Recovery of Overhead and Profit when delay occurs

When a Contractor has established a right to an extension of time which also carries a right
to reimbursement of costs for the delay to his Works, then subject to the terms of the
contract, they may be able to recover as part of a claim all the losses which have been
incurred as a result of being delayed. This can be considered and referred to as part of a
loss of opportunity cost. The key element of this concept is that there must be a direct link
between the lost opportunity and the project works.
The first hurdle for a Contractor to overcome is the obligation to demonstrate that he was
unable to recover or make up the loss with other work. In other words, where the claimant
cannot evidence he was unable to recover head office cost elsewhere, there would be no
right of recovery in respect of the delayed contract.
For example, if the claimant was incurring costs associated with back office costs, which
could include buying costs, estimating staff costs and accounting staff costs, then unless he
can demonstrate that the profitability of the company was materially affected by the delays
or, to put it another way, that there was a direct link between the delays and the deployment
of the above-mentioned costs, the prospects of recovery are remote.
Because of the complication of assessing these costs with any degree of certainty or as the
courts would say on the balance of probability, a recognisable mechanism is needed to
identify the correct figure a claimant would be entitled to recover. This is where the use of
formula comes into its own.
Using formula to justify such a claim was given a boost and approved by the courts in 1989
in the case of J F Finnegan v Sheffield County Council. Although the judge referred to
Hudson formula in his judgment he actually used the Emden formula to assess the
Contractors losses.
Further endorsement of the use of formula was given in 1997 in the matter of Norwest
Holst Construction Ltd v Co-Operative Wholesale Society Ltd. Amongst other matters,
Judge Thornton considered CWSs right to recover overheads arising out of delays by
Norwest Holst. He laid down certain rules concerning recovery of overheads which still hold

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good today and said to qualify for recovery of overheads, the following issues must be
addressed:

If the Contractor had earned additional money through variations any losses may be
recovered by the overhead recovery on those variations.

If the Contractor could have made up the loss by way of obtaining additional work
elsewhere the loss would have been made good.

Referring back to the Hudson formula, which the judge in the Finnegan case thought he was
using in 1989, this uses the assumption that the Head Office Overheads and Profit
percentage allowed in the tender is also what the Contractor's business would lose because
of the delay.
The Hudson formula is:
Contract Profit Percentage x Contract Sum
Contract Period (weeks)
= Value of recovery of overheads per week
For example
15% x 100,000 / 12 weeks = 1,250.00
So for every week the contract overruns the Contractor can argue he is losing 1,250.00 by
way of a lost opportunity claim.

The courts endorsed the right of the Contractor to recover such sums in the matter of
Beechwood Development Company (Scotland) Ltd v Stuart Mitchell t/a Discovery
Land Surveys in 2001.

In this case, the builder's turnover for the year was to be 1.4m. Beechwood's average
charge for overhead and profit in the previous two years was 14.7%. On this basis and using
the relevant data the Contractor claimed 3100 a week for 22 weeks. The judge said the
Contractor was entitled to a 10 week extension of time with costs and awarded 31,000.

