Head office overhead is the contribution made by each contract to the contractor's central cost base — the cost of running the head office, the senior management, the central support functions and the like. Where a contract is prolonged as a result of an employer-caused event, the contractor will argue that it has been deprived of the head office contribution it would otherwise have earned during the period of delay, and that this deprivation should be compensated as part of its loss and expense.
Three formulae are commonly applied to estimate the head office contribution lost as a result of delay: the Hudson formula, the Emden formula and the Eichleay formula. Each takes a slightly different approach, and each has its strengths and weaknesses. None has been universally accepted by tribunals, and the use of any formula is generally regarded as a fallback to be applied where actual cost cannot be proved.
The Hudson formula calculates the head office contribution by taking the head office overhead and profit percentage from the contract, applying it to the contract sum, dividing by the contract period, and multiplying by the period of delay. The principal weakness of the formula is that it relies on the tendered overhead and profit percentage, which may bear little relation to the actual overhead carried by the contractor's business at the time of the delay.
The Emden formula is similar in form but uses the contractor's actual head office overhead and profit percentage, derived from its audited accounts, in place of the tendered figure. This is a more defensible approach but it requires disclosure of the contractor's accounts and depends on the reliability of those accounts as a measure of head office cost.
The Eichleay formula, developed by the United States Armed Services Board of Contract Appeals, takes a different approach. It calculates the daily head office contribution allocable to the project (by allocating total head office overhead across all projects in proportion to revenue) and multiplies that daily figure by the period of delay. The Eichleay formula is widely used in US federal construction claims but has been received with caution in other jurisdictions.
The preferred approach, where the records permit, is to prove the actual additional head office cost incurred as a result of the delay — for example, the cost of additional senior management time devoted to the prolonged project, or the cost of additional support functions required. This avoids the artificiality of the formula approach but requires detailed time recording and a clear understanding of the contractor's head office cost structure.
An important threshold question, often overlooked, is whether the contractor has in fact suffered any loss of head office contribution. The formulae assume that the contractor was unable to take on alternative work during the period of delay because its resources were tied up on the prolonged project. If that assumption is wrong — if, for example, the contractor was operating below capacity throughout the period of delay — then no loss of head office contribution has been suffered, and no recovery should be allowed.
Our quantum experts at Construction Expert Witness have addressed head office overhead claims on disputes ranging across the UAE and GCC. We assist parties in selecting the most appropriate methodology for the case, in substantiating the claim with proper documentary evidence, and in defending or attacking the methodology and figures advanced by the opposing expert.