful recently. This formula
is calculated by comparing the value of work carried out in the contract period for the project
with the value of work carried out by the contractor as a whole for the contract period. A share
of head office overheads for the contractor can then be allocated in the same ratio and
expressed as a lump sum to the particular contract. The amount of head office overhead
allocated to the particular contract is then expressed as a weekly amount by dividing it by the
contract period. Theperiod of delay can then be multiplied by the weekly amount to give a total
sum claimed.

Eichleay formula

Eichleay formula is thus Value of work during Total Head Office Contract Period x Overhead
during Total value of work during contract For Company as a whole Period During Contract
period

= Total Head Office Overheads during contract

Period

Head Office Overhead Allocated to the Contract x Period of Delay Contract period
 = Amount Claimed

The formula looks complicated, but is not and was recently used (but not named) in the case of
this complexity.

So the use of formula to calculate head office overheads is not dead, Hudson's or probably
better Emden's formula can be used where the contractor can prove some lost opportunity to
recover contributions to head office overheads from other projects, and Eichleay can be used
where a claim based on actual costs is more appropriate.