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Including other heads of claim, Mitchell, the defendant, was found liable for 60,000. It is
worth bearing in mind that Beechwood didn't really lose its overhead and profit at all.
Recovery was delayed so instead of earning that money at a particular time as the contract
originally envisaged, it earned it 10 weeks later. However, since Beechwood did one job at a
time, its next job was delayed by the same 10 weeks. Only one short sentence in the
judgment deals with this: "There is nothing to suggest the lost time was ever made up." The
logic of the decision in this case was that the expected recovery reduced the companys
return for the year by 10 weeks in a 52 week year.
Before us English folk rely on this case too heavily, please bear it in mind that it is a Scottish
case which means it has only passing relevance in English law.
The real snag in the Hudson formula is that it is almost impossible for a Contractor to prove
his tender actually would have achieved a particular return. This is what many commentators
have said is the failing in this formula compared to the Emden Formula. For this reason the
eleventh edition of Hudson's Building and Engineering Contracts and the sixth and later
editions of Keating on Building Contracts will show that the modern description of the
Hudson Formula does not necessarily involve the tender head office and profit percentage.
The thinking is now to use 'a fair annual average' for head office and profit percentage.
The Emden Formula was devised by Alfred Charles Richard Emden a barrister and County
Court judge. This calculates the average head office overhead and profit percentage that
was achieved overall in the Contractor's business and applies it to the reimbursable period
of delay. Like the Hudson Formula, it assumes that the average weekly contract turnover
anticipated at the outset of the Works would also be true during the period of delay. This is
unlikely but as the burden of proof is on the balance of probability it is a good enough
assessment.
Duplicated recovery may occur in the use of formula, especially if there has been additional
work that has been valued and paid as such payments would, in most cases, include the
head office overhead and profit percentage which was inherent in the Contractor's pricing of
the variation.

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The Emden Formula looks like this:

*Company Overhead and Profit Percentage x Contract Sum
Contract Period (weeks)
= Value of recovery of overheads per week
10% x 100,000 / 12 weeks = 833.00

The company profit percentage would be taken from the audited accounts of the company in
the relevant account reporting period in which the additional (delay) occurred.

Slightly different is the formula developed by the Eichleay Corporation in America. This
assumes an average weekly turnover, but this time it is derived in part from the Contractor's
head office and profit percentage for his whole business and in part a proportion of the
delayed contract value.
It is possible to weed out the complicating factors in all these formulae but if done properly it
is a time-consuming exercise for all but the simplest of projects. The reality is that none of
the formulae will give even an approximation of the true loss of head office and profit
percentage in most prolongation situations.
Other ways of calculating losses have been attempted and some cases have succeeded and
some have failed. For example, in Tate & Lyle v GLC (1983), a case which concerned the
building of a wharf in the Thames, the plaintiff claimed 2.5 per cent on prime cost for
managerial time. This sort of mark-up is used in admiralty cases. The court accepted that
additional costs caused by the inefficient use of managerial time caused by a matter for
which the other party is contractually responsible was admissible; however it was held that
managers had to keep time records of their activities.
The 2003 case of Euro Pools v Clydeside Steel Fabrications Ltd concerned delays to a
swimming pool in Surrey. The court decided that the Claimant was entitled to recover staff
costs arising out of delay +350% (for overheads) +50% for directors.

Some contracts take a particular hard line on the right of recovery of losses arising out of
delayed contracts. For example, the GC/Works family of contracts talks about the
Contractors right only to recover Expenses i.e. excluding the Contractors right to losses.

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The NEC suite is very prescriptive in its approach to the valuation of Compensation Events
which effectively excludes any right to the recovery of head office cost and profit. True, there
is the right to recover a fee on any costs found in the Schedule of Cost Components, but I
doubt this is enough to recover losses as would be recovered under the Hudson or Emden
formula. Put very simply, if the schedule of cost components produces a value of say 5,000
per week and the fee is stated as 10% then the recovery of head office and profit would
amount to only 500 per week; whereas formula recovery would have allowed recovery of
some 1,000.

Another case which confirmed a Contractors right to recover overheads was Alfred
McAlpine Homes North Ltd v Property and Land Contractors Ltd 1995. This involved a
JCT 1980 Contract to build 22 houses in Shipton. McAlpine gave PLC an instruction to
postpone the Works. The matter was first addressed by an arbitrator, a Mr Rawson, who
found that PLC was not entitled to recover loss of overhead and profit under the Emden
Formula, but was entitled to recover on the basis of overhead actually expended and not
recovered during the period of delay. However In his second interim award, Mr Rawson
awarded PLC the sum of 59,661.68 as additional head office overheads incurred and not
recovered elsewhere. The matter was referred to the Court of Appeal which held that in
general terms, the formulae are appropriate in some circumstances, but the formulae do not
relieve the Contractor of the need to show that he has suffered at least some loss in terms of
overheads and profit by reason of a delay.
Other cases which have addressed the issue of overhead recovery include:
St Modwen Developments v Bowmer & Kirkland (1996) which concerned the construction
of an office block. This case followed the general principle that overhead and profit are
recoverable.
Babcock Energy v Lodge Sturtevant (1994) Here, Babcock was in a strong position in that
it had kept very good records of the additional hours spent by head office staff in connection
with the delayed matters. Babcock had also produced evidence to show that its order book
was full, that work had been farmed out and that agency staff had been employed. This was
good enough for the Official Referee. Turning the argument around in favour of the
Contractor he held: "The plaintiffs might have provided an alternative quantification by
reference to the additional cost to them of employing others, but I do not consider that they

