Overheads   © Daniel Atkinson 1999

The decision in Norwest Holst Construction Ltd v CWS on 17 February 1998 is the second in a series of appeals from the award of an arbitrator in a case that deals with many issues which concern the construction industry. One particular issue which his Honour Judge Thornton Q.C. dealt with is the use of formulae when evaluating overheads. The formula involved in this case is the Emden formula which uses the Head Office Overheads and Profit expressed as percentage of turnover. The decision gives a useful summary of the principles involved and each of these principles was applied to the case. These are given below and provide useful practical guidelines to contractors.

Proved Loss

In this case the arbitrator had found that the delay of 19 weeks had involved the Head Office employees in some additional costs and that it was reasonable to assume that the extra time spent on the contract would otherwise have been spent productively on other contracts. A loss had therefore been proved.

Loss of Opportunity

This second principle can be the most difficult to grasp, since it is easy to confuse proof that some loss has occurred, with the proof of the extent or quantification of that loss.

The arbitrator had found that the loss of productive management time created a significant likelihood that overhead recovery on other contracts was diminished. He assessed CWS's loss as being one-fifth of that allowable under the Emden formula.

It was argued that actual loss must be proved and reliance was placed on the decision in McAlpine v Property and Land Contractors 76 BLR 59. There have indeed been a number of decisions, not referred to in judgment in the present case, which suggested that at least in respect of managerial time exact quantification was required. So for instance in Tate & Lyle v GLC (1983) 1 All ER 1159 the plaintiff claimed 2.5% on prime cost for managerial time. Whilst it was accepted that such a head of claim was admissible, the method of evaluation was rejected. It was held that managers had to keep time records of their activities. The decisions in Babcock Energy v Lodge Sturtevant (1994) and Milburn Services Ltd v United Trading Group (UK) Ltd (1995) followed Tate & Lyle.

It was held that the decision in McAlpine did not rule out the use of a formula to ascertain the loss and expense arising from the expenditure of additional overheads. The question therefore was how it could be applied in this case and whether a percentage of the formula could be used.

Reference was made to the decision in Allied Maples Group Ltd v Simmons & Simmons (1995) CA. It was held in that case that where the plaintiff claims that he himself would have acted in a particular way, he must prove it on a balance of probabilities. However where the claim is that an independent third party would have acted in a particular way, he only has to prove that there was a "real" or "substantial" chance of the third party's action. An assessment then needs to be made of that chance and discount the loss accordingly.

The distinction in this case appears to be between the probable effect of the actions of managers on the instant contract and the probable effect on other contracts. The claim for overheads was in relation to the loss of contribution from other contracts.

CWS had proved that third parties would have acted in a different way if more of its management time had been spent on these other contracts, so that the element of "substantial chance" had been proved. It was therefore open to the arbitrator to take the Emden Formula and discount it substantially.

No Increase in Overhead Recovery

The bar to recovery did not arise because there had been no variations associated with the delay period.

Overheads Incurred in any Event

The overheads would have been incurred in any event, but there would have ben additional turnover to help meet them but for the delay.

Constraint on Overhead Recovery

CWS was trading reasonably profitably during a period of intense competition in the construction industry. CWS had greater turnover than budgeted for, but its overhead recovery was significantly less than budgeted. The only doubt was how much of the under recovery was due to the delay, since some might have been caused by low pricing of other work and keen pricing of its overheads in the instant contract.

Conclusion

The use of the Emden formula has been approved and extended by the decision. The case is an Aladin's box of contractual riches and warrants careful examination by contractors seeking practical guidance.