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Contract Changes and Claims: Translating Changes and Changed Conditions Into Dollars and Time Extensions
Published by American Subcontractors Association, Inc. Foundation of the American Subcontractors Association, Inc. 1004 Duke Street Alexandria VA 22314-3588 (703) 684-3450
[email protected] www.ASAonline.com
Copyright © 2017 by the American Subcontractors Association, Inc. and the Foundation of the American Subcontractors Association, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the American Subcontractors Association, Inc. Disclaimer: This publication does not contain legal advice. The discussion is intended to provide information and guidance to individual subcontractors for their use in managing contract changes and claims. Specific circumstances vary widely, so subcontractors may need to consult their attorneys before acting on the premises described herein. Each subcontractor should decide for itself the contract terms and conditions which it believes will best protect its interests. Subcontractors should not agree among themselves as to the form of contract terms and conditions they will use. Such agreements may violate federal or state antitrust laws and could result in the imposition of civil and/or criminal penalties.
Table of Contents Introduction
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Proof of Causation
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Proof of Quantum (Amount)
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General Considerations Regarding Proof of Causation and Quantum
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General Pricing Methodologies and Considerations
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Direct Cost Pricing
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Indirect Cost Pricing
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Delay, Disruption and Impact on Other Work
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Remedies for Delay
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Remedies for Disruption (Productivity Loss and Inefficiency)
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Miscellaneous Costs
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Contract Changes and Claims: Translating Changes and Changed Conditions into Dollars and Time Extensions Introduction A subcontractor’s cost of performance can be affected, sometimes substantially, by unanticipated changes and changed conditions. Furthermore, the subcontractor often is entitled to an adjustment of subcontract time and money because of changes or changed conditions. The subcontract adjustment process achieves a balance between the subcontractor’s responsibility to continue performance and the subcontractor’s corresponding right to equitable adjustment. The objective of the contract modification process is to make sure that the subcontractor receives a full and fair adjustment for any changes or changed conditions. The subcontractor must consider the total impact of the change or condition to assess the costs which must be recovered. The expected rate of return on a project can only be achieved if the subcontractor fully recovers every penny of increased costs, plus a reasonable profit. Full and accurate measurement of that impact is necessary for complete recovery. Once legal entitlement and procedural compliance have been established, the subcontractor must clear two final obstacles: 1) Demonstrate that the change or changed condition caused the additional costs, delays and disruptions; and 2) Reasonably quantify, calculate and support the amount claimed. The clearer the demonstration of causation and quantification of impact, the more likely a quick and equitable agreement (and payment) will be achieved. Failing agreement, clear proof of causation and quantification is even more essential in the formal change prosecution process.
Proof of Causation The vast number of activities involved in a typical construction project and their complex interrelationships often make it difficult, if not impossible, to link precisely a change or condition to a result. Consequently, the subcontractor seeking adjustment is legally required to demonstrate causation only to a reasonable degree of certainty. The subcontractor should strive to prove as clearly as possible that the change, problem or condition did, in fact, impact the subcontractor’s work, cause delay or increase costs. There is no standard or ideal method to link cause and effect in the complex world of construction. The method of proof selected can be as varied as the many different circumstances encountered. The subcontractor must be creative and diligent in using the tools to identify, monitor and correlate change or condition with the claimed delay, disruption or additional cost.
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This white paper offers guidance on proving cause and effect. However, the ultimate success or failure of proof often relies on the adequacy of the project documentation and recordkeeping system. Thus, a subcontractor should immediately respond to any change, problem or condition affecting work, and immediately develop a documentation strategy directed toward simultaneous recording of the problem and its impact on the subcontractor’s work.
Proof of Quantum (Amount) As with the proof of causation, the courts and boards of contract appeals do not require proof of the increased cost to a mathematical certainty. Reasonableness is again the legal standard in measuring a subcontractor’s claim for additional time and money. Once a subcontractor establishes entitlement and causation for some impact or adverse effect, courts and boards of contract appeals simply look for a reasonable basis of computation and measurement. To fully recover compensation for a change or changed condition, the subcontractor should show: The relationship of the cost to the event conferring entitlement. The reasonableness of the methodology used for determining the cost. The reasonableness of the cost incurred. The cost is properly allocated, directly or indirectly, to the contract in question. The cost is determined by using proper accounting procedures and standards. The cost item is recoverable under any contract terms or regulatory provisions pertaining to such an adjustment. The more comprehensive the substantiation for the amount of adjustment requested, the more likely full recovery will be achieved. There is no magic formula that applies to the pricing of each claim or change proposal. However, the foundation for proof is facilitated by proper and complete documentation and recording of the cost impact. The subcontractor must be very methodical in considering and assessing potential cost impacts resulting from a change, problem or condition. Each change or changed condition should be viewed from two perspectives: cost impact and schedule impact. Obviously, there are many interrelationships between these two categories. For example, any schedule impact or disruption usually affects the cost of performance. However, separation of these impacts analytically will help isolate and quantify the full effect of a change or changed condition. There are many considerations relating to assessment of cost impact and schedule impact. For ease of reference, the general categories of recoverable costs, which must be considered, are: Direct Costs: Labor, Material, Equipment, Subcontractor Indirect Costs: Project Overhead, Home Office Overhead (General and Administrative) Delay, Disruption and Other Impact Costs
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Miscellaneous Costs: Bonds and Insurance, Interest and Cost of Capital, Attorney & Consultant Fees, Profit
General Considerations Regarding Proof of Causation and Quantum When pricing change proposals or claims, a subcontractor must determine whether it is possible to discretely determine the costs linked directly to the condition at issue or if the subcontractor can only look rather at its gross impact on the entire cost of performance. In the first approach, referred to as the discrete method of pricing, the subcontractor starts, figuratively speaking, with an empty bucket and only places in it those costs that can be directly linked to the change or condition. In the other approach, known as the total cost method, the subcontractor, again figuratively speaking, places all costs for the project in the bucket and then removes only those known not to result from the change or condition (such as the base contract amount or costs associated with other unrelated changes or conditions). In theory, although the methods approach the problem from different directions, each method should produce substantially the same result. In practice, however, results are often dramatically different and the approach selected is critical to a fair recovery or any recovery at all. Discrete Proof of Causation and Quantum When it comes to changes and claims, cause and effect can be best demonstrated by first isolating and identifying each work item that was affected, and then demonstrating the cost effect of the change on that portion of the work. This method of proof generally is the only approach available for pricing changes prospectively. In prospective pricing, the subcontractor must identify in advance all elements of work that will be affected by a change or condition and then estimate the degree of impact on these elements. The linkage is drawn logically between the change and the consequence. The consequence is measured by an estimate or projection of anticipated cost. By its nature, prospective pricing dictates an itemized, discrete calculation of all estimated costs. Prospective pricing is not as dependent on complete documentation, cost accounting and schedule systems as is historical pricing of the same change. However, in attempting to assess the future impact of a change or condition under prospective pricing, project documentation and performance data will provide helpful and often necessary information to permit a reasonable estimation of the full impact. When used with an historical pricing approach, the discrete itemized method requires separate and detailed accounting, scheduling and recordkeeping systems. These permit the recording and segregation of the cost impact of the changes on the discrete elements of affected work. As discussed earlier, the methodologies established and maintained throughout the project for cost control, documentation and scheduling will, to a large degree, determine whether and to what extent the discrete method of proof can be employed. 3
To assure complete recovery of the actual costs incurred using the discrete method, all aspects of work affected by the change must be identified, measured and linked to the change. Great care is required in assembling and analyzing data. Should the subcontractor’s records not allow full demonstration of cause and effect, the additional costs that cannot be adequately linked to the change will then have to be absorbed by the subcontractor. Total Cost Method The impact of a change or changed condition on a subcontractor’s work is often subtle and complex. In addition, documentation and recordkeeping techniques may be inadequate. Therefore, sometimes it is simply not possible or practical to segregate all of the costs relative to the change or changed condition. The overall cost or time of performance may increase, but the subcontractor is not able to show how or to what degree any increase relates to the change or changed condition. In that situation, the only alternative is to look at the total cost (or time) overrun, and attribute it to the change or changed conditions conferring entitlement to adjustment. This technique is the total cost (or total time) method. It calculates the total difference between the subcontractor’s anticipated cost (or time) of performance and the actual cost incurred (or time expended). The subcontractor then can seek adjustment for the total cost (or time) increase, without segregating any of its components or identifying any of the individual causes. The presumption is that all the additional costs are recoverable. However, courts and boards of contract appeals usually consider the total cost method inappropriate because of the inherently speculative relationship between the change or changed condition and the time or money requested. The total costs (or time) often include many other costs (or delay factors) which are attributable to a myriad of causes other than those principally underlying the change request or claim. Because of these difficulties, the total cost method should be used only if there is no other way of directly demonstrating the impact of the change or condition. Variations of the pure total cost methodology can reduce its abstractness and generality and therefore increase its acceptability and utility. These are the modified total cost and the partial total cost approaches.
Modified Total Cost Method. The modified total cost method recognizes that certain costs or delays are probably attributable to noncompensable causes not relevant to the change proposal or claim. These extraneous costs are then quantified (by discrete or direct pricing methods) and removed from the total aggregate cost calculation. Because the modified total cost method addresses one of the principal deficiencies of the total cost method — its generality — it often meets with greater success. However, even this approach can be entirely undermined by failure to identify and include all noncompensable causes or the inability to reasonably quantify on a discrete basis the impact of each cause. Partial Total Cost Method. Another variant of the total cost method is to use it only with respect to certain aspects of work which were affected by the change or condition. This requires a cost control system that permits extraction of the 4
estimated and actual costs for only those portions of the work. For instance, if the subcontractor is attempting to show that only the cost of concrete placement was affected by certain owner-caused delays, the subcontractor would focus only on the cost of that aspect of the work. Because it focuses more narrowly on work affected only by a specific change or condition, the partial total cost method generally is considered more viable than the total cost method. When and How to Use the Total Cost Method and Its Variants When difficulties occur in using the discrete method of demonstrating causation and the amount of impact, the total cost method may be the only option available. To properly use the total cost method (or its variants), the subcontractor must demonstrate that: The nature of the change or condition makes it impossible or highly impractical to demonstrate the impact, with a reasonable degree of accuracy, in any other way. The subcontractor’s original estimate, or the portion used, was reasonable. The actual costs incurred by the subcontractor were reasonable. All cost overrun is attributable to excusable or compensable causes. The failure to establish any of these elements will cause the change or proposal or claim to fail. Therefore, a subcontractor using the total cost method or its variants, should follow the set of guidelines listed below. Total Cost Guidelines Validate the estimate. Validation is critical because it establishes a baseline. To demonstrate the validity of the estimate or the portion that relates to the claim: Compare the bid price with the price of other subcontractors bidding on the same scope of work. Demonstrate that proper methodologies and resources were employed in estimating the project. Verify the original estimate by an after-the-fact re-estimate by an independent party.
