Watch overhead

Contractors working federal government gigs need to be aware

Blog Entry May 05, 2015

Larry Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction.

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Most heavy/civil contractors account for their on-site project general and administration costs as indirect costs.
In particular, such costs are charged directly to the project rather than to home office overhead. However, because site overhead costs are incurred indirectly and in support of actual construction work on the project, these costs are usually estimated separately from direct costs.  
Contractors performing work on federal government contracts need to be aware of possible pitfalls to the recovery of site overhead costs. Pursuant to cost principles contained in the Federal Acquisition Regulations, site overhead costs can be recovered as either direct or indirect costs. The contractor must elect at the beginning of the project which methodology it will use and, as a recent case decided by the Armed Services Board of Contract Appeals reveals, no change in the methodology will be permitted.
In Appeal of Watts Constructors, LLC, 2015 ASBCA No. 59602, the Naval Facilities Engineering Command Southwest (NAVFAC) awarded a fixed-price contract to the contractor for relocation of a sewer lift station. At the commencement of the project, the contractor elected to recover its site overhead costs as “indirect” costs. This meant the contractor would receive an agreed-upon markup on direct costs for all contract modifications—regardless of whether the work referenced in the modification involved an extension of the project time. The other option, which the contractor rejected, was the “direct” cost approach that involved receiving a daily rate for its site overhead costs on modifications that involved an extension of the project time.  
During the project, the contractor encountered differing site conditions and it promptly notified NAVFAC, which then sought pricing from the contractor before allowing work to proceed. Just as it had done on three previous contract modifications, the contractor computed its direct costs and then added the agreed-upon markup to account for site overhead costs. Unfortunately, the process of negotiating a price for the changed work took well over a month and, in the meantime, the contractor completed all other available work on the project. When NAVFAC circulated the final draft of the contract modification, the contractor sought to add language reserving for itself the right to seek additional costs associated with the delay in obtaining the modification. NAVFAC responded as follows, “[b]ecause you charge [site overhead costs] as a percentage rate, we don’t agree that you are entitled to additional costs for the delay associated with this mod. However, you are more than welcome to submit a proposal for delay costs.” To avoid further delay to the work and allow the contractor to proceed to correct the differing site conditions, the parties agreed to include the direct costs of the work, which amounted to $20,991, in the contract modification and address additional time and time-related costs at a later date.
Several months later, the contractor submitted a request for a time extension of 56 days and site overhead costs of $41,148. This sum was significantly greater than the amount the contractor would have been entitled to for site overhead costs using the percentage markup methodology. NAVFAC denied the request and the contractor’s claim that followed, and the contractor appealed the matter.
On appeal the Board acknowledged that the contractor had experienced a delay and that it had incurred site overhead costs in an amount greater than its recovery using the percentage markup methodology. However, citing prior cases, the Board ruled that despite the economic hardship involved, once a contractor chooses one of the two available distribution bases for site overhead costs, it is stuck with that election.
The choice of site overhead costs distribution methodology is thus a difficult one and can result in significant losses or gains based upon fortuitous circumstances. For example, if a project experiences a large dollar sum of changes that do not significantly affect the project schedule, recovery of site overhead via the percentage markup approach will improve the bottom line. On the other hand, if the project schedule is extended significantly by changes, the markup on direct costs might be woefully inadequate to cover the contractor’s additional site overhead costs. The direct cost, or daily site overhead cost rate, methodology is a safer methodology because although it yields no recovery on changes that do not prolong the project, it insures the contractor is made whole on changes that do involve additional time. R&B

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