Unabsorbed Overhead Costs and the Eichleay Formula

• Author: Major Jeffrey W. Watson
• Pages: 05

I Introduction

A government contracts attorney should know what costs contractors can assess against a government contract This article w11 present a user-friendly guide to unabsorbed overhead costs with the aim of clarifying what initially may appear as an enigma. Trepidation and "Sweaty palms" may greet the contract law attorney who does not understand unabsorbed overhead costs. Howeuer. unabsorbed overhead cost IS both comprehensible and recoverable 1

\$%hat happens when a contracting officer informs you that the construction project at your installation needs to be suspended temporarily? \That advice do you give? What 1s the government's liability when it suspends contractor performance? How are equitable adjustments measured? Although this article will touch on all of these issues. it wll focus on the formula to u8e m measuring unabsorbed overhead costs.

To understand this subject. the article begins with an hietoncal overview of home office' expense as an unabsorbed overhead

'Judge .Adiorate genera!^ Department. United Stater Air Farce Current!,

1992 hereinafter FAR >Tj/ 11 "n, k.. . . . . ~ . . ....... , ..~.~ .......... ,

. . . . . . . . . . . . . . . . . . . . . . . . . .... . . . . . . . . . ,-.. . . . . . , .- .. .

, ..

tratije funcnonr and may ale0 perform bemice funrriana ~n mpport of:he operations ai the S ~ T I O U L iegments .An orgamirnan which has Intermediate levels. ruch ai p~oups ma> haie several home offices which ienori to B cornman home ofke An intermediate oreamsarion ma) be bbth B iegnient and rn hame officeId

M&JOR JEFFREY

~~~~~~~~~~~~ ~ ~~~ ~~~ ~ ~

)___

cost Then, it describes varmu~ formulas used to calculate these costs. Finally, it COVETS the current case law since the Federal Circuit decision in Wxkham Contraetrng Co v Fiseher3 which decreed that the E~hleay~formulawas the only proper method to use m government contracts.

11. Historical Perspective an Unabsorbed Overhead Costs

Fifty years ago, in the seminal case of Fred R Comb Co. ii.

United state^,^ the Court of Claims held that the government was liable to the contractor for damages caused by delay The court found that the contractor suffered damaged awaiting the conclusion af a property dispute. The contractm submitted its costs, including overhead expense, for the suspension period. The government denied these C O S ~ S . ~

At that time, the key to alloivability of costs depended on whether the contract granted authority to aaust the contract price. Far the government, it mattered not that its conduct caused the additional expense incurred by the contractor. Accordingly, the con-tractor sought relief in the Court of Claims.

Far the first time, the court laid the foundation for the pay. ment of unabsorbed overhead costs. The government contested an allowance of any main (home) office overhead. Further, B court commissioner found no proof of the additional office overhead. The court held It irnmatenal and reasoned that it was unlikely that a contractor would enlarge his home office staff and facilities dunng a sus-pension period. It noted further, however, that if the contractor laid off some of its employees dunng this period, it would be material.' It would be material because that is an overhead expense.

The court explained that lapng off home office employees dur. ing a suspension penod of short and indefinite duration ordinarily i8 impractical. Finding that a contractor is forced to wmte the salary of home office staff dunng a period of suspension, the court finally held "the Government, having breached its contract, has no

'12 F3d 1574. 1581 [Fed Cir 19941'Eichleay Cow, ASBCASo 5183. 60-2 BCA P 26883103 Cr CI 174 (1946)

Vd at 183 "It 11 a breach of contract far the auner to negligently ~nvolve a eonlrarfar m the problems and delays of a lirigarion abaut the ate of the work IP a breach of contraci "Idid

right to say, in effect thar irs breach shall go uncompensated unless the contractor proies, with premsmn. what 1% usually nor iusceptible of such proof."S

Understanding the court's analyais 1s important because it prondes the framework for relief used today. Current cases mvolwng overhead recogmze that home office expenses continue dunng the suspended period This cost 13 called m indirect cost9 and, generally, many of these costs are allowable 10

The Court of Claims's holding LS significant because IT vas a change from previous court rulings. In a case decided four veers earlier," the Court of Claims also held that the claimants were entitled to a portion of overhead costs Unforrunately, the court failed to articulate the formula used to calculate cost8 12 The holding was proper because payment of a pro rata portion of a contractor's alloiuable overhead cost more equitably compensates the contractor In Rust Engrneering Co c Cnrted States l3 the Court of Clams linked actual damages to the direct coste of the contract There was more

~~~~ ~ ~ ~ ~ ~~ ~ ~ ~~ ~ ~

'Id at 184 cxatm ommed''EAR. supra note 1. at 31 203. which states Indirect CUE~P

8s)

An indirect cost LP any cost not directly idenofled with d single final coat objective but lden 0 or more ana1 C O i t ab,ectlvei or ar.