Adjust for estimate error. If any errors are determined to exist in the estimate, then the subcontractor must make an appropriate allowance and adjustment to reflect the error.
Focus on work items affected by changes or changed conditions. If possible, focus calculations on only the portions of the work affected or for which more direct proof is not available. Segregate both the estimated cost and the actual cost incurred for these portions of work so that an accurate comparison can be made.
Adjust for noncompensable factors. Any cost increases claimed must result from changes or changed conditions that are compensable. If the subcontractor is aware of any other factors or causes, including the subcontractor’s performance, contributing to that specific cost increase, each factor should be identified and the costs estimated. These extraneous costs should then be conspicuously accounted for and deducted from the aggregate cost. 5
Demonstrate the reasonableness of the costs incurred. Reasonableness can be established in the following manner: By observation and the opinions of experienced personnel. By identifying, quantifying and removing from the cost base known subcontractor problems and inefficiencies. By comparing productivity during periods unaffected by the change with estimated or historical productivity rates.
Adjust for authorized or pending changes. To the extent that the work, or the portions focused upon, have been affected by prior or pending contract modifications, both the estimated cost calculations and the actual cost calculations should be adjusted to accurately allocate only the amounts attributable to the change or changed condition.
Jury Verdict Method When all else fails, a jury verdict method sometimes is employed by courts or boards of contract appeals to establish quantum, even though a demonstration of cause and effect is lacking and the total cost approach has been rejected as inappropriate. A jury verdict method may be employed only upon a clear finding that (1) there is basis of entitlement, (2) at least some amount of additional costs was demonstrated by the subcontractor, and (3) there is some reasonable basis for estimating or computing the additional costs. In these limited circumstances, a court or board of contract appeals may attempt to reasonably approximate the consequences and award some of the costs requested. However, because of the uncertainty and unpredictability regarding this approach, a subcontractor should never assume that it can be used to salvage an otherwise unprovable claim for adjustment.
General Pricing Methodologies and Considerations While the methodology for pricing change proposals or claims must vary with the circumstances of each proposal or claim, there are some general considerations and principles. Prospective Pricing The prospective pricing method usually involves preparing a price proposal for changed work before the work is done and the cost is fully known. Pricing is based upon estimates or projections of the cost of the changed work. While this does not require detailed tracking of actual costs, the method still requires a comprehensive determination of all the work directly or indirectly affected and an estimate of all the elements of cost expected to result from the impending change. This method permits early pricing of the change proposal and usually encourages early and equitable resolution, as well as prompt payment. This is desirable because it minimizes the drain on the contractor’s limited working capital.
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Under prospective pricing, the subcontractor assumes the financial risk for performing the changed work. Once the parties have agreed on a contract modification, based on estimates, the subcontractor retains any savings achieved by performing the changed work at less cost. On the other hand, the subcontractor must absorb any unanticipated costs Prospective Pricing Guidelines To minimize the risks of prospective pricing for a change proposal or claim, a subcontractor should consider the following guidelines:
Account for escalation. To the extent that labor, material and equipment cost increases can be reasonably foreseen, such increases should be factored into the cost estimate for the changed work.
Consider expected conditions of performance. Site, weather or other conditions that may impact the efficiency of performance should be taken into account. The productivity factors used in estimating the direct costs should reflect a realistic assessment of the anticipated actual conditions of performance.
Assess the effect of other work; price it or preserve rights. The impact of the additional work on work required under the original scope must be assessed to anticipate any resultant delay, disruption or other costs. The cost of secondary impacts can be substantial. An updated project schedule is often necessary to assess these impacts. If the amount of delay or the secondary impact can be reasonably identified and projected, it should be included in the proposal. If it cannot be estimated at the time of pricing, any possible delay or impact should be expressly noted in the proposal. In addition, a subcontractor should expressly reserve the right to supplement the proposal or seek a separate adjustment later when an accurate determination can be made.
State critical assumptions. The proposal should expressly state any conditions or assumptions upon which it is based. For example, it should state if the pricing is affected by the timing and sequencing of the anticipated work, the availability of equipment or materials, or access to portions of the work.
Impose a time limit for acceptance. A change proposal is often based upon timesensitive cost and pricing information. Therefore, the proposal should expressly limit the time within which the other party may accept it. Upon expiration of that time, the subcontractor would be free to amend, modify or withdraw the proposal.
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Historical (Cost-Based) Pricing Historical (cost-based) pricing is employed after the work has been substantially completed and the actual cost impact of the change or condition can be determined. This after-the-fact cost-based method of pricing often occurs after a change proposal has been previously priced by the prospective method. When a prospectively-priced proposal is not quickly resolved, and the subcontractor proceeds with the changed work without agreement on the change order, future projections soon become historical costs. Once actual cost information is available, the subcontractor may elect or be required to reprice the proposal on an actual cost basis. If repricing is left to the subcontractor’s discretion, the subcontractor should select an approach which optimizes the proposal. The subcontractor should, however, always clearly distinguish estimated cost calculations from actual cost calculations. Furthermore, even for work performed or conditions already encountered, the subcontractor may elect to base the proposal on estimates, if it is difficult or impossible to segregate the actual costs. The actual cost method is sometimes mandated by contract provisions for force account or other directed work. These provisions typically provide that the subcontractor shall be entitled to reimbursement of costs incurred plus a defined percentage markup for overhead and profit. The key to recovery of additional costs is how the contract provision defines reimbursable costs. If an actual cost item is not within those defined as reimbursable, then these costs can only be recovered as part of the markup allowed. Compared to prospective pricing, historical pricing, theoretically, allows a greater probability for all costs to be recovered. However, there is less opportunity for increasing the margin because the percentage markup does not permit the subcontractor to achieve any savings by performing the work more efficiently. In addition, full recovery of actual costs is sometimes difficult to achieve. The efficacy of this method depends entirely upon the thoroughness and accuracy with which the subcontractor can measure and demonstrate the actual cost ramifications of a change or condition. An inherent disadvantage of historical pricing is that it has a slower turnaround and change proposal resolution timeframe. The proposal cannot be submitted until most of the work is completed and the historical cost data is gathered. Therefore, there is often a substantial lag between expending the funds and recovering them. This deficiency can be resolved, however, by inserting subcontract language that permits interim payment on directed changes for costs as they are incurred. Unit Price Considerations Contract documents often specify a unit pricing mechanism for adjusting the bid quantities when the quantity of a work item is expected to vary. The subcontractor includes with the bid the offered unit price for each item. If the work in question is increased or decreased, the price will be adjusted.
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Depending upon the bidding strategy of the subcontractor, the unit price bid may be lower or higher than it otherwise would have been if it were negotiated at the time of the change. In addition, if there are substantial changes in the quantity of unit price items, the contract adjustment may not realistically reflect the true impact on cost or duration of performance. It is difficult to use alternative pricing methods when the contract specifies unit price adjustments. A subcontractor should consider the following ways to supplement or supersede the unit price approach:
Delay and secondary impact. Significant changes in the quantities of unit price items may cause a delay and disruption of other unrelated work. Unless the subcontract specifically precludes it, the subcontractor should include the secondary cost impact and a time extension request as a separate element in addition to the unit price adjustment. A bid unit price can only estimate the direct and indirect cost related to a unit of the affected work. It cannot and should not reasonably be considered to include the secondary impact or cost increases caused to other work.
Substantial variance from bid quantities. Unit prices generally include both fixed and variable cost elements. As quantities of work vary, the cost of performing each unit can also vary significantly. Recognizing this, contracts often provide that, if the units vary in quantity by more than a specified percentage, an equitable adjustment of the unit price is appropriate. Even without an express range limitation, entitlement to adjustment for substantial quantity variance might be available under a changed conditions clause. Alternatively, adjustment may be sought, outside the unit price mechanism under the theory that the variation was so substantial that the parties could not have possibly contemplated that degree of difference.
Scope of included costs. The subcontractor should review the subcontract documents to determine precisely what costs are included within the unit pricing amount. If the unit price provisions do not expressly include, for example, home office overhead or the secondary impact of other work, the subcontractor should make an additional claim for these indirect or secondary impacts.
