In construction projects, it is very important to solve problems that can influence price or time for completion as soon as they are encountered (or even earlier to avoid or mitigate the consequences) while all equipment, human resources, and witnesses are still on site. Negative consequences of specific hazards are allocated in the form of a risk to the parties by contract. If a risk is allocated to one party, the other party may usually claim additional payment or extensions of time after such risk is realized.
It is common in international construction contracts for parties who consider themselves to be entitled to a claim to be under a duty to notify it. This notice can draw attention to the problem. The duty to notify creates a natural responsibility to keep contemporary records. This brings with it a higher probability that faster solutions will be implemented (to mitigate consequences) and problems resolved in a timely manner.
A structured claim management system also prompts the contract administrator (the engineer), the employer, the contractor and others involved in a construction project to respect and take claims seriously. They must follow the contractual claim procedure, document events, report and quantify the consequences by paying more attention to the claims and related site inspections and investigations.
The claim management is, in the most general sense, created by being able to identify, document and quantify a claim. It is strongly recommended to commence claim preparation and administration from day one, i.e. from receipt of the tender invitation by the contractor. Well-experienced contractors, engineers and employers prepare themselves for every individual project prior to its commencement by using a set of checklists, organizational charts and sample forms of letters that facilitate future claim management.
The principles of claim management are also discussed in case law. For example in Attorney General for the Falkland Islands v. Gordon Forbes Construction Limited and National Insurance Property Development Co Ltd v. NH International (Caribbean) Ltd. Particular claims usually correspond to damages caused by the employer, the contractor or external grounds. When proving damages, one has to deal with difficulties based mainly on the three following problems: causation, concurrency and calculation. The subject of causation will be dealt with in connection with global claims (discussed below in Section 10.6), the subject of concurrency will be touched on in connection with concurrent delay (Chapter 7) and the difficulties with calculation will be dealt with in Headquarters Overhead Claims (also discussed below in Section 10.4.1). Causation, concurrency and calculation issues lead to uncertainty in the way the tribunals decide about claims for damages.
While there is no easy solution that can overcome these difficulties, if the parties are aware of the uncertainty, they can take steps at an early stage to assess the best way to establish the claim before a particular tribunal. This means that the party can carry out the necessary analysis to formulate a robust position and assess the risks which will increase the likelihood of successfully establishing the claim (Ramsey, 2013). The best place to prepare a strong claim is at the construction site itself provided that contemporary records of delay, disruption and their respective effect on costs is up-dated in the time programme and progress reports.
An application for damages (whether in a court or via a claim submission), can be both confusing and tedious. Since the purpose of a claim is the recovery of damages, making the application clear, simple, and easily understandable is extremely important. The damages claimed should, whenever possible, reference and tie to the contractor’s accounting documents and records. This provides evidence which can be verified and accessed. Damages that cannot be traced to accounting records are immediately suspect, no matter how reasonable the amount claimed may seem. There is a tendency for damages to be overstated in a claim submission, with the idea that it can later be negotiated down to a more realistic but still acceptable amount. However, this approach is not advisable, as the claimant will lose credibility and will eventually have to explain the discrepancy between the claim amount and the amount sought at trial (Schwartzkopf and McNamara, 2001).
There are three types of claims in general, i.e. claims for:
- extension of time (EOT);
- additional payment;
- extension of time and additional payment.
In some situations, the contractor can claim extensions of time for completion. It is in fact a defence against contractual penalty/delay damages filed by the employer and a form of risk sharing in some of situations such as extremely adverse weather. The position of the SCL Protocol on the purpose of extension of time is that the benefit to the contractor is only to relieve them of liability for damages for delay for any period prior to the extended contract completion date. The benefit of an EOT for the employer is that it establishes a new contract completion date and prevents time for completion of the works becoming ‘at large.’ Entitlement to an EOT does not automatically lead to an entitlement to compensation. The parties should attempt—as far as possible—to deal with the impact of employer risk events as the work proceeds in terms of EOT and compensation. Where the full effect of an employer risk event cannot be predicted with certainty at the time of the initial assessment by the contract administrator, the contract administrator should grant an EOT for the then predictable effect.
The employer usually claims an extension of the defects notification period in terms of time (under Sub-Clause 2.5 in the FIDIC forms). Under the FIDIC forms (CONS/1999 Red Book), the contractor may claim an extension of time for completion under Sub-Clause 8.4. The contractor is entitled (subject to Sub-Clause 20.1) to an extension of the time for completion if and to the extent that completion is or will be delayed by any of the following causes:
- Variation (unless an adjustment to the time for completion has been agreed in the variation procedure) or other substantial change in the quantity of an item of work.
