LAW: The Contractor's Side

Eichleay formula calculates overhead

Article December 28, 2000
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As readers may be aware, the “Eichleay” formula is a method for calculating a daily rate of “unabsorbed” home office overhead resulting from an owner caused delay. Public and private owners have contested the use of the Eichleay formula for years. This article is the first in a series which discusses the Eichleay formula and recent cases contesting its use.

Although formula recoveries of home office overhead had been utilized before, the Eichleay formula was established in a 1960 Armed Services Board of Contract Appeals case. In the case, the government had delayed Eichleay causing its work force to be idle. The board explained that:

It must be borne in mind that overhead costs, including the main office, or home office, expenses involved in this case, cannot ordinarily be charged to a particular contract. They represent the cost of general facilities and administration necessary to the performance of all contracts. It is therefore necessary to allocate them to specific contracts on some fair basis of proration.

The Eichleay formula consists of three steps:

1. Contract billings / Total billings for contract period x Total overhead for contract period = Overhead allocable to the contract.

2. Allocable overhead / Days of performance = Daily contract overhead.

3. Daily contract overhead x No. days delay = Amount claimed.

The Federal Circuit has expressly endorsed the use of the Eichleay formula for calculating unabsorbed indirect costs in spite of the federal government’s strong arguments to discontinue its use entirely and has even gone so far as to explicitly hold that the Eichleay formula is the only acceptable method for calculating these costs. Contractors also have successfully used the Eichleay formula in cases involving private owners or state and local governments.

Although the Eichleay formula is well established, a contractor’s entitlement to recovery of the unabsorbed indirect costs remains an area of contention. Over the past several years, owners have contested entitlement to a recovery based on the formula in several cases. Courts in those cases have given somewhat of a roadmap for recovery.

Elements of entitlement

Assuming an owner caused delay, the test used by the courts has contained only two elements: (1) that the contractor was on “standby;” and (2) that the contractor was unable to take on other work.

Contractor on standby

Standby is an indefinite delay that results from the owner’s action or failure to act. It typically does not cover strategies where the time of performance was extended solely because of extra work. “The proper standby test focuses on the delay or suspension of contract performance for an uncertain duration, during which a contractor is required to remain ready to perform.” In a recent case, the court found that the contractor was able to continue working on non-critical phases of the project while waiting for instructions.

Because there was no additional work, this resulted in spreading the same income over a period that was three months longer than originally expected. The court recognized that even though some work was ongoing, an extended project may result in reduced income just like a suspended project and stated that “[t]here is no requirement that a project be suspended before a contractor is entitled to recover under Eichleay.” The court rejected the contention that Eichleay can only be used for “pure delays” and cannot be applied to extended projects.

Replacement work

The element of uncertainty also can play a big part in justifying the contractor’s inability to obtain replacement work during the delay. If the length of the delay is uncertain, a contractor cannot judge if it can safely bid and obtain replacement work. This second prong has been the focus of many government challenges in recent years.

An important step in the Eichleay development occurred in 1995 when the Federal Circuit Court recognized the existence of the prima facie case. In Mech-Con Corp. v. West, 61 F.3d 883 (Fed. Cir. 1995), the court recognized that due to the impracticality of a contractor making reductions in home office staff or taking on additional work when placed on indefinite standby, the burden of proof should shift to the government to show that the contractor had, or could have, avoided all loss by reducing its overhead or taking on replacement work. It is interesting to note that Mech-Con was considered to have been on standby even though it took more than three months for it to mobilize after given the notice to proceed. The government was unable to rebut Mech-Con’s prima facie case with this fact alone. The court did not allow recovery for overhead during the period of re-mobilization, however.

In my column next month I will discuss the two most recent federal circuit cases involving the recovery under the Eichleay formula.

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Overlay Init