Deleted Versus Added Work When a change results in certain aspects of work being deleted or reduced in quantity, the owner is entitled to a credit. When regulations or contract provisions govern credits, the practice in many areas is to credit only the cost savings that would be achieved in the direct cost categories of labor, material, equipment and field supervision. Generally, the subcontractor is not expected to give back any overhead and profit because project overhead and resource commitments will remain substantially the same. If the direct cost of deleted work is estimated to be less than the price originally included in the bid, the subcontractor need only credit the cost that would have been expended in completing the work, not the higher bid price. However, as is more usually the case, the price of the work increases during the project. Upon deletion of any such work, the 9
subcontractor should credit the work at the estimated price. The owner is not entitled to achieve a windfall at the subcontractor’s expense by deleting work that would be more expensive to produce or perform than it was at the time the contract was made. If changes add and delete quantities of the same work items, the totals of each work item should be netted. If a net increase results, that increase should be priced out as a new work item. On the other hand, if the net result is an overall reduction in items, only the amount of the reduction should be credited back to the owner. Cost and Pricing Regulations and Provisions Subcontract documents often contain provisions defining, restricting or limiting the categories, amounts and methods of calculation that may be used to determine adjustment for a change or changed condition. In addition, the subcontract documents may incorporate other regulations or restrictions regarding the pricing of changes, especially public work. Some state and local governments have regulations that restrict the pricing of changes. The Federal Acquisition Regulation applies to federal construction contracting; it limits and defines how costs can be determined and calculated and how they must be documented. Many of these complex regulations are applicable at the subcontractor and sub-subcontractor levels. In addition, there are specified cost principles and cost accounting standards that apply to federal construction contracting and change order processes. This information should be acquired and understood before any change order or claim pricing begins. To avoid controversy, any deviation from contractual or regulatory requirements should be specifically identified, explained and justified. Contractually-Specified Markups Subcontract documents frequently specify a percentage markup for overhead and profit on changed work. In the case of routine change orders, there is a relatively small impact on the overall project margin. However, if changes significantly expand the overall scope of the project or if conditions are encountered which delay completion without significantly increasing the cost of performance, straight percentage markups may be unrealistic and inadequate to compensate for the true indirect or overhead cost impact. Faced with such a prospect, the subcontractor should: Review the applicable provisions carefully to determine if the cost items are expressly included in such markups. Cost items not expressly included may be claimed separately. Characterize certain costs as the impact of the changes on other work, separate from the cost of performing the changed work itself. Disclosure of the Pre-Bid Estimate Many subcontractors are very sensitive about the disclosure of pre-bid estimates. The methodologies employed in preparing bids are considered by many subcontractors to be proprietary in nature. Furthermore, any estimate on a complex project can be examined closely and nitpicked for small errors and inconsistencies if someone seeks to undermine 10
its validity. For these reasons, a subcontractor should be cautious in pricing its proposals. The method used by a subcontractor to price the proposal usually will determine whether the subcontractor is obliged to provide the prime contractor or the owner with all or part of the pre-bid estimate. If the proposal price is in any way dependent upon the original estimate, as it would be in the case of the total cost method, the content of the estimate is relevant to resolution of the proposal. Consequently, disclosure could be required by any court or board of contract appeals. On the other hand, if the proposal is based only on data or estimates prepared at the time of the change or thereafter, or by a comparison to other previously performed work or work performed elsewhere on the project, the pricing does not depend upon the estimate. The estimate therefore is not relevant to the proposal. Thus, the subcontractor is in a much stronger position to resist producing the original estimate. Defective or Fraudulent Pricing of Change Proposals The fastest way to go from an offensive to a defensive posture when pursuing change proposals and claims is for the owner or prime contractor to believe that the subcontractor has misrepresented the facts upon which the pricing of the proposal is based. Owners and prime contractors often have the right to investigate or audit the documentation and data supporting a subcontractor’s proposal. Private owners and prime contractors frequently reserve the express right to audit and investigate the subcontractor’s records, especially for cost reimbursable contracts or other cost-based adjustment requests. On public projects, the right of audit and investigation are far greater, and are imposed by statutes or regulations applicable to subcontractors as well as prime contractors. Consequently, the risk of a detailed review of the pricing proposal and the supporting documentation always is present. If an investigation discloses that the proposal or any of its components are false, inflated or otherwise unsupportable, at the very least, the subcontractor’s loss of credibility will make negotiating the proposal to prompt resolution more difficult. At worse, the subcontractor also may lose all claim rights as well as be subjected to civil and criminal penalties and sanctions for fraudulent claims and misrepresentation. The precise nature and extent of rights and liabilities vary depending on the particular jurisdiction and whether the owner is a government or private entity. A good set of rules for avoiding misrepresentation are: Make sure that the proposal is based upon cost and pricing data that is accurate, complete and current. If the proposal is based upon any estimates or projections, clearly note that fact so that there can be no misunderstanding. Only represent as fact (actual cost, actual labor spent, subcontract quote, etc.) that which can be substantiated as fact.
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Direct Cost Pricing Definition Direct costs are those directly related to the performance of additional or changed work. They usually consist of additional quantities of labor, material, equipment or other onsite resources which are consumed directly because of the performance of extra or changed work. For ease of reference, general categories of direct cost are: Labor and Field Supervision. Material. Equipment. Subcontractor. Documentation and Proof Because of the discernible correlation between changes or changed conditions and the amount of additional labor, material and equipment directly required, direct cost items can and should be accurately and fully measured and recorded. The most appropriate pricing method, both in prospective and historical pricing, is the discrete method which relates specific items and quantities of extra work to causes. Proper cost accounting systems can identify all direct cost items related to a change or changed condition. However, when any cost item cannot be segregated from other work during performance or in the cost accounting records, estimates of the costs should be prepared during the performance of the work. If neither of these methods proves feasible, a modified partial total cost approach should be considered. This approach focuses strictly on the direct cost categories and cost codes affected by the changes. Direct Labor Cost Guidelines The subcontractor should be compensated for all labor-related costs which directly result from the change or changed conditions. While these costs generally encompass field labor costs, all other forms of direct labor that were required to perform the added or changed work also should be included. The following guidelines can assist in pricing direct labor costs.
Identify all labor categories affected. Include all types of labor that can be directly identified and allocated to performance of the changed work. Generally, this includes field labor costs, field engineering costs and foreman-related and supervisory costs if separable and charged on an hourly basis.
Segregate and document during performance. If the additional labor required by a change or changed condition can be segregated from other labor, it should be separately accounted for using new cost codes and recorded during performance.
Use estimates when actual cost data is not available or when segregation is not possible. If a change or claim proposal is being priced prospectively, or if the nature of the changed work is such that its cost cannot be reasonably segregated for 12
documentation and accounting purposes, estimates should be used. For example, the base labor rate should be adjusted to consider anticipated performance which involves: Overtime or a prolonged work week. Congested working conditions. Difficult access. Adverse weather and site conditions. Disruptive sequences. The learning curve for new or less-experienced workers. Expanded demands on the existing work force. Diluted supervision and management. Removing damaged or working around previously-installed work. Multiple handlings of materials and equipment. The effect of demobilization and remobilization.
Consider labor rate escalation. Any known or reasonably anticipated increases in labor rates must be considered in calculating a labor cost estimate.
Include labor burden. Labor costs should include payroll taxes, insurance and other wage-related costs. All employer tax and insurance contributions and all fringe benefit contributions should be included. These expenses usually are calculated as a fixed percentage of direct wages and are based upon historical verification and substantiation.
Include small tools and consumables. The cost of small tools and supplies consumed or used in the field is often difficult to track and account for. Thus, small tool and consumable costs often are calculated as a fixed percentage of the direct labor costs, and are based on overall company or industry experience.
Consider premium time, allowances and differentials. If the change or changed condition requires performing work outside the normal working schedule or hours, labor costs must reflect the increases resulting from overtime premiums, shift differentials, and meal or accommodation allowances.
Comply with labor rate regulation. Labor rates must conform to applicable contract or government requirements which apply to a project (e.g., collective bargaining agreements or statutory prevailing wage rates). In addition, any mandated ratios of foremen, journeymen, apprentices and helpers must be included.
Review increased supervision, project engineering and project management. This cost factor generally is included under project overhead. However, if an extraordinary increase in any of these categories is experienced and can be traced solely and directly to a change or changed condition, the increase can be shifted to the direct labor category.
Direct Material Costs 13
The subcontractor should be reimbursed fully for all actual or reasonably anticipated increases in the cost of materials used or consumed because of the change or changed condition. The following guidelines can assist in the pricing of direct material costs.
Identify all material costs affected. This includes materials used and consumed because of the changed or changed condition.
Separate and document material costs as they occur. This requires the establishment and management of a proper documentation system.
Account for actual or expected cost escalations. Consider not only the increased cost of procuring the extra materials required by the change or any materials under the base contract, but also the potential cost escalation of these materials if procurement is delayed because of the change or changed condition.
Consider ancillary purchase and delivery costs. Include charges for expediting, handling, shipping, insuring or processing the order and delivering the materials.
Include internal material overhead costs. To the extent that the subcontractor can demonstrate and reasonably allocate any extraordinary internal costs incurred in connection with expediting, facilitating, handling, inspecting, storing or insuring material purchases, these costs should be included as a separate element of material price.
Include sales and use or other taxes. Unless specifically exempted by law or by the contract, include an allowance for sales tax, sales and use tax, and other government charges relative to material purchase or usage.
Consider custom duties and other international-related purchasing costs. Consider the additional customs charges and duties that are required to gain entry to a United States port. Where applicable, consider any costs associated with letters of credit or other payment assurance devices especially for purchases of foreign made materials and equipment.
Include restocking and disposal costs. Account for any actual or anticipated costs for returning or disposing of materials originally procured, but deleted or replaced by change orders. This includes handling or restocking charges, as well as transportation, insurance, etc. Further, if materials cannot be returned or used on the project, consider the ensuing waste and disposal costs.
Consider storage, insurance and multiple handling. Consider the additional costs of storage, insurance and multiple handlings, as well as the breakage costs that normally result from early delivery. This problem is compounded if the project delay results in receipt of materials well in advance of their installation date.
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Properly account for inventory transactions. When materials are taken out of and returned to the subcontractor’s inventory, pricing will be dictated by the subcontractor’s standard accounting method.
Review price structure for intercompany transfers of material. Companies often procure components from other divisions of their company. If these components are procured at a standard reasonable commercial rate, such as the catalogue price, interdivisional sales can be accounted for at the actual sales price. However, if there is no standard commercial market for the kind of interdivisional transfers involved, then the subcontractor usually is required to price the material based on their manufacturing cost rather than based on the value assigned for interdivisional purposes.
Consider extended warranty costs. If a delay in completion of a project is foreseen, the subcontractor should add any anticipated charges for extending the necessary warranties to the material and equipment.
Direct Equipment Costs The subcontractor should be compensated for all costs of equipment ownership, rental usage and operation which can be traced directly to an item of changed work. Costs that can be segregated and allocated to the change or changed condition should be charged as a direct cost. If the cost of equipment cannot be segregated and allocated, those costs should be considered part of the project overhead cost. The following guidelines can assist in the pricing of direct equipment costs.
Identify all categories of equipment used. Except for small tools and consumables accounted for as a direct labor cost, all additional equipment expenditures should be charged as a direct equipment cost. This includes not only heavy field equipment, but also pumps, drills, pneumatic hammers, etc.
Use actual rates for rented equipment. If the rental rates for pieces of equipment are within a reasonable commercial range and the contract does not specify any other means of establishing the rates, the subcontractor should use the actual rental rates paid. Because rental rates usually are higher than ownership costs, it is generally more advantageous to use commercial outside rental rates. If the subcontractor owns the equipment, a commercial rental rate generally cannot be used. Instead, pricing must be based upon the subcontractor’s cost of ownership. However, rental rates may be used with owned equipment, if the subcontractor can demonstrate that the extended or additional equipment consumption on a project tied up essential pieces of owned equipment that otherwise would have been available for other projects. Then the actual rental rates paid to procure substitute equipment should be used in pricing the change proposal or claim.
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Use actual costs for owned equipment. Except for small tools and equipment consumed, the value of the equipment owned by the subcontractor must be based upon the actual costs of ownership. For each piece of equipment, the purchase price, less salvage value, must be depreciated and adjusted for financing and insurance costs to determine the actual periodic cost of ownership. The subcontractor must include the cost of ownership and operation (e.g., gas, oil and routine maintenance). If a subcontractor does not have the resources or otherwise has failed to maintain the detailed accounting records to calculate periodic cost of ownership, several industry sources are available for pricing the cost of ownership and the usage of types or categories of construction equipment. In addition, subcontractors should review their subcontract documents to determine if there are equipment usage and operation rates established for the project or any industry source specified as the basis for pricing equipment in a change proposal or claim.
Include all costs of equipment operation. For each piece of equipment, include the actual or estimated costs of operation (e.g., labor, fuel, oil, maintenance, insurance, etc.).