- Cause of delay giving an entitlement to an extension of time under another Sub-Clause (mainly Sub-Clauses 1.9 (late information, instruction, delayed drawings), 2.1 (denied or late access or possession to site ), 4.7 (errors in setting out information), 4.12 (unforeseeable physical conditions), 4.24 (fossils), 7.4 (testing), 8.5 (delays caused by authorities), 8.9 (engineer’s instructions to suspend work), 10.3 (interference with tests on completion),16.4 (termination by contractor), 17.4 (employer’s risks), 19.4 (force majeure), or 19.6 (optional termination)).
- Exceptionally adverse climatic conditions.
- Unforeseeable shortages in the availability of personnel or goods caused by an epidemic or governmental actions.
- Any delay, impediment or prevention caused by or attributable to the employer, the employer’s personnel (including the engineer who is listed as employer’s personnel under Sub-Clause 18.104.22.168.), or the employer’s other contractors on site.
If the contractor considers themselves to be entitled to an extension of time for completion, the contractor shall give notice to the engineer in accordance with Sub-Clause 20.1. When determining each extension of time under Sub-Clause 20.1, the engineer shall review previous determinations and may increase, but shall not decrease, the total extension of time.
If the contractor obtains an extension of time, they may be in a position to recover costs associated with the delay. However, there is no link (obligation) between Sub-Clause 8.4 and additional payment.
The contractor must keep proper records of the consequences of the event causing the claim in order to prove it. Documentation and reporting must follow the particular contractual provisions. For example, the contractor must keep records of labour, materials, equipment, progress reports, photographic and video documentation.
The importance of a maintained, detailed and up-to-date time schedule should be noted here. A claim for extension of time for completion is often submitted along with the updated time schedule detailing how and to what extent the claim events have influenced the individual construction works and relationship between activities. Critical paths in the time schedule are then explored together with floats, if any.
In the event of extremely adverse climatic conditions, for example, the contractor shall submit records of the weather encountered which can then be checked against the official statistics of the local bureau of meteorology.
Related to claims for additional payment, it is important to explain how the bids are priced (see Chapter 6). Pricing methods may vary, depending on the practices used within a particular company. The pricing method which enjoys widest use is based on a calculated unit cost which is then increased by a per-cent surcharge.
The bid price is usually a total sum of the direct costs of equipment, material and labour, indirect costs of site overhead, headquarters overhead, risk and profit surcharge. Most frequently, a claim for additional payment rests on the documented direct costs plus overhead and profit surcharge.
Under FIDIC forms (Sub-Clause 22.214.171.124, for example), ‘cost’ means all expenditure reasonably incurred (or to be incurred) by the contractor, whether on or off site, including overheads and similar charges, but does not include profit. Profit is allowed only in specific claims, i.e. usually those where there is an employer default.
These surcharges should be defined or agreed for the purposes of claims quantification. It should further be noted that the terms ‘cost’, ‘expenditure’ and ‘overhead’ could be interpreted differently in particular jurisdictions. For example, these terms may be interpreted in the common case law sense (see Hadley v. Baxendale (1854) 9 Ex. 341) or in the civil law sense (see Compagnie Interafricaine de Travaux v. South African Transport Services and Others (680/89)  ZASCA 16; 1991 (4) SA 217 (AD); (21 March 1991).
With every claim, the first test to be done is the test of liability, i.e. does the other party bear the risk of the particular hazard subject to claim? If so, it must be examined and potentially compensated.
The contract defines what claims the aggrieved party is entitled to and if there is also an entitlement for an additional payment. The claims for additional payment must be further subdivided into claims for:
- direct cost;
- direct cost and overhead;
- direct cost, overhead and profit.
The structure of a particular claim for additional payment depends on the wording of the contract and/or the governing law.
In its most general form, the heads of contractor’s claim for additional payment would include:
- claims resulting from variations;
- claims resulting from delay and/or disruption under the particular provisions of the contract;
- claims resulting from governing law.
The employer usually claims delay damages, liquidated damages (or contractual penalties) and an additional payment caused by a lack of quality (price reduction) because the works are not performed to the agreed standard.
10.3.1 Claims resulting from variations
The employer usually has the right to order the contractually defined and allowed variations. The contractor, in contrast, has the right to compensation in terms of time and price. In some cases, variations are managed smoothly via the agreed variation orders. A complication often appears where one of the parties is breaching the contract or where contractual interpretation is unclear. In such cases, a routine variation procedure may become a claim for an additional payment and/or extension of time for completion.