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are obliged to do so if they can satisfactorily demonstrate the cost to them of time
unnecessarily spent and therefore lost. It is for the defendants to show that the losses prima
facie incurred are not the correct measure of damage and this (the defendants) failed to do".
The most recent case to come before the High Court is Walter Lilly & Company Limited v
(1) Giles Patrick Cyril Mackay (2) DMW Developments Limited. In their claim, Walter Lilly
sought to recover overheads where the agreed contract was the JCT standard form of
contract. Walter Lillys claim used the Emden formula. This was accepted by the judge.
In allowing this claim, the judge reviewed the authorities on delay related loss of head office
overheads and profit claims. The judge made the following observations:

A Contractor can recover head office overheads and profits lost as a result of delay
caused by factors which entitle it to loss and/or expense;

The Contractor has to prove, on the balance of probabilities, that if there was no
delay that it would have secured other work which would have produced a return
over and above cost, representing a profit and/or contribution to head office
overheads;

The use of a formula, such as Emden or Hudson, is a legitimate and helpful way of
ascertaining, on a balance of probabilities, what that return can be calculated to be;

The ascertainment process under clause 26 of the JCT does not mean that it must
be certain (i.e. sure beyond reasonable doubt) that the overheads and profit has
been lost. Assessment is part of the ascertainment process and all that is required is
confidence that the loss and/or expense being allowed had been incurred owing to
delay factors under Clause 26.

Further, in allowing this claim, the Judge reviewed the parties evidence. In particular, the
Judge took into consideration the following evidence presented by Walter Lilly:

Walter Lillys business model was to use only directly employed staff in lead roles
when undertaking contracts;

Walter Lilly would identify suitable contracts to tender which would commence at the
time appropriate staff became available (i.e. following completion of their current
contracts or when their expertise was no longer required on a particular project);

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The future tender strategy and staff availability was reviewed at weekly meetings, at
which directors would accept or reject tender opportunities depending on resource
availability;

Walter Lillys tender success rate was 1 in 4 between January 2006 and December
2008 (the extended/delayed period) and during that period Walter Lilly declined a
number of tendering opportunities owing to the delays on this project (as recorded at
the weekly meetings);

The market for the type of projects constructed by Walter Lilly was buoyant in the
2006 and 2008 period (the extended / delayed period).

Having regard to the fact that the Employer caused delay and the above matters, the Court
accepted Walter Lillys evidence and was satisfied that, if the management team from this
project had been available, more tenders would have been submitted and that 1 in 4
additional tendered projects would have been secured. Accordingly, the Court held Walter
Lillys claim was established in full and allowed the amount claimed.
In summary the Court found that, on a balance of probabilities, had delays not occurred the
Contractor would have secured work elsewhere and that the use of a formula, such as
Emden or Hudson, is a legitimate and helpful way of ascertaining the loss of contribution to
head office overheads.
The key principle which came out of these cases was that good record keeping showing the
impact of delays on a companys performance and also records addressing the inability of a
company to take on more work because of delays on a contract that are tying up key head
office resources, will greatly assist in the recovery of head office overheads and profit.

Paul Lomas-Clarke FRICS, FCIOB, FCIArb

paul.lomas-clarke@jrknowles.com

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