Optimize pricing of equipment costs. Once a basis has been established for pricing the equipment usage and operation, an hourly, weekly, monthly or annual total cost rate per piece of equipment should be calculated. That rate should then be applied to the number of hours accounted for under the change to usage of the equipment, which can be attributed to the entitling cause. Generally, the shorter the increment of ownership or rental cost used, the higher the rate. The subcontractor should use the smallest incremental units that can be reasonably justified in calculating costs (e.g., hourly over daily over monthly, etc.).
Consider small tools and consumables. As discussed above, these cost items often are allocated based on labor hour consumption because there is generally a direct correlation. However, if small tools and consumables were not included under direct labor costs or if the labor allocation method would not fully account for their excessive usage because of a change, a discrete accounting approach should be used. This requires a detailed itemization of all tools and consumables that were especially purchased for use on the changed or delayed work.
Maintain complete and accurate equipment usage records. The only way to fully recover equipment costs is to establish precisely what equipment was used on the project, how it was used, how long it was used, and what the costs were to operate it. In fact, the amounts charged for equipment often depend on if the equipment was being used or standing idle. This underscores the need for a detailed recording and accounting system to track major equipment items.
Segregate equipment costs for changes. If equipment and periods of usage can be segregated and directly related to a change or changed condition, their costs should be charged discretely to that change. Otherwise, recovery can be obtained from a general allocation of the equipment portion of the project overhead pool. 16
Direct Subcontract Costs Should the costs of any sub-subcontractor be affected by the same circumstances underlying the subcontractor’s request for adjustment to the prime contractor, the subcontractor has an obligation to seek adjustment on behalf of the sub-subcontractor as well. Typical subcontract language limits the sub-subcontractor’s right to recovery for extra work, delay or disruption to only that which can be recovered by the subsubcontractor. Failure to include a sub-subcontractor’s interest in a change proposal or claim or to expressly reserve that sub-subcontractor’s right could leave the subcontractor directly liable to the sub-subcontractor. A portion of project management and project resources are devoted to the overall coordination of the sub-subcontractor’s work and the administration of change orders or claims on the sub-subcontractor’s behalf. Accordingly, the subcontractor generally is entitled to a percentage markup of the sub-subcontractor’s request for adjustment. The following guidelines can assist in the coordination, handling and pricing of subsubcontractor change proposals or claims.
Include all involved sub-subcontractors in pricing a change or claim. Give notice of the change or changed condition to all sub-subcontractors. All responses and requests for contract adjustments should be required to comply with the subsubcontractor’s contract. Those procedures should allow a subcontractor to comply with the procedures imposed by the prime contractor in the subcontract.
Mark up sub-subcontractor claims. Once the change proposal or claim of a subsubcontractor is received, it should be incorporated as a separate cost element in the pricing of the subcontractor’s proposal. All sub-subcontract proposals should be aggregated. The total amount should be that percentage markup specified in the subcontract documents, acceptable by industry standards, or specified by prior negotiations on the project. This markup generally ranges from 5 to 10 percent.
Protect sub-subcontractors’ rights. The subcontractor legally is entrusted to pass through and pursue the change proposal or claim of sub-subcontractors if the prime contractor or owner is responsible. Therefore, the subcontractor should not do anything to jeopardize, release or disadvantage any sub-subcontractor’s entitlement in dealing with the prime contractor. Otherwise, the subcontractor could be liable for the contract adjustment requested by the sub-subcontractor. For example, if the subcontractor settled the entire change proposal or claim, including the subsubcontractor’s portion, without the consent of the sub-subcontractor, the subsubcontractor may be able to demand that the subcontractor pay the balance.
Make no admissions or denials of liability. If a sub-subcontractor’s claim is passed through to the prime contractor or owner, the subcontractor should maintain complete neutrality on any of the sub-subcontractor change proposals or claims. While the subcontractor should not pass along frivolous or totally outlandish claims, 17
the subcontractor should be equally cautious about agreeing, admitting or denying the entitlement of the sub-subcontractor. Admissions may haunt the subcontractor because they could create direct liability by the subcontractor to the subsubcontractor.
Indirect Cost Pricing Definition Indirect costs are those necessary for the transaction of business, but not specifically related to items of work or performance. They fall into two categories: 1) Project overhead (or field overhead) costs are the costs incurred in the overall management and supervision of the work on a project. 2) Home office overhead costs (also referred to as general and administrative expenses or G&A) are the costs incurred in the overall transaction of a subcontractor’s business. Both are real costs which must be recovered on all projects to stay in business. Since these costs often are not recovered directly, they only can be recouped through generalized allocation methods which spread total overhead costs over some logical cost or other basis such as project revenues, project expense or man hours expended. General Pricing Considerations The methods employed to allocate and compute project overhead and home office overhead are very different. However, they have the following principles in common.
Formulas are not always accurate. The customary methods of general allocation are based on percentage of cost or revenue formulas that do not always fully recognize the true direct cost burden of a problem job. Centralized management and other resources that normally are considered part of the general overhead of the project, often are consumed in excess when significant delays, disruptions or other problems require extraordinary management attention and response. Using a general formula for the allocation of overhead (indirect expenses) frequently will not quantify the true resources consumed in a problem situation.
Categorize as much overhead as possible as direct costs. Recognizing the limits of the general allocation of overhead formula, the subcontractor should review the overhead resources used on a project to determine whether any general resources normally considered overhead were consumed in excessive amounts on the project or by work. Home office expenses that can be traced, segregated and allocated to a project should be directly accounted for and charged to that project. Similarly, if project overhead costs can be directly related to changes, these items should be directly accounted for and charged to those changes. In general, the chance of recovering the actual amount of resources consumed is maximized when they are accounted for and charged directly to the project. The chance for recovery is even better when the resources consumed can be directly accounted for and charged to 18
an item of change or changed condition. If such items are categorized as direct costs, the direct cost amounts must be removed from the home office or project overhead pools when calculating overhead. Project Overhead Guidelines Project overhead costs represent the generalized costs incurred in managing, staffing and equipping the project. The following guidelines may assist in identification and clarification.
Identify all project overhead costs. These typically include: Project management and supervision. Technical and engineering staff. Clerical and accounting staff. Quality control and quality assurance staff. Shop management and supervision, if applicable. Project office furnishings and equipment. Project storage facilities. Project consumables, supplies and materials. Utilities, such as electric, water, telephone, Internet, etc. Security costs. Clean-up crews. Insurance costs. Business license and taxes. Small tools and taxes, if not accounted for as direct cost items. Construction equipment and vehicles, if not accounted for under direct costs.
Compile a complete inventory. A complete inventory of significant equipment and vehicles, and their respective costs, should be compiled for each project. A reasonable basis for pricing each item should be determined.
Where possible, shift indirect costs to direct costs. If some or all of the project overhead costs can be directly related to performance of changed work, those costs should be shifted to a direct cost item for recovery as a direct cost charge. For example, if a project engineer spent six straight weeks working on design conflicts resulting from defective contract documents, these costs should be accounted for as part of project labor and supervision rather than project overhead.
Compare costs to the fixed markup. Contract documents often provide for a fixed percentage markup of direct costs to compensate for project overhead. However, when the fixed percentage does not fully recognize the increased burden of project overhead, other options should be explored. Include management, equipment or other project overhead as a direct cost for a change or changed condition.
Consider the effect of changes or changed conditions. Project overhead tends to increase in three ways because of changes, delays and disruptions. It may increase discrete items or amounts of equipment, staff or other project resources 19
because of the change or changed condition. It also may vary in amount to the extent that problems may require increased total staffing or equipment. Similarly, even without increasing staffing and equipment beyond that originally planned, project overhead can increase by the extended duration of performance. The same work force performs for a longer period and the extra project cost is a direct out-ofpocket loss unless it can be recouped. On many projects, overhead can increase because of both increased equipment and staffing and an extended duration of performance, especially when delay and disruption intertwine. Home Office Overhead Considerations Home office overhead represents the general and administrative expense of the day-today operation of a business. Generally, construction home overhead costs are fixed rather than variable. Most management facilities and resource costs stay relatively constant. Occasionally, resources or personnel may be added because problems arise on a project. This would provide a variable element to the home office overhead pool of expenses. However, variable elements usually are negligible. Recovering home office expenses on a delayed or disrupted project often is characterized as extended overhead. The term extended overhead applies more accurately to project overhead where delay extends the project overhead costs. The use of this term in connection with home office overhead is not appropriate because most home office expenses are fixed. That is, they do not vary with the extended duration of a project or even after the project is completed. In theory, except for minimal variable overhead cost, extending the project time does not increase home office overhead costs. Extending the project time does, however, result in an under-absorption of home office overhead. The delayed project either reduces the revenue obtained during the original contract period thereby decreasing recovery of home office costs anticipated as part of the gross margin, or causes the subcontractor not to take on additional work thereby decreasing payments for home office overhead as part of the gross margin that would have been realized on other projects, or both. In either case, and certainly when both effects occur, the subcontractor incurs injury because the amount of home office expense absorbed is less than the actual costs. Because these concepts are so abstract, courts and boards of contract appeals frequently require actual proof of the increased cost before allowing any element of home office overhead to be recovered. Home Office Overhead Guidelines The following guidelines will assist the subcontractor in demonstrating, calculating and allocating home office overhead expenses for a delayed or disrupted project:
Carefully assess the overhead pool. Make sure that only allowable and reasonable expenses are included. For example, the CEO’s trip to England with his family, if charged to the company, is probably not allowable on any basis. On federal projects, the Federal Acquisition Regulation and other cost and pricing principles as well as cost accounting standards, quite strictly define what categories of cost can 20
be included or must be excluded. In addition, the overhead pool must be adjusted to remove any central company resource or service items that are routinely charged to separate projects, such as the cost of central engineering, scheduling, accounting and billing services. Finally, adjustments should be made to eliminate any overhead costs that have been electively charged on a direct cost basis to the project because of unusually high consumption of that resource.
Categorize as much overhead as possible as direct cost. If changes or changed conditions require an unusual amount of home office management or consume excessive engineering or administrative resources, these excess costs should be allocated out of the home office overhead pool and charged as a direct cost. For example, if the company’s head estimator was required to spend a full month assisting with a series of significant direct changes, rather than a couple of days that would have been typical for a job of that type, the excess costs should be charged directly to the project. This includes salary, benefits, travel and all related expenses. Of course, the amount charged directly must be removed from the overhead pool. To accomplish this, a subcontractor must keep careful documentation demonstrating that the use of the central resource did exceed the normal level for projects of that type and size. Also, all costs reallocated must be justified and substantiated with proper records. Keep in mind that general accounting systems often are set up with tax considerations or cash flow purposes in mind. These systems may allocate more cost as indirect than is normally done in construction accounting. Therefore, some of the costs shown as G&A expense in financial statements may in fact be direct costs.