To distinguish the contractor’s individual claims for additional payment or for an extension of time for completion as a result of a variation, the following situations can be defined:
- directed variation;
- constructive variation;
- voluntary variation.
For more details, see Chapter 8 (including acceleration claims).
Acceleration is an example of a claim for additional payment (but not additional time).
The question of particular claims under the contract and time bars was discussed in Chapter 9. In the following part, the specific heads of claims will be discussed. See also the Table of Contractor’s and Employer’s Claims under FIDIC CONS/1999 Red Book in Appendix D4. Many of those claims are typically both for an extension of time and additional payment.
10.4.1 Delay claims
If stipulated in the contract, an extension makes it possible for the contractor to claim an additional payment—particularly in the following circumstances:
- increased variable costs for site overhead expenses;
- increased variable costs for headquarters overhead expenses;
- pass through claims where a subcontractor usually claims disruption (if working under worse conditions) or when working overtime and wants to be compensated for increased variable costs;
- lost profit;
- financial costs and interest claims;
- increased cost of material, labour and equipment;
- claim preparation costs.
- increased cost of material, labour and equipment;
Site overhead claims
It was mentioned above that the contractor prices the bid to include site overhead expenses. These expenses are often aggregated within the individual items in the bill of quantities and tend to cover operation of the site facilities, the wages of the project team management and other personnel costs, the rentals for offices and the like. Higher site overhead expenses on the contractor’s side typically occur due to the extended time for completion. However, the contractor does not include these expenses in the bid price as the above items are time-dependent. Whenever submitting a claim, the contractor must, if it is possible, identify these expenses in the bill of quantities (if any) and document the actual direct costs as they arise. An agreed surcharge as the case may be (such as profit, headquarters overhead, and so on) is usually allowed.
Examples of costs of running the site for an extended duration include:
- site staff (including personnel costs and accommodation)
- site facility and accommodation
- attendant labour
- plant & small tools
- temporary electrics
- skips/rubbish removal
In terms of the above-mentioned period for evaluation of compensation, the position of the SCL Protocol is that once it is established that compensation for prolongation is due, the evaluation of the sum due is made by reference to the period when the effect of the employer risk event was felt, not by reference to the extended period at the end of the contract.
Where a delay in a large construction project occurs, it is often the case that a contractor and engineer (contract administrators) and the employer will hire additional supervisory and management staff to deal with the issues that have arisen. When this happens, claims will often be made for additional payment in respect of those resources that are in addition to that anticipated to be required.
Headquarters overhead claims
It was already stated that the contractor (and in certain situations also the employer) is entitled to be compensated for indirect costs in the form of increased, unabsorbed headquarters overhead expenses if, for example, the work completion date is extended or disrupted because of reasons on the employer’s side. This is because extra payment for such a prolongation by the contractor has not been included in their bid price. This form of recovery received judicial approval in the case Alfred McAlpine Homes North Ltd v Property and Land Contractors Ltd 1995 76BLR59. At paragraph 70G of the judgment, HHJ Humphrey Lloyd QC explains:
The theory is that because the period of delay is uncertain and thus the contractor can take no steps to reduce its head office expenditure and other overhead costs and cannot obtain additional work, there are no means whereby the contractor can avoid incurring the continuing head office expenditure, notwithstanding the reduction in turnover as a result of the suspension or delay to the progress of the work. The reduced activity no longer therefore pays its share towards the overhead costs.
In order for such a claim to succeed, it is necessary for a contractor to prove the following:
The loss in question must be proved to have occurred. The delay in question must be shown to have caused the contractor to decline to take on other work which was available and which would have contributed to its overhead recovery. Alternatively, it must have caused a reduction in the overhead recovery in the relevant financial year or years which would have been earned but for that delay. The delay must not have had associated with it a commensurate increase in turnover and recovery towards overheads. The overheads must not have been ones which would have been incurred in any event without the contractor achieving turnover to pay for them. There must have been no change in the market affecting the possibility of earning profit elsewhere and an alternative market must have been available. Furthermore, there must have been no means for the contractor to deploy its resources elsewhere despite the delay. In other words, there must not have been a constraint in recovery of overheads elsewhere.
Where the parties have not agreed in advance on a definitive percentage or other amount for the head office overheads, the amount for overheads can usually (but not always) be evidenced by reference to pricing information supporting the tender or by using the contractor’s audited accounts. If the accounts used are for prior years (i.e. other than the period during which the works were carried out), care should be taken to ensure that the attribution of overheads to the project is appropriate and not inflated. In practice, the hardest of the tests to satisfy when valuing head office overheads is the ‘but for’ test (that is to say; ‘but for this delay, would the contractor have been able to recover additional monies in respect of the (claimed) overhead costs by taking on other work?’). Put another way, was the contractor deprived of the opportunity to mitigate these costs by, say, making staff redundant sooner? Proof that the contractor was turning work away because of the delay to a particular project may be found by reference to the contractor’s order books, invitations to tender and general market conditions (Kitt and Fletcher, 2013).
