Evaluation and Preparation of Claims in Construction Projects

ABSTRACT

Claim management is an essential skill required by the Contract and Project Management Professionals, especially due to the increase in both number and value of claims in construction projects. A claim must be presented in a professional manner with sufficient details including the basis, calculations and evidences in order to save time, cost and effort of the Claimant and Defendant.

This Technical Paper describes the importance and meaning of claims, method of evaluation, and preparation of a successful claim presentation. The relationship between the contract base lines, i.e., Contract Price, Scope, Schedule and Conditions are established here along with the head of claim due to change in conditions, delay and disruption. Methodology for the calculation of Head Office Overhead and Profit is also discussed with their relative importance and interrelations. This Paper further discusses about some of the common terms in claim. As the final output of the evaluation process is the claim presentation, this paper describes the structure and requisites of it.

1. INTRODUCTION

Claim is a request for a benefit for which the Claimant believes or contends he is entitled, but agreement has not been reached. The construction industry is witnessing an increased numbers of claims in both domestic and international sectors and the claim presentation is important in claim related issues in Project Management. The Project Management and Contract Management Professional should have basic knowledge about the meaning, evaluation and preparation of claim.

Claim leads to wastage of money, time and efforts, especially due to unprofessional presentation of it. A survey conducted with 24 construction projects in Western Canada, demonstrated that the total amount of claims contributed to a 40% increase in project cost and total delays to 48%. The study also revealed that more than half of the claims led to a cost increase of at least 30% of the original contract value.

The unfortunate reality is that construction claims are often resolved by people who were not directly involved in the construction project. In the courtroom, it is settled by lawyers and judges; or in conference room often by corporate, vice presidents, or financial officers with little construction experience. Hence, it is critical to provide a simplified, graphically driven presentation of claim issues. Too much information and not enough information are two main pitfalls of claim presentation, and should be avoided in claim presentation.

A well prepared claim presentation helps all the involved in settling the issues in an early stages, before going to arbitration and litigation, which are expensive and time consuming. A claim must be presented in a professional manner with sufficient details including the basis, calculations and causations. If the claim presentation is transparent and reasonable, it is easy for both parties to reach in agreement in an early stage itself and this requires a professional claim presentation, which is the rationale of this Paper.

2. MEANING OF ‘CLAIM’

A claim is a demand, request or application for a benefit for which the Claimant believes or contends he is entitled, but agreement has not been reached. In other words, claim may be defined as a failure to fulfill obligations under the contract or law by either of the parties. Change order claims can be defined as, written authorization provided to a Contractor that approves a change from the original plans, specifications, or other contract documents, as well as a change in the cost. A claim may be for money, for time, or both; however it should be noted that a successful claim for time extension does not automatically honor a valid claim for money, and vice versa.

When the liability of the discovered change is easily attributable and the consequences of the change can be ascertained (cause and effect) by evaluation; then a formalized variation orders will be the result. Sometimes the liability of the change cannot be easily attributed or for which liability is disputed, then it will lead to claims. Claim is usually caused by defects; conflicts or ambiguities in the Scope or Schedule; Exclusion clauses; or Endeavour to avoid un-quantified risk. In order to successfully justify such claims, it is usually necessary to carefully analyze the scope and the schedule, particularly the contract documents and the provisions of the law.

Claims under Contract and Law

A contractual claim is an entitlement under the contract itself where specific provisions or implied conditions of the contract can be invoked to support the entitlement. A Claim under law, sometimes referred to as an ‘extra-contractual’ claim is where the entitlement accrues from the provisions of the law.

Notice of Breach or Claim

The injured party (Claimant) shall give notice of breach to the defending party (Defendant), immediately upon discovering the breach; and such notice should specify the nature of the breach in most of the jurisdictions. Most of the Construction Contracts contain a requirement of notice to submit a claim both for time extension and for money. The purpose of the notice is to enable the other party to be aware of and to mitigate the effects of the breach causing the claim. Failure to give prescribed notice is a breach of the contract conditions and while such breach may not deprive the Contractor of his rights under law, such breach may lead to a defense by the Employer that lack of knowledge about the breach had prevented actions to mitigate the effects of the breach and had also prevented proper evaluation of the effects of the breach.

Evaluation

Evaluation is the process of assessing the quantum in money value and for the extension of time. As Burden of Proof is on the claimant, the claimant must show that there is a direct link (causal link) between the breach (cause) and the loss (effect) thereby sustained. When there is more than one competing causes, then it is necessary to ascertain and define such competing causes and responsibility, the timing and effect, and losses actually and properly sustained. Generally a claim can only comprehend the losses actually incurred, possibly with the addition of an agreed or ascertained element for overheads and profit.