Select an allocation method. Select the most appropriate, reasonable and justifiable method of allocating the costs left in the overhead pool. This may be controlled by contract provisions or regulations or dictated by existing accounting practices. Consider all options.
Use contractually specified methods. Subcontract terms and conditions often stipulate that home office overhead expenses can be recovered only as a fixed percentage of direct and indirect project costs. In other cases, the parties agree to percentage markups for overhead. Make sure that the percentages are sufficient to fully account for all cost categories including project overhead, home office overhead and profit.
Use the existing company allocation system. Many companies historically have allocated home office overhead expenses to projects in proportion to such factors as project revenues, project costs or man-hour consumption. The result is a percentage of home office overhead costs relative to project costs. The same formula can be used to calculate the additional overhead due to a change or changed condition.
Compare actual costs to the fixed markup. The concept behind a fixed percentage, either as contractually specified or historically calculated, is that each dollar spent (or each dollar of revenue earned) must support an average amount of general overhead expended by the company during that period. This rationale fails 21
when the actual amount of overhead consumed is substantially exceeded. Two examples illustrate this: A project that is suspended or significantly delayed may not generate enough revenue to pay for the home office overhead. In a total project suspension, the subcontractor would be required to maintain some level of overhead commitment and yet multiplying the fixed percentage by the added cost would not cover the continuing home office overhead burden. At the other extreme, changes can be so frequent or so massive that, even though substantial direct and indirect project increases result, the percentage simply fails to recoup the extraordinary investment necessary to respond in chaotic project management situations.
Use the Eichleay formula or one of its variations. Because of the deficiencies in other approaches to the calculation of home office overhead, courts and boards of contract appeals recognize alternative methods. These alternative methods attempt to allocate the unabsorbed or under-absorbed home office overhead so that it truly reflects the burden the project has placed on the home office. The best know method is the Eichleay formula, derived from an administrative appeal on a federal construction project before the Armed Services Board of Contract Appeals. Proponents of an overhead claim calculated based on the Eichleay formula or one of its variants must establish that: All variable overhead items are separated from the fixed overhead items. The variable items must be charged directly to the projects consuming those resources. There is no other reasonable basis for allocating the remaining fixed overhead items to the distressed project. The subcontractor incurred real injury in the form of increased costs or increased G&A burdens. This can be established by showing that the delayed project restricted the subcontractor’s ability to take on other new work by tying up limited resources, bonding capacity or financial resources.
The objective is to allocate a portion of the total company overhead based on the billings attributable to the project compared to the total billings for the company. This permits calculation of an actual allocation of overhead at a daily rate that, when multiplied by the days of delay equals the home office overhead attributable to the delay of the project. In the final analysis, if costs can be reasonably substantiated and explained, almost any method can be applied to any circumstances. Since the result may vary, the subcontractor may want to try different methods. The method that optimizes the claim should be used.
Delay, Disruption and Impact on Other Work Introduction
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The direct consequences of a change or changed condition usually can be identified and quantified. However, the secondary impact of that change or changed condition often extends far beyond the work items directly affected. Schedule slippage, resequencing and other forms of deviation from the planned performance schedule can affect subsequent work and even the entire project. This indirect or secondary impact usually falls into one or both following general categories:
Disruption resulting from deviations from the planned sequence, duration or manner of performance. Delays causing an extended duration of other work activities or even the entire project.
If the change or changed condition causing the impact entitles the subcontractor to an adjustment of subcontract time or money, such entitlement also extends to its secondary consequences, unless specifically foreclosed by subcontract language. Secondary impacts frequently constitute the major consequences of the change or changed condition on the subcontractor’s performance. However, these impacts are much subtler and are difficult to foresee and measure. Consequently, they often are overlooked, ignored or underestimated in the subcontract adjustment process. The subcontractor is left at risk to absorb the unplanned costs that were not included in subcontract change orders. While more difficult, proof of causation and quantification of the secondary impact of a change can and must be generated to protect the subcontract profit margin. There is no standard method that will guarantee success. The approach is dictated by the circumstances of each change or changed condition (and each project), as well as by the subcontractor’s administrative resources and the level of sophistication available to deal with schedule matters. Delays and disruptions often go together but they should be separated when analyzing the full impact of changes and changed conditions. This section reviews various techniques to prove causation and quantification of delays and disruptions. Delays and disruptions often go together, but they should be separated when analyzing the full impact of changes and changed conditions. Scheduling Techniques Delay and disruption are impacts that must be measured against the original performance plan or project schedule. Because the schedule is the reference point for measuring the secondary impact of changes and other causes of delay, a basic understanding of schedule techniques is essential. The time-scaled bar chart remains one of the most commonly used scheduling methods. A bar chart portrays graphically the various project activities and their respective durations relative to the time scale on the chart. However, this method generally does not show any work or resource restraints or other interdependencies among the various work activities. Therefore, in assessing delays on large, complicated 23
projects, the bar chart is not an effective analytical tool for demonstrating the impact of delay factors on all or part of the project work. Because of the limitations of bar charts, the most commonly used scheduling methods are precedent techniques, such as the critical path method. These systems show not only the work activities and their individual durations, but also link the work activities logically and sequentially, thus reflecting the various interrelationships, interdependencies and restraints. In even more sophisticated scheduling methods, the work activities are integrated with resource allocation (e.g., man loading) and the cost of performance of each activity. Using the Critical Path Method, the critical path of the project can be easily calculated. The critical path is the longest consecutive sequence of logically-related work activities from beginning to end of the project. Thus, it is the combination of activities which establish the soonest the project can be completed, thereby defining the total planned project duration. A delay to any activity along the critical path then causes a commensurate delay to the final completion date of the project. The duration assigned by the schedule for performance of each critical activity is the same as the planned duration for that activity; any deviation will affect the project completion date. In all projects, there are many noncritical path activities that are performed in parallel to those on the critical path. With respect to each of these noncritical activities, the schedule will assign a duration that is longer than the time it will take to complete the noncritical activity. The difference between the work duration and the time available for performance of a noncritical activity is termed the float or slack. Delays in performing noncritical activities would not affect the critical path (and delay the project), unless all the float available for that activity had been consumed. The concept of critical versus noncritical activities is very important to the issue of entitlement to an adjustment to contract time. An adjustment to the subcontract time or price generally can only be obtained for delays to the critical path. Therefore, a subcontractor seeking subcontract adjustment for delay must be able to demonstrate that a change or changed condition caused a delay to the critical path. This is true regardless of the scheduling format employed. This does not mean that delays to noncritical items are irrelevant to the analysis. Noncritical activity delays can be so substantial that all float is consumed and they become critical path activities. Entitlement to relief in this situation would depend largely upon which of the parties was entitled to consume the float and the sequence in which the float was consumed. In general, in construction scheduling, unless the contract specifies differently, all contractors (the prime contractor and all subcontractors) “own the float” in the schedule. The contractors retain the right to use the float of an activity for their own planning and scheduling purposes. An owner’s consumption of that float by changes or changed conditions affecting that activity is unauthorized. To the extent that the owner consumes float, a contractor and its subcontractors may later be entitled to
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adjustment if the activity is delayed long enough to impact the critical path and project duration.
Remedies for Delay Proving Delay and Its Impact The subcontractor seeking adjustment must show that the work did not proceed per the original plan because of certain changes or changed conditions. The subcontractor must show that the change or changed condition resulted in a delay to the work and increased costs. In many cases, the subcontractor’s change proposal or claim is part of a consolidated change proposal or claim prosecuted primarily by the prime contractor against the owner. Obviously, a prime contractor is in a better position to analyze the impact of all delay factors on the project schedule. Subcontractors should be cautious in proceeding with consolidated delay claims, especially if they suspect that the prime contractor or other subcontractors contributed materially to any of the project delays. Nevertheless, when appropriate, a consolidated claim relieves the subcontractor of the burden of performing an independent analysis of the project schedule and the delays affecting it. In such a case, the subcontractor’s role in the claim’s schedule analysis is primarily providing information. However, this “coat tail” claim approach is not a viable option in many cases, including: When the claim is directed primarily at the prime contractor. When the prime contractor elects not to assert a claim against the owner and defers that effort to the subcontractor. When the subcontractor is functioning as a prime contractor. If any one of these cases occurs, the subcontractor must then demonstrate independently the relationship of delay not only to the subcontractor’s own work, but also to the project’s critical path. The following discussion focuses on these situations. The subcontractor generally knows or at least suspects the principle causes of delay. That is not enough to persuasively establish entitlement to relief. All principal causes of delay to the project schedule must be identified to demonstrate which controlled progress and impacted the critical path. Each cause impacting the critical path must be excusable or compensable in nature, entitling an extension of time or compensation, or both. The subcontractor also must demonstrate that all procedural and notice requirements have been satisfied, and that entitlement has not been bargained away by change orders. Finally, a subcontractor seeking compensation must demonstrate that there were no concurring causes of critical path delay. These would reduce or eliminate entitlement to relief. If concurrent delays exist, their impact to the critical path delays must be allocated between compensable and noncompensable causes. The schedule analysis must be tailored to the project, the scope of the subcontractor’s responsibilities on the project, the nature of the problems encountered, the type of schedule, and the documentation available. The subcontractor must be creative and resourceful in detecting the causes of delay and determining the best method for 25
analyzing and depicting their impact on the project. There is no standard method for accomplishing this. However, the following Action Steps describe the methods that have proven successful in many claims for delay. Action Step 1: Delay Analysis Procedures Accumulate the necessary information and data for identifying the delaying factors and relate them to the project schedule. The following sequence of activities will help accomplish this task: Research the project files. Research all available project files to identify known or suspected causes of delay. Sources should include: o Daily reports o Change order logs and change orders o RFI and submittal files and logs o Construction change notices o Equipment usage logs o Correspondence files o Schedule meeting minutes o Schedule reports and updates o Project photographs or videos Establish delay issue files. For each change, constructive change, condition or other cause of delay identified, prepare a separate file of relevant documents and materials. In addition, for each delay issue, estimate or determine the party responsible, the date and duration of the delay or other impact, the work activities affected, and whether there is a basis for a claim or entitlement. The use of a standardized format for recording information regarding each delay issue often helps. Segregate delay issues by responsibility. Separate the identified delay issues into three separate categories: o Compensable causes (i.e., those for which the owner or prime contractor is responsible). o Excusable causes (i.e., those excused by the contract or under general legal principles). o Unexcusable causes (i.e., those resulting from the subcontractor’s own mistakes or inefficiencies). Establish procedural compliance. For each compensable or excusable delay, verify that all notice and other contractual procedures have been followed, or otherwise excused or waived, to preserve the right to additional contract time or money. If a delay issue relates to a change order, verify that the rights to an adjustment for additional costs or time have not been released. Action Step 2: Determine Appropriate Schedule Analyses. A simple one-line diagram or summary bar chart analysis often will prove sufficient to demonstrate the cause and effect of the delay factors on the critical path of the project and, thus, on the subcontractor’s work. When such a straightforward method will suffice, the use of more complex approaches is not only unnecessary, but may be
