When a variation arises on a construction project, how should prelims and overhead costs be valued? Is there a correct way to value an amount due under the contract? As Andy Hewitt observes “On the one hand, it could be this, but on the other hand, it could be that.” The problem is that, as with so many things in life, ‘it depends’.
We’ll start with the assumption you are familiar with variations. Under a construction contract, anything that is a change may be a variation. A variation might arise as a result of a mistake in the original plan or scope, a change in circumstances or (often) ground conditions, changes in technology or or a design change. Any number of circumstances may lead to a variation.
In simple terms, a surveyor might value a change and price it according to a mechanism in the contract and/or in agreement with the contractor / client.
However, what if there are knock-on effects of a change? What if extra costs arise indirectly? Overhead costs, such as prolonged preliminaries or office costs continue to arise. There may also be effects on time and the programme.
As you will now be gathering, the potential outcome of a small variation may quickly become complex.
So what needs considering, when valuing and submitting a claim or valuation for of a variation that affects overheads?
Firstly, there is case law that tells us you can recover your costs for overheads. In Deepak Fertilisers and Petrochemical Corp v. ICI plc, the judge stated that such costs are ‘no more remote’ (too far-removed to be claimed) than the cost of reconstruction. There should be no doubt that overheads are recoverable.
Yet the question is how?
The contract will dictate which overheads are recoverable and how. However, one of the problems with overheads is the difficulty in identifying them. With the arrival of a variation, there may be new overheads to consider.
So how can a reasonable amount be reached for additional costs or time incurred? A contractor may have to devote exceptional resources to a change or default by the employer. The anticipated level of overheads may not remain the same as planned.
Fixed or Anticipated Overheads
There have been many attempts to work out the best way to identify additional overheads. These include methods which absorb the costs in an analytical or theoretical manner or through a formula. Formulae include the Emden, Eichleay or Hudson methods of valuation.
The problem of course, with formulae, is that they are theoretical. Courts or tribunals are often not keen on things which do not clearly identify cause and effect. Another technique is using a simple percentage. The original figure will likely have been based on a percentage of the original contract sum. It might therefore be reasonable to anticipate that a percentage increase based on the additional work anticipated might be a good way to calculate added cost. A simple correlation is at least simple to understand and reasonably logical. This is generally acceptable for pricing a variation but less so for evaluating a claim for loss & expense.
There is also the possibility of additional overheads. Things that can be calculated. Andy Hewitt, in the article referenced above, suggests these should be claimed separately. A claim for extra work would form one claim. This is because an agreement should be straightforward to achieve and could be agreed by the quantity surveyor. Therefore, any extra items required for hire / off-hire, any assets made unavailable by extended use or increased costs for plant being displaced might be separately accounted for.
But it is important to ensure no duplication occurs as a result of this process. Anything accounted for through a formula or percentage should not appear in an additional overhead claim.
Another consideration in some major projects might be currency or exchange rate fluctuations. Some projects involve international transactions and costs. Therefore, a reasonable or accurate assessment of the value of money at the time of transaction may need to be brought into contemplation.
As with most things in life, there is little in the way of an easy answer. The key is accuracy and clarity. The more accurate a claim, the more likely its acceptance. But clarity should not be sacrificed. A claim which is theoretically accurate might be so complex as to be incomprehensible. One such case was that of Alstom v Yokogawa . In that case, a consultant contrived such a complex analysis of time that it erred (in the words of Captain Mainwaring of Dad’s Army) into ‘’the realms of fantasy’’.
Any analysis or claim for loss and expense should be grounded in fact. It should be clear and accurate. This is no different for an overhead claim than for any other form of claim. Whatever method is used to claim for overheads, the reasons for its use should be reasonable and justifiable.
If you are interested in finding out more about variations, prelims and overheads, join us in Manchester on 19th March.