.. .

. ..

.

If has been neueaaary ia apportion ~omeof the items oi coat which attached IO the entire conrraci and to allot the p~oper psrf of these items to Building& 1 and 2 and rork dependent thereon and mmdenf thereto Ai io the general ofice oierhead rhe evidence ahoui that the plaintiff company engaged ~n other c u n ~ ~ m c ~ ~ o n work at the lime the contract rork iniolied ~n this laigsnan UB: being done There. hmever. were eamparatirel! mall caniraefi We have. therefore apportioned the general off~ce oierhead and allotted the propei part of sane to this particular contract In turn ~ , e haw allorred the proper part of the net reiult thus obtained to the vnforereen delai in connecfmn mith the ~on~mucfmna1 Buildinpa 1 and 2Id 8emohas~added

.

.

formality in the requirements of proof. Particularly, the court relied on the stnct language of the contract.

A more draconian view can be found in Leuering & Gnrr~gues

Co. U. United States 14 The contract allowed compensation far increased direct labor and material charges based on changes to the contract 16 However, the Court of Claims did not allow indirect cmts,18 and suggested that the contractor should anticipate delay." The court applied Its holding in Moron Brothers Co v UnLted States,ls that "if the defendant were made liable for consequential and ather damages attributable to delays resulting from changes, the result nould be either that the stipulated right to make changes was not effective or that the cost of the vessel might be vastly mcreasd"19 This restrictive view could work a hardship far government contmctmS. Before 1940, entenng B contract with the govemment apparently was at the financial pen1 of the contractor. Unless expressly permitted by the contract, the contractor could not recover consequential damages for government delay.

Quoting iMcCord u United States,20 the Court of Claims explained the government's right to demand such harsh results:

This privilege of the United States to make alterations on the terms stated being expressly provided for m the eon-tract, the contract pnce related to that privilege a8 much as to any other provision m the contract, and therefore it must be taken as included in that price, and paid far in

lt 21

Isid at 515

Paragraph 17 af the general pmmsmns ai the specifications provides that the Government reaemes the neht to make such ehanees in the

IS not enhrled to recover tha sum of,

861 CL C1 73, 102(1929i%euriing 73 Ct C1 at 523 ''It -,a% never contemplated [either by the etatuieOTI by the contract that delay8 incident ID changes would subject the Government to damaee bevond that involved m the chanees rhemaelveb Id

-209 Ct CI 165, 169 118731 2)Le~eirng 73 Ct CI at 623

aid ~f 521 (''The plamhff ssoo. m cost of iuperintendence and iierk hire fnr rhe three weeks rhe work of drmng pilmg weiran the propeas mhedvle "I The enun found that the government did not delay eonatruefron Lo any"appremab1e amount "

'Id sf 523 ("The provision af the contract authannng changes. carned with if Be reasonable implication that if mch changes U ~ T B made. delay m the pmsecu-

hon afthe work might result "J

The deeper one digs into the case Ian, the more strictly construed are the cases against contractors

The government's posmon was that it has paid for the right to alter the terms of a contract Addmonally, if the claimed damages cannot be proved no grounds for recovery exist. Against this histoncal backdrop, the court8 decision in Fred R. Comb, granting the contractor unabsorbed overhead costs 1% all the more remarkable

111 Terminology

Before going further, some basic terms require definition. Direct costs are those costs identified wth one cost objecti\e,2z nhile indirect costs are those that are identified with two or moreCost objectires or an intermediate cost ObjectiYe 23 A cost 0b~ectiv.e~~

1s often a contract. although not all cost objectives are contracts For example, if a manufacturer has two different plants !A & BI producing a particular Item. the two separate plants can be considered intermediate cost objectives within the company. If an indirect cost cannot be identified with a particular segment (e g., state income tax. where plant A 1s in Geor~aand plant B 1s m New Yorkl, then

the indirect cost may be attributed to the segments as intermediate cost ObjeCtiwS. The Cost object1wL in this case are the intermediate segments (A & BI, not contracts.

What does It mean to idennfy a cost wth a coat objettnel To reimburse the contractor its costs, the costs must be allocable and allowable The total cost generally, 18 the sum of allowable direct

Id

W d 31 203

and indirect costs allocable to the contract. either incurred or to be ineurred.2j

Regarding allocation. group indirect co& lopcally and reason-ably based on the benefit provided to the cost...