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counterproductive by making a simple issue confusing. A bar chart analysis is especially appropriate in the following circumstances: When the project work activities generally are sequential in nature, rather than concurrent. Linear interrelationships generally allow the assumption that all the principal activities are critical and any delay along the course of the project would be a delay to the critical path. When the subcontractor’s involvement on the project is limited and the involvement is on the critical path, and the subcontractor’s work activities are impacted by factors which can be analyzed separately from other activities on the project. When a restraint, suspension or delay is so substantial that it virtually shuts down the entire project, including all the activities for which the subcontractor is requesting a contract adjustment. In other circumstances, a line diagram or bar chart analysis may not effectively demonstrate that a delay or combination of delays impacted the critical path and entitled the subcontractor to additional time or money. In these situations, a more comprehensive approach will be required. Action Step 3: Identify the As-Planned Schedule. The original project schedule should be identified to provide a baseline “as-planned schedule.” Preferably this will be the official project schedule used in planning and performing the work. Hopefully, it is a schedule format showing the logical interrelationships of activities. If there is no original project schedule or it cannot be obtained, the only alternative is to prepare an “as-would-have-been-planned” schedule as accurately as possible. The general contours of this schedule can be drawn from contractual durations, milestones and other specified or known constraints. An “aswould-have-been-planned” schedule should attempt to approximate as closely as possible what the schedule would have looked like at the beginning of the job. Action Step 4: Create an Adjusted-as-Planned Schedule If necessary, modify the original project schedule to create an adjusted-as-planned schedule. Examine the original project schedule carefully to determine whether there were any errors or problems with the logic, durations or sequencing of activities. Often, in retrospect, it is discovered that certain aspects of the project could not have been constructed as originally conceived. The schedule should be adjusted to revise the logic so that the baseline as-planned schedule represents a reasonable and workable original plan. The revised schedule is termed the “adjusted as-planned schedule.” Action Step 5: Create an Expanded Adjusted As-Planned Schedule If necessary, add detail to create an expanded adjusted as-planned schedule. The adjusted as-planned schedule should present sufficient detail regarding activities known to have been affected by delay issues, especially if they affect the subcontractor’s work activities. If not, the level of detail in the schedule should be expanded. Breaking down activities that are shown on the adjusted as-planned schedule into greater detail permits an accurate evaluation of the impact of the known sources of delay. As in Action Step 4, this process should identify the work activities so that the baseline as-planned schedule represents a reasonable and workable original plan. 27
Action Step 6: Confirm the As-Planed Schedule Confirm that the as-planned schedule, expanded or adjusted, provides a proper baseline reference. The as-planned schedule will form the baseline for subsequent schedule updates and analysis. Therefore, the as-planned schedule, adjusted or expanded, should accurately reflect the original plan for the project, and portray a reasonable and workable plan for accomplishing the work activities required. Action Step 7: Prepare an As-Built Schedule The “as-built schedule” depicts the actual sequence and duration of the activities shown on the as-planned schedule plus any work activities added during the project. The asbuilt schedule is prepared from historical data. Its format should be comparable to the format used in the presentation of the as-planned schedule. The level of detail is, of course, dictated by the data available in the project records. Action Step 8: Compare the As-Planned and As-Built Schedules The critical and near-critical path activities on the as-planned and as-built schedules should be compared to determine which activities show delay or disruption. This comparison can be accomplished by chart or other graphic means of presentation. To facilitate this comparison, summary versions of the as-planned and as-built schedules can be prepared by deleting extraneous activities irrelevant to the delay analysis. This allows the comparison to focus specifically upon the key sequences of activities which control the pace and schedule of the job Action Step 9: Correlate Critical Path Delays with Delay Issues Delays of work activities on the critical path should be compared to the delay issues previously identified in Action Step 1. Superimpose the delay issues and their estimated impact on the as-planned and as-built schedules. Compensable delay issues should be correlated to determine if they caused the entire delay. If the delay cannot entirely be explained by compensable factors, the excusable delay factors should be reviewed to determine if they account for the remainder of the critical path delay. If the delays cannot be explained by excusable delays, the unexcused delay factors should be taken into consideration. If all critical path delays cannot be fully accounted for by the identified delay issues, further research and data analysis will be required to determine the remaining source of delay. Action Step 10: Summarize the Type of Delay Total critical path delays should be analyzed to determine which portions were attributable to compensable causes, excusable causes and unexcusable causes. If the delays were compensable and the subcontractor is seeking additional time or money, any concurrent noncompensable delays and their impact must be isolated. If any unexcusable or noncompensable cause is concurrent with a compensable cause, then the delay period is excusable but not compensable. Once this analysis has been completed, it can be shown which portions of the total project delay were compensable and excusable, excusable but not compensable, or unexcusable.
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Action Step 11: Prepare an Impacted Schedule for Comparison Purposes If the scheduling system permits, the subcontractor can verify the types of delays obtained from the preceding action steps by preparing an “impacted as-planned schedule.” The as-planned schedule, adjusted or expanded, is modified by inserting each identified delay factor, its estimated duration, and its effects on other activities. Scheduling programs facilitate this process. Theoretically, when all known delays factors are inserted into the as-planned schedule, the resulting impacted schedule should roughly approximate the as-built schedule. By removing the unexcusable delay factors from the impacted as-built schedule, the remaining excusable delays should, in theory, be identical to those determined under the as-planned versus as-built analysis. Likewise, if the unexcusable but noncompensable delay factors were removed from the impacted as-built schedule, the remaining compensable delays should also approximate those determined under the as-planned versus as-built analysis. Action Step 12: Prepare an Impacted Entitlement Schedule If the subcontractor is seeking to demonstrate constructive acceleration, one further step should be taken. To lay a foundation for demonstrating constructive acceleration, the as-planned, adjusted or expanded, schedule should be modified by inserting all delay issues that would entitle an extension of time, both compensable and excusable factors. This “as-planned impacted schedule,” sometimes called an “entitlement schedule,” when compared to the as-built schedule, often will show that the work was completed sooner than the extended completion date a subcontractor would be entitled to had the proper extensions of time been granted. While this comparison does not, by itself, prove acceleration, it would help to support entitlement. Extensions of Time Once entitlement and causation have been established, it is possible to show how much of the delay is attributable to excusable causes. If all procedural requirements for requesting time extensions have been satisfied or otherwise legally excused, the subcontractor is entitled to an extension of subcontract time for performance of work. This is an essential contract adjustment which must be specifically requested and obtained. Although the extension of time may not result in any increase in subcontract compensation, it will relieve the subcontractor from any liability to the prime contractor or owner for liquidated damages, if stipulated in the subcontract, or actual damages. Recovery of Delay Costs and Damages The entitlement and causation analysis also provides the basis for showing the subcontractor’s entitlement to additional money. The schedule analysis shows compensable delays. If all procedural prerequisites of recovery have been satisfied or legally excused, the subcontractor is entitled to any additional costs incurred which can be related to demonstrated periods of compensable delay. The schedule analysis also must be used to show the difference between the planned and actual expenditure of cost items and the receipt of funds. Any increase in cost or loss of revenue attributable to compensable delays should be recovered. Delay Cost Guidelines 29
The following elements should be considered in assessing delay costs:
Calculate extended project overhead. The cost of general staffing, administration, facilities, and equipment for the project generally is fixed or substantially fixed. Project overhead expenses can be one of the most significant costs resulting from delay. These costs can be demonstrated by comparing the planned project overhead expense to the actual project overhead expense on a modified partial total cost basis, or by calculating the daily rate of the cost of the fixed or substantiallyfixed portion of the project overhead and multiplying that daily rate by the number of days of compensable delay.
Calculate extended home-office overhead. A delay in completion of a project requires the continued attention of the home office and the continued consumption of centralized resources. Those general and administrative expenses must be accounted for during the period of compensable delay.
Calculate material and equipment escalation. Increased costs resulting from delayed purchase of materials and equipment is another major source of delay costs. The planned-versus-actual dates of procurement and any cost increases occurring during that period usually can be shown by referring to actual records and cost accounting data for specific categories of materials or equipment. If general construction materials cannot be traced through the cost accounting records to show specific cost increases, use industry sources to identify the rate of cost increases for material items or categories.
Demonstrate labor escalation. Actual hourly wage rates and salaries for project personnel should be compared to the as-planned man loading and staffing of the project. This will show any increased labor or staffing expenses incurred because of the labor being expended later than originally planned and at more expensive rates. Prepare a graphical or tabular plot of how and when the labor was planned to be expended, or would have been expended without the project delay, and compare it to a plot of how and when the labor was expended. Any shift of labor and project staffing into labor periods can then be correlated to known increases in labor costs.
Document the increased amount of direct labor, equipment and tools. Substantially delayed projects often experience an increase in the total labor required. Inefficiencies caused by increased turnover, idle crews and equipment, and loss of morale, not only increase the total cost of labor but also increase the total cost of tools, equipment and consumables. Demonstrating compensable delay creates entitlement to recovery of these additional costs.
Include temporary utility and facility costs. If the subcontractor is contractually obligated to supply temporary power, water or other utilities during construction, an extended project increases those costs. These costs usually can be shown on an itemized cost basis. If the project cost accounting system does not permit
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itemization, a comparison on a budget or line item basis between the estimated and actual expenses can be used on a modified partial total cost basis.
Include the costs of storing materials and equipment. Materials and equipment often are purchased early in the project and, upon approval, are delivered by the vendors and manufacturers. When the project is delayed, there can be a significant unanticipated lag between the time of delivery and the time of actual use. This requires prolonged storage, insurance and security. These costs should be separately itemized. If the project cost accounting system does not permit itemization, a comparison on a budget or line item basis between the estimated and actual expenses can be used on a modified partial total cost basis.
Include any unexpected weatherization costs. Often, project delays cause a delay in enclosing the buildings under construction. This, in turn, requires unanticipated weatherization of the structure (e.g., temporary enclosures and temporary heat). These expenses should be itemized and demonstrated on a discrete cost basis.
Include any increased costs for weather sensitive work. Similarly, delays often push weather sensitive work into unplanned adverse weather and adverse site conditions. While this delay and its compensability should be proven as an element of delay damage, quantification of its cost must be performed using the techniques described below.