3. ‘CONTRACT BASE LINES’: THE BASIS OF CLAIM EVALUATION

Firm Fixed Price (FFP) or lumpsum contracts are most common and are more vulnerable to claim due to its inherent natures. While lumpsum contracting provides the lowest possible financial risk for the Employer, it provides the highest risk for the Contractor, because any variance in scope, schedule, or conditions affects the Contractor’s costs. When the work is changed, the Contractor is expected to perform the work as a result of which he may sustain additional costs. Obviously, the Contractor will attempt to seek additional compensation based upon each such change, and often extensions of time, within which will lead to claims and disputes. All changes in the scope, schedule or conditions under which the Contractor’s work will be performed, which result in delay or time-related claims, should be considered in terms of their deviation from the ‘baseline’. As illustrated in the Figure below, the contract defined scope, schedule, and conditions constitute the ‘baseline’.

Scope Schedule

Contract

Price

Conditions

Figure: The Contract Base Lines

Schedule is the most easily affected element of the lumpsum contract baseline, because any delay, acceleration, disruption, or distortion of performance constitutes a change which may entitle the Contractor and obligate the Employer to pay additional compensation. ‘Time is money’, is a factual reality, and the failure by either or both the Employer and the Contractor to recognize this relationship can lead to substantial delay and subsequent time-related damage claims.

The Contractor’s right to obtain time related compensation must be proven against the contract’s ‘baseline’, which should be accurate and verifiable with the contract scope, schedule, and condition. The Employer, on the other hand, must ensure that he has a clear idea of the effect of its actions upon these three ‘baseline’ elements.

A claim consisting of a request by the Contractor for money or time, due to a change in any of the three basic elements of the contractual baseline, given that each change is beyond the control of the Contractor, may affect his cost and thus decrease his profit unless an appropriate adjustment is made to the contract.

4. EVALUATION PROCESS

Evaluation is the process of quantifying the amount or extent of the additional costs sustained due to the breach, and establishing that the subject losses were actually and properly sustained as a result of the breach. As the Contract Price of the lumpsum contract is equated to the elements of ‘baseline’, each of the three basic elements should be priced to aggregate to the ‘Contract Price’.

The basis of the pricing is usually referred to as the ‘Price Analysis’, given that the Contract Price usually aggregated from the total of a Bill of Quantity, the rates which in turn are broken down or analyzed into the primary cost elements of :

Labor

Material

Equipment

Subcontractors

Overheads & Profit

The more detailed the price analysis the more accurately and quickly any variance from the original contract price can be ascertained. Budget of a project, which can be used as a benchmark for measuring any variation in respective cost element coupled with proper cost monitoring and control mechanism will enable to evaluate the claim adequately and effectively.

Records

While it is important to have an accurate and detailed make up of the contract price it is equally important to keep accurate contemporary records of the usage of key resources of labor, equipment and material. A brief list of the more important records that should be properly and regularly updated for the purpose of efficient project management, and particularly to claim management, is as follows:

• Tender and contract documentation
• Works records sheets
• Daily record of labor and plant staff etc.
• Materials received and issued
• Drawings register
• Materials approval register
• Request for information register
• Site Instructions register
• Correspondence and minutes files
• Site diaries
• Site instructions
• Variation orders
• Additional works register
• Contract program
• Updates of contract program
• As-built program
• Photographs and video
• Agreed measurements of ‘covered’ works
• Delay notifications
• Claim notifications
• Materials orders and invoices

Any other project documents related to schedule, cost, risk or quality including correspondence between various stakeholders can be used as Detailed and Extensive Records in the evaluation and preparation of claim.

5. HEADS OF CLAIM

Most of the construction projects are unique by their very nature and have varying characteristics; however certain heads of claim that occurs frequently, can be grouped into three main categories as follows:

New or changed conditions or circumstances

Any change in conditions or environment, where the contract is operating has a corresponding change in other factors and may be measured in money terms, i.e., cost. This change can be adjusted with a different factor or factors without changing the cost. The following are the main constituent of changed conditions:

• Ground conditions, obstructions etc.
• Occurred Risks not mentioned, not quantified or excessive
• New or changed laws, regulations, duties, taxes etc.
• Unforeseen problems of supply and/or delivery of resources
• Loss due to carrying out work at a time of the year involving special factors
• Particular climatic conditions

Prolongation costs due to delay

It may be identified that the act of postponement is the ‘cause’, and hindrance is the ‘effect’ of delay. Primarily construction activities may be delayed