ARTICLE

The Impact of Delay Damages

by: Smith and Howard

July 10, 2014

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Delays in construction projects can lead to a cascade of negative financial repercussions for both owners and their contractors. The parties may even wind up in court.

Calculating damages in these cases can prove especially tricky when an owner causes the delay. Why? Because a significant portion of a contractor’s costs will need to be allocated among multiple projects. But a qualified financial expert can help.

Two overhead allocations

A delayed contractor will likely seek damages to cover some of its overhead costs, but construction companies rarely segregate overhead by project. Two types of overhead costs will require cost segregation or job-specific allocations:

1. Extended field/jobsite overhead. This overhead classification consists of costs which are necessary to support the work at the jobsite and, therefore, are directly chargeable to the project. These costs represent indirect expenses associated with the project and can increase because of delays. Such items can include but aren’t limited to the following:

  • Field office and equipment rental,
  • Project managers, supervisors and office workers,
  • Field office vehicles,
  • Field office utilities (including electricity, water and sewer usage), and
  • Supplies.

Contractual damages for these costs are based on the assumption that the original contract price included only the jobsite overhead costs necessary to support the project for the expected project completion timeline.

Determining a reasonable method to allocate the costs to various jobsites or projects can be challenging when employees (such as supervisors) work on multiple jobsites, meaning their time must be allocated. Cost allocation is also necessary when a delay creates the need for additional supervision, equipment, reporting, quality control and scheduling.

2. Indirect overhead items. These claims are a contractor’s “cost of doing business” and are frequently among the most contentious points of construction litigation. Disagreements often stem from the fact that such items can’t be directly charged to a specific project. Examples include:

  • Salaries (for company officers, estimators, accounting staff and others not assigned to a specific project),
  • General and administrative costs,
  • Insurance, and
  • Taxes.

Unlike jobsite overhead, indirect overhead items generally are not directly increased by a project delay. However, slowdowns can impede the contractor’s ability to generate revenue. As a result, project delays negatively impact profitability and lead to reduced margins.

Much of litigation revolves around the appropriate cost allocation method formula. Several approaches have been used, including the Eichleay formula, Carteret formula, direct allocation method and fixed percentage approach. The Eichleay formula is probably the most common method. Under this method, a contractor must establish that:

  1. a compensable delay occurred,
  2. the construction company was working on standby, and
  3. the business couldn’t take on other projects.

Additional contractor damages

Depending on the circumstances, a contractor could pursue several other types of damages — including productivity losses and damages for escalation. Although a contractor typically assumes the risks related to the costs of labor, equipment and materials during the course of a project, contractors could be entitled to damages that result from increased production times that result from such delays.

For example, a construction company might postpone a materials purchase because of the delay. If the materials cost more when purchased later, the owner could be liable for the difference in costs.

If, on the other hand, the contractor went ahead and bought the materials within the original period, it could seek damages to reimburse it for storage costs incurred because of the delay. In addition, the construction company could demand compensation for costs associated with idle labor and equipment.

On the upside, courts expect damaged parties to make reasonable efforts to mitigate their losses. So, a contractor’s damages may be limited to the extent that managers failed to take steps to minimize damages once they knew about the delay.

Don’t delay

The list of damages a contractor may seek following a construction project delay can seem daunting. But a qualified financial expert can help you determine whether these damages are reasonable by ensuring both the appropriate allocation of overhead and the reimbursement of legitimate charges under the contract. Furthermore, should the dispute land in court, the expert can present testimony on the proper calculation of damages.

For more information, contact Mark Abrams, Sean Taylor or Tim Agnew in our Real Estate Niche at 404-874-6244.

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