Consider extended warranties and added equipment. When equipment is purchased early in the project but not installed or accepted until much later, the cost of standard specified warranties for such equipment increases. These costs can be demonstrated on an actual cost basis if the extended warranties are purchased from the manufacturer of the equipment. Otherwise, the extended warranty costs can be determined from historical information or standard estimation procedures. Alternatively, estimated or actual costs of maintaining the equipment under warranty during the delay period can be used as the basis for pricing this item.
Include any increased costs for maintaining and protecting work. Once work is in place and equipment is installed or stored, delays increase the costs of maintaining and protecting these work items. This can be shown by actual costs or by comparing the planned versus actual costs for specific items. If the records do not permit comparison, estimates should be used.
Calculate delayed release or reduction of retainage. It is not unusual for a prime contractor to retain a percentage of progress payments until the subcontractor’s work has been completed and accepted. A delay in the project completion or release of retainage causes the subcontractor to lose the use of those funds. The longer the delay, the longer the subcontractor must wait for a reduction in or payment of any money retained. As-planned versus actual comparisons permit a calculation of the loss at a contractual or commercially-reasonable interest rate. 31
Calculate financing costs. Delays in project completion often correlate to delays in reimbursement for extra costs. This may result in the use of borrowed funds or a diversion of the subcontractor’s working capital. Either can result in additional project costs to the subcontractor. Financing costs can be demonstrated by a tabular or graphical analysis showing when recoverable costs were incurred, when they were due (allowing a reasonable time for payment under the ordinary processing of requests), and when such costs were paid or projected to be paid. This permits a progressive calculation of the actual imputed interest.
Include sub-subcontractor costs. Obviously, delay costs claimed by subsubcontractors should be included. In addition, if any failure of performance or a default by a sub-subcontractor can be correlated to delay, any increased completion costs attributable to that default should be included.
Include the costs for business license, permits and taxes. Any costs related to project licenses or permits or other business licenses and taxes should be included if the compensable delay required additional payment of such costs.
Remedies for Disruption (Productivity Loss and Inefficiency) Proving Disruption and Its Impact The conditions of performance will affect the rate of and efficiency under which construction work will proceed. This, in turn, affects the cost of performing the work. When a subcontractor estimates, bids and contracts to perform work, certain assumptions about the conditions under which the work will be performed must be made. Assumptions about how work is customarily performed generally are drawn from what is indicated in the bid documents, together with the experience and expertise of the subcontractor. The subcontractor is not entitled to assume optimal performance conditions, but may assume that performance will proceed under conditions typical for that kind of work, unless otherwise specifically indicated in the bid documents. Changes and changed conditions entitle the subcontractor to an adjustment of time or money. These changes or changed conditions often act independently or in combination to cause various aspects of the work to be performed in sequences, or under conditions different from those anticipated and planned. It is reasonable to expect that changes in sequence, means and methods, or conditions of performance will to some degree, affect the efficiency of work performance. However, because of the intangible and direct and indirect nature of such impacts, the major obstacle confronting the subcontractor seeking reimbursement disruption costs is demonstrating a causal relationship between the changes and changed conditions and any resulting impacts on productivity or efficiency. Disruption Causation Guidelines Compare schedule charts of disrupted activities. Focus as narrowly as possible on those activities known or suspected to have been affected by disrupting factors 32
and plot a detailed as-planned versus actual schedule comparison. This plot often will show the following classic patterns of disruption: Disruption in work sequences from the original plan (e.g., a start and stop pattern, jumping around, disorderly progress). Work performed out-of-sequence (e.g., work activities performed in sequences that detrimentally affect the accessibility or productivity of subsequent work). Overlapping and compression of work activities that were planned as sequential. Stacking of multiple trades. This causes congestion and requires conflicting operations to be performed concurrently in the same areas. Compression of the subcontractor’s work activities into shorter than planned durations.
Plot disrupting events. In conjunction with the as-planned versus as-built charts developed above, plot (separately or superimpose) all known disruptive factors affecting the activities involved in the analysis. These would include: Numerous requests for information, especially if responses are untimely. Change orders and change order requests. Suspensions and restraints. Identifiable conditions impacting work. The plot may show a direct correlation between these factors and the disrupted patterns. It also could indicate an aggregate or ripple effect on the work involved if many disruptive events had occurred.
Compare as-planned versus actual man loading and equipment use. Focus on an activity known or suspected to have been impacted and plot the as-planned versus actual man loading and labor consumption on a time-scaled chart. This kind of plot can indicate several patterns, including: o Erratic peak-and-valley man loading rather than smooth transitions in the buildup and scale-down of the labor used. o A massive crunch, far exceeding projected man loading or crew size plans, toward the end of the project, suggesting directed or constructive acceleration. o A significant total increase in overall man loading and labor consumed. This same approach can be employed, if information and data is available, for the labor-related consumption of equipment. Plots of as-planned versus actual major equipment use can be correlated and, thus, support man loading analysis.
Demonstrate acceleration. Constructive acceleration, as well as directed acceleration, can substantially affect the efficiency of the subcontractor’s work. As discussed in Action Step 12 above, entitlement for constructive acceleration can be supported by a schedule comparison.
Develop an historical record. Review and compile information in the project documents (e.g., daily reports, schedule reports, photographs, correspondence, change order logs, RFI logs, equipment usage logs, etc.) to develop an historical record indicating delay, disruption and inefficiency. Record such factors as: Delayed response to RFIs and change order proposals. 33
Excessive turnover. Standing time. Delay. Disruption. Rework. Congestion. Scheduling difficulties. Adverse site conditions. This is especially helpful if the record can be correlated to the patterns of delay, disruption and inefficiency indicated by the schedule analysis.
Demonstrate the impact of unplanned overtime. Prepare a schedule plot of the planned versus actual use of manpower and equipment for overtime. This plot should include not only extended work days, but also extended work weeks.
Document additional crew and equipment use. Demonstrate, by reference to historical documents and cost records, the need to add additional crews and related equipment and vehicles because of performing tasks in an overlapping fashion that had been planned to be performed sequentially.
Document slippage of work into less desirable weather or other adverse conditions. Refer to the schedule analysis discussed above and demonstrate that weather sensitive activities were performed in unplanned adverse weather and under different site conditions.
Obtain supportive opinion evidence. Because of the difficulty in measuring objectively the impact of productivity loss or inefficiency on the performance of work, first-hand observations by qualified observers can be useful. Opinion evidence can be drawn from experienced project management and supervisory personnel as well as from outside experts and consultants.
Demonstrate that the disruption is not necessarily dependent upon delay. While there usually are correlations between delay and disruption, a substantial disruption of work can occur on a project without a critical path delay. Productivity losses can occur even though they relate to activities that do not delay the project schedule completion date. Nevertheless, they may be compensable and should be monitored, evaluated and claimed if they can be clearly demonstrated. The fact that no excusable delay has occurred on the project does not foreclose the possibility of recovery for disruption.
Recovery of Disruption Costs Proving the amount of inefficiency or productivity loss is a difficult task. There are no precise formulas or methods that apply to every case. The goal is to prove, with a reasonable degree of certainty, what work should have cost in comparison to what it did cost because of the disrupting factors. This requires a comparison of the planned versus actual efficiency or productivity of the work, which generally is measured by the 34
amount of input (e.g., man-hours or cost) against the output of units of work accomplished. The more efficient and productive work performance, the lower the cost of labor input to produce a unit of output. The categories of cost most frequently affected by disruption are labor costs and any equipment, small tools or consumable costs that are related directly or indirectly to the consumption of labor. However, variable cost items, such as project overhead also may be affected. Because of the inherently difficult nature of this correlation, a subcontractor seeking additional money for disruptions should quantify the claim in more than one way. Several methods can be used. Disruption Pricing Guidelines The following guidelines will help in quantifying disruption costs.
Compare productivity rates. The productivity rates of impacted work can be compared to the rate or productivity that would have been experienced without the disrupting factors. Segregate the affected work activities and calculate productivity rates (e.g., cubic yards of concrete placed per man hour, linear feet of pipe installed per direct labor cost, etc.). Actual productivity can then be compared to a baseline standard of productivity. A demonstrated decrease in productivity allows the increased costs to be calculated. Baseline productivity rates can be obtained from several different sources, including: Comparisons of productivity achieved in performing similar work on the same project during undisrupted phases. Productivity rates established by controlled tests or time-and-motion studies on the same project performed under undisrupted conditions. Historical data of productivity rates achieved by the subcontractor on other similar projects. Productivity rates used in initially estimating the work based upon performance factors and estimated data drawn from company history. Industry sources for productivity standards. If the type of work involved or the records maintained do not allow a unit productivity determination, a gross comparative study may be made. Compare the percentage of work completed to the overall labor costs or manpower of the job. This permits a comparison of the cost of performing work during undisrupted periods with the cost during disrupted periods.
Prepare empirical calculations based on industry productivity studies. There are several industry studies on productivity rates or labor efficiency for various categories of disrupted work. These rates usually are presented as a percentage of productivity or efficiency loss. For example, a severe stacking of trades causes a 30 percent loss in productivity. If the conditions identified in these studies can be matched to the conditions experienced on the project, the inefficiency rates derived from the studies can be multiplied by the estimated labor used for the affected activities to determine the impact on labor costs. To continue the example, if 1,000 man-hours were originally estimated to complete the work, a severe stacking of 35
trades, using the above example, would suggest an expected labor consumption of 1,427 man-hours or a 427-man-hour increase. Summarize all calculations and compare them to actual data. Use industry studies to ensure that any comparisons between the studied conditions and the project conditions are analogous. Note that some studies are more objectively based than others. For these reasons the best use of an empirical approach is to verify disruption costs calculated by other methods.
Determine the increased cost of unplanned overtime. Unplanned overtime, either extended work days or extended work weeks, often results from acceleration or other disruptions to the subcontractor’s work. There are three elements which must be considered to assess the full impact of planned overtime on the subcontractor’s cost and performance. First, the direct increases of the premium wage rates must be paid. Cost accounting records can show this increase. Second, additional costs often are incurred in providing temporary services and facilities during the extended work days or weeks. These costs also should be included. Finally, if unplanned overtime is required over extended periods of time, the overall efficiency and productivity of the work force is diminished. Consequently, this is a very real cost of prolonged, unplanned overtime. Productivity loss can be demonstrated either by comparing the total estimated labor hours to the actual labor hours expended on the tasks requiring overtime (if the records and the cost accounting systems permit), or by computing the productivity loss on an expirical basis.
Demonstrate increased composite labor rates. Work often is estimated upon using a composite labor rate based upon the composition of the work crews. However, disruption often results in a higher proportion of foreman to journeymen/apprentices/helpers. This will increase the actual composite labor rate. Cost records and labor reports can document this increased cost.
Document the increased consumption of project overhead. Project overhead costs on a disrupted project often vary substantially from the costs originally estimated. Requirements for additional staff, supervisors, engineering support, equipment and other facilities used usually result in less efficient use of the labor force. If this can be demonstrated by an itemized comparison of the as-planned and actual project staff and equipment records, that approach should be used (for example, if two cranes were required instead of one or two field engineering crews were required instead of one). Otherwise, a modified partial total cost approach focusing only on the project overhead categories experiencing increased resource consumption should be used.
Document waste or loss of materials, supplies and tools. If these costs can be correlated to an increased consumption of labor, use that method of computation. Otherwise, use an estimate unless itemized cost increases can be shown on an asestimated versus as-expended basis. 36
Obtain supportive opinion evidence. As discussed above, a good method of proving the cost of disruption of efficiency loss is by providing first-hand observation by qualified observers. The subcontractor’s own project supervisors and management often are in the best position to assess the overall impact of the disrupting factors or conditions on performance. For example, an experienced project manager’s assessment that a disruptive condition caused a 25 percent efficiency loss would likely be accepted in court and board proceedings as sufficient proof of the amount of disruption cost, especially when supported by other more objective forms of evidence.
Consider using expert engineering consultants. Because conventional construction cost accounting systems do not permit a clear proof of efficiency variations, disruption losses are subject to expert engineering analysis and opinion. These opinions are enhanced if the expert has had the opportunity to observe, test and measure the conditions encountered on a first-hand basis. Therefore, subcontractors anticipating substantial disruptions should consider hiring an engineering consultant early to permit onsite participation and analysis.
Miscellaneous Costs Definition There are several categories of costs that do not fit into the direct and indirect cost categories discussed above. They are, however, real and potentially substantial in amount. Some of these costs are easily recoverable and some are not. This discussion is limited to the following categories: bonds and insurance, interest and imputed interest or cost of capital, and attorney and consultant fees and expenses.
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Bond and Insurance Costs Most projects require subcontractors to procure different types of insurance coverage. In addition, many projects also require that the subcontractor procure performance and payment bonds. The cost of that insurance coverage and bonding is based on the estimated duration of the project as well as the original subcontract amount. Most insurers and sureties realize that projects can change substantially in duration and amount. Accordingly, most insurance companies make a practice of adjusting the premiums at the time of project completion to reflect the increased duration. Therefore, keep in mind that the insurer and surety will likely demand an additional premium based upon the final subcontract amount and project duration. Consequently, include as part of any change proposal or claim, the actual or projected costs that the subcontractor will incur because of contract modifications. These costs should be shown as a separate line item on the proposal after profit has been calculated. Interest, Imputed Interest and Cost of Capital The theory behind interest recovery is entirely consistent with the principle of equitable adjustment—namely, obtaining a full and fair recovery for changes or changed conditions. In an inflationary period, a request for $100,000 would be worth $10,000 less in two years if inflation were 5 percent annually. To receive the full value of a request if settled two years later, the subcontractor would have to receive approximately $110,000. Interest must be recovered to ensure that the subcontractor is fully reimbursed for performing work today and resolving change proposals or claims months or years later. If interest is not allowed, any delay in settling change proposals or claims becomes a very real, out-of-pocket loss to the subcontractor. There are four general approaches to recovering interest. Some are more applicable and acceptable than others, but they should all be understood so the best option can be selected. Interest at a Contractually-Stipulated Rate. Many contract documents stipulate that, if payment is not made when due, the amount owed shall accrue interest at some stated rate from the date payment became due until the payment was made. Interest rates are sometimes stated expressly in the contract. Other times they are referred to as the legal rate of interest. Generally, the legal rate of interest has not kept pace with commercial lending rates. Thus, parties should attempt to negotiate a more realistic rate that is pegged to commercial lending rates, the Contracts Disputes Act rates, or the prime rate set by the Federal Reserve Board. Establishment of a realistic rate of interest is one of the most beneficial rights obtained in contract negotiations. To be entitled to interest, the subcontractor must comply with all required procedures. Construction contractors and subcontractors working on federal projects must deal with an entirely separate body of laws concerning interest entitlement, including the Prompt Payment Act and the Contract Disputes Act. Interest under Statutory Law. Most states have statutes that allow prejudgment interest at a statutorily prescribed legal rate. Under these statutes, the application and the rates vary from state to state. Generally, the most important requirement is that the 38
claim be in a liquidated amount—an amount that is fixed and definable. Most construction contract claims, at least for direct and indirect damages, are considered liquidated. The problem with this approach, however, is that the specified legal rates usually fall short, sometimes substantially, of commercial interest rates. Imputed Interest and Equity Capital. A subcontractor also can look at interest as a true and actual cost that must be recovered. Specifically, if a project has had substantial cost overruns, the subcontractor must divert additional working capital to meet the project’s significantly higher cash requirements. The project consumes more working capital than the subcontractor had planned. Additional working capital can come from one of two sources; it can be borrowed or it can be diverted from other working capital of the subcontractor. If borrowing is required, the contractor incurs a real and direct cost in financing the loan. To enhance the chance of recovering these costs, the subcontractor should demonstrate: That a separate loan was procured strictly to finance completion of the problem project. That no other sources of working capital were readily available. That all borrowed funds were used to fund completing the troubled project. If the money was drawn from a general line of credit, this resulted in an extraordinary and definable draw on that line of credit. If the subcontractor diverts working capital that otherwise would have been put to some productive use, the subcontractor would incur an imputed interest cost by using cash that otherwise could have been earning other income. To establish the predicate for recovery of imputed interest under the equity capital theory, the subcontractor should show: The precedent of maintaining a substantial balance of working capital for taking on new projects. That the withdrawal of funds demonstrates a substantial departure from standard operating procedure. A pattern of investing the uncommitted working capital either in conventional investments, etc. Alternatively, an imputed interest cost could occur if the subcontractor could not take on new work because of reduced working capital. Presumably, the new work could have earned a profit at historical rates of return. This situation is probably the most realistic. It recognizes a true cost that is incurred in a cost overrun situation and approximates a realistic rate of interest to allow a full and fair contract adjustment. The ability to recover these costs has met with varied success in federal and state courts, but it is worth calculating to determine if it maximizes the opportunity for full recovery. Interest as an Element of Profit. Several courts and boards of contract appeal specifically have not allowed recovery of interest costs for diverted capital but have considered interest recoverable as an element of profit. Consequently, the same 39
rationale and factual showing discussed above would apply here, and should be included in calculating the appropriate profit percentage on the total claim. While it may exalt form over substance, this approach can make the difference in using the equity capital method of demonstrating costs. Attorney and Consultant Fees The general rule throughout the United States, known as the American Rule, is that each party must pay its own attorney and consultant fees in connection with litigation. However, there are several sources available to obtain reimbursement of all or part of the costs of attorney or consultant fees.
Look first to the contract. Contract documents often provide that under certain circumstances, one of the other parties is entitled to recovery attorney fees or the prevailing party, in a dispute, can recovery attorney fees.
There is a common-law principle in most states that allow attorney fees when the other party has been stubborn and litigious in forcing the subcontractor to commence an action where clear liability exists.
On federal projects, the party contracting with the federal government may be entitled to recovery of litigation fees and expenses under the Equal Access to Justice Act. This law is restrictive in defining the size and characteristic of companies that can use this statute, thereby excluding contractors. Moreover, since the subcontractor must prosecute its claims on government projects through the prime contractor, even if the subcontractor’s company is within the size standard required, the subcontractor may be excluded from coverage because the prime contractor exceeds the size standard. More critically, the law requires a finding that the government’s position was not “substantially justified” in defense of the contractor’s claims. This is a difficult standard; the courts have exhibited a general reluctance to award interest except in extreme cases of government abuse or discretion.
Profit or Return on Investment Profit is the amount received by a subcontractor for performance of work in excess of any direct or indirect costs. Profit is an essential element of all business transactions, since it provides the necessary return on investment that justifies the venture. Without profit, the subcontractor would be well-advised to simply place working capital into a money market account. While the base subcontract amount includes some profit, the percentage depends upon the competitive environment and other factors surrounding the subcontracting process. If changes are made that increase the subcontractor’s costs of performance, then profit on that increased cost must be obtained to maintain the return on investment. The subcontractor is entitled to a fair profit on additional costs incurred because of changes or changed conditions. This entitlement should be carefully monitored and pursued.
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Profit Guidelines The following guidelines will assist in preserving the subcontractor’s profit or return on investment.
Often subcontract documents specify a certain percentage for profit, especially for cost reimbursable changes and claims and force account work. If a percentage is contractually specified, both the subcontractor and the prime contractor will be bound to it.
If there is no contractually specified percentage, the parties are free to negotiate on a change-by-change basis. Alternatively, they could agree on a uniform percentage rate for all change orders. These percentages generally range from 5 to 15 percent. However, in negotiating a percentage, it is critical to consider what element of cost is recovered by profit. The term margin is ambiguous and could refer to either the net margin (i.e., true profit) or the gross margin (i.e., true profit plus home office overhead). If the gross margin is intended, the percentage allowed must be sufficiently high to ensure that both home office overhead and return on investment are recovered.
If profit is based upon a percentage of costs, it should be calculated after all direct and indirect costs have been considered (including project overhead and home office overhead). Generally, however, the miscellaneous cost items are not added to the cost base upon which profit it calculated.
If project changes result in substantial dollar increases or in significant delays or suspensions, a negotiated or contractual percentage for profit may not achieve a reasonable result. If the change results in large-dollar adjustments, a set percentage, such as ten large-dollar adjustments, a set percentage, such as 10 percent pure profit, may be too high (if the originally-anticipated net profit was only 3 percent and the industry average is only 2 percent). On the other hand, if the change or changed condition results in a substantial delay or suspension, but does not add significantly to the cost of performance, then 10 percent may not be sufficient to compensate the subcontractors for valuable resources that are tied up on the problem project. In such circumstances, alternative approaches should be considered. The subcontractor should consider: o The net profit rate included in its subcontract amount. o The historical return on investment for similar kinds of work. o The historical return on investment for the industry on projects of that type.
On federal projects, profit calculations become more complicated. They are based on the application of the Federal Acquisition Regulation, which provides for a structured analysis, using such consistently applied factors. A determination should be made to show whether and to what extent such factors or guidelines apply and how they relate to a pricing proposal. Applying these factors can produce a wide range of results ranging from 2 to 3 percent on the low end to 10 to 12 percent on the high end. 41
If not recoverable as interest in a claim, the cost of imputed interest or equity capital may be allowed as an element of profit or at least as a consideration in calculating the amount of profit. Since profit is often a function of risk and the amount of working capital invested to achieve it, the imputed interest or equity capital approach provides a realistic basis for assessing this element.
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