What are overheads?

Overheads are one of those types of loss, like loss of profit and interest, that are added on to the end of a delay claim, sometimes as a bit of an afterthought.

Overheads are usually claimed as a percentage of the main losses claimed, based on the claimant’s “standard” overheads percentage. Very rarely is there an explanation of how the standard percentage rate is arrived at.

The Technology and Construction Court decision in Fluor v Shanghai Zhenhua Heavy Industry Co. Limited, however, serves as reminder that a claim for overheads is far from straightforward, and needs as much thought as any other type of loss. In particular, simply giving a standard overheads percentage will not be enough.

What are overheads?

To start with, the Court clarified exactly what overheads are: the costs of running a contractor’s operation as a whole, most notably head office costs, such as rent on the contractor’s buildings, general support staff costs and other office costs such as IT, phone lines, etc.

Critically, however, it is not enough to simply show that the contractor had overheads during the period of the delay. It must also show that its staff would have been otherwise profitably employed on other projects.

It is this “lost opportunity” element that is often hard to prove. It may be difficult for a large contractor to show convincingly that delay on one of its projects has affected its ability to take up other opportunities. What would those opportunities have been, and would they have been profitable?

Calculation is key

Firstly, a contractor needs to show that it was running overheads during the period of delay, and that it could have employed those resources profitably elsewhere during that time had it not been for the project overrun. The next challenge is to show how it calculated its overhead percentage rates. It will not be sufficient to simply say “this is our standard overhead rate”.

A detailed breakdown of the overhead costs must be provided, with an explanation of what they are. For example, the Court will not be prepared to accept items described as generally as “administrative expenses” (as per paragraph 31 of Fluor v Shanghai Zhenhua Heavy Industry Co. Limited).

Conclusion

A claim for overheads is one of those items that will always be contested by the defendant and challenged by the Court. To make a successful recovery for overheads, a contractor must be able to show what exactly its overhead costs are, and what projects its staff could otherwise have been employed on had it not been for the delay on the current project. Gathering the information for an overheads claim therefore requires a good deal of work, but that work will pay off if done properly.

As an aside, the judge in this case also explained that a contractor can make a claim where its overheads have been “thickened” during the period of overrun. He gave the example of a contractor who, because of a subcontractor’s breach of contract, has to increase its senior accountant’s workload to cope with the extra work. As a result, it has to bring a junior accountant onto the team. That junior accountant is not assigned to the “problem” project but, nevertheless, the contractor may be able to recover the costs of employing him, because it is a direct consequence of the subcontractor’s breaches.

In fact, such a claim for the costs of employing that junior accountant may be more of a “management time” claim than an “overheads” claim. Nevertheless, it is interesting that the TCC is indicating that such costs can be claimed, even though the employee was not directly involved in the work caused by the breaches of contract.