The Defense Contract Audit Agency has issued revised guidance evaluating contractors’ claims for unabsorbed overhead resulting from government suspension or delay of contract performance.  The 19 page guidance is intended to address recent court decisions affecting delay damages under the so-called Eichleay formula for calculating unabsorbed overhead and expand on the meaning of “replacement work” that limits contractors’ recovery.

Unabsorbed Overhead and Eichleay.  The guidance defines “unabsorbed overhead damages” as fixed overhead costs whose allocation to a federal contract has been altered by the reduction in the stream of direct costs caused by the government’s delay or suspension of that contract.  The Eichleay formula specifies a method to calculate a daily overhead cost to be applied to each day of delay.  The Federal Circuit has ruled the Eichleay method is the exclusive means for calculating unabsorbed overhead on construction contracts and is a widely accepted method on most other contracts.

Entitlement to Unabsorbed Overhead.  The revised guidance reflects the West v. All State Boiler, 146 F.3d 1368 (1998) case that provides for using the Eichleay formula if a contractor shows (1) a government-caused delay or suspension resulted in a delay of contract performance (2) the government required the contractor to stand during the delay/suspension period (3) it was “impractical” for the contractor to take on other work and (4) the delay prevented the contractor from completing the contract within the original contract performance period as extended by any modifications.  Under the ruling, a contractor need no longer show it was “impossible” to take on other work.

The guidance goes on to state the government may rebut the contractor’s case by showing (1) it was not impractical for the contractor to obtain a replacement contract during the delay period (2) the contractor’s inability to take on other work was not caused by the government’s delay or suspension or (3) the contractor was able to to reduce fixed overhead expenses during the period of delay/suspension.

The guidance also states that the Eichleay damages are recoverable only for the period by which the overall performance of the contract is extended because of the delay.  The only exception is if a contractor can show it (1) intended to complete the contract early (2) had the ability to do so and (3) actually would have completed early but for the government’s action.  In that case, it can recover damages for the extended period.

Adjustment of Recovery for Replacement Work.  If replacement work is found, it would be able to absorb the overhead.  Replacement contracts (either government or commercial) are considered contracts for work that would not have been obtained and performed had there been no delay or suspension.  The guidance discusses Melka Marine v. United States, 187 F.3d 1370 (1999) where it was ruled if replacement work absorbs the same amount of overhead as the delayed contract, all Eichleay damages are precluded.  However, if the replacement work did not fully absorb all of the overhead, Eichleay damages would be limited to the amount of overhead not absorbed by the replacement contracts. 

Under Melka, the court explained that replacement contacts may differ in size, duration or type and DCAA expands on that to stress auditors should be on the lookout for replacement contracts.  The Eichleay damages can be reduced by other substituted work which includes (1) significant work performed out-of-sequence in the delayed contract (All Seasons Construction & Roofing) (2) substantial additional or change order work on the delayed contract (Safeco Credit and Fraley Associates v. United States) or (3) acceleration of other contract work under manufacturing or supply contracts (Libby Corp.).

Other Matters.  The guidance stresses that only fixed costs should be properly included in the unabsorbed overhead calculation and that variable costs – those that fluctuate either directly or proportionately with some measure of direct costs – should not be included in the calculation.   In home office overhead, only fixed costs that benefit all contracts and are hence prorated to all contracts may be included in the calculation.

For job site or field overhead, the guidance tells auditors to make sure home office costs that benefit the company as a whole are not included.  Job site/field overhead costs can be indirect or direct as long as they are consistent with established accounting practices.  Also, following the M.A. Mortenson Co., ASBCA No 4750 (1997) case, only one allocation method for recovering job site/field overhead may be used.

The guidance also warns against contractor modification of the Eichleay formula that results in excessive recovery.  Examples of such modifications include (1) using the original contact price as opposed to actual contract billings (revenue) when calculating the total fixed overhead allocable to the delayed contract (2) the original or planned days of performance as opposed to the complete performance period, when calculating the daily contract fixed overhead rate and (3) actual delay or suspension days rather than extension days beyond the original or revised completion date.    

(For a more detailed discussion of this guidance, see our expanded article in the upcoming GCA DIGEST.)

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