Various formulas are also used to quantify the head office overhead because of the difficulty of exact assessment. The reason is the difficulty or impossibility of identifying the headquarters overhead for a particular contract in the bill of quantities as it consists of the expenses incurred by the contractor’s administrative units (such as top management, office staff and services). These administrative units concurrently handle a large number of projects and the related allocation of costs can be very complicated and, in many cases, impossible.
Ideally, a contractor would keep records of all activities carried out by head office personnel but this seldom happens in reality. To help solve this problem, UK courts appear reasonably happy to assess loss based upon industry-recognized formulas (Kitt and Fletcher, 2013).
The best-known and most widely used formulas for determining claims for costs incurred in connection with overhead increases are the Hudson Formula and the Emden Formula. The Hudson Formula comes from the Hudson’s Building and Engineering Contracts publication. This publication is traditionally used as a source of information by lawyers and civil engineers worldwide (Dennys et al., 2010).
The Hudson Formula, for example, won recognition in the case J F Finnegan v. Sheffield City Council (1988) 43 BLR. Sir William Stabb QC sitting as Official Referee stated:
It is generally accepted that, on principle, a contractor who is delayed in completing a contract due to the default of his employer, may properly have a claim for head office or offsite overheads during the period of delay, on the basis that the work-force, but for the delay, might have had the opportunity of being employed on another contract which would have had the effect of funding the overheads during the overrun period.
There are other formulas, such as the Ernstrom, Manshul, Carteret and Allegheny formulas—all derived from the cases where they have been used. They are mostly variations of the Hudson Formula. The Eichleay Formula is the most widely used in public contracts in the United States.
The subject of formulas is connected to the certainty of damages which was discussed in a more general sense in the cases Canadian case of Wood v. Grand Valley Railway Company (1915) 51 SCR 283 and Chaplin v. Hicks  2 KB 786 where the English Court of Appeal held:
I do not agree with the contention that, if certainty is impossible of attainment, the damages for a breach of contract are unassessable … I only wish to deny with emphasis that, because precision cannot be arrived at, the jury has no function in the assessment of damages … In such a case the jury must do the best they can, and it may be that the amount of their verdict will really be a matter of guesswork. But the fact that damages cannot be assessed with certainty does not relieve the wrongdoer of the necessity of paying damages for his breach of contract.
Often imprecise documentation evidencing damages lead to the need for an ‘assessment’ by the judge based on the particular submissions of the parties to the dispute. The main issue is the uncertainty of the outcome caused by the different approaches of judges, arbitrators and adjudicators in particular jurisdictions and by the lack of universally accepted methods of delay and disruption analysis. Because of this, the use of expert evidence to support a quantum claim is widespread in international arbitration. Very often, the engagement of the expert is used as a means of presenting the case on quantum rather than limiting the expert’s involvement to purely expert accounting issues or matters which require expertise in assessing the sum to be claimed (Ramsey, 2006).
As with global claims, this approach to damages calculation (use of formulas) may be viable in common law litigation, DAB or arbitration but can be difficult in civil law litigation where judges strictly require precise evidence of damage via detailed documentation including causation.
It must be pointed out however that in the majority of civil law jurisdictions and under UNIDROIT principles however if the amount of the claim can only be determined with difficulty or cannot be determined at all, the court shall determine it at its sole discretion and where the amount of damages cannot be established with a sufficient degree of certainty, the assessment is at the discretion of the court.
The SCL Protocol also proposes some best practice guidance in terms of head office overhead. It divides head office overhead into: dedicated overheads through which administrative costs are assigned on the basis of good record keeping, and unabsorbed overheads (such as rent and some salaries) which are incurred by the contractor regardless of their work volume. Unless the terms of the contract make unabsorbed overheads irrecoverable, they are generally recoverable as a foreseeable cost resulting from prolongation. The contractor must then be able to demonstrate that because of employer risk events they were prevented from taking on other overhead-earning work.
The authors of the SCL Protocol recommend the Emden and Eichleay formulas. The authors further recommend that when the formulas produce an inaccurate or unsuitable result, verification is required by using another formula. At www.eotprotocol.com are guidelines for determining unabsorbed overhead claims. The guidelines are a useful tool because they take into account a number of variables.
In its original form, the Hudson formula appears as follows:
The Emden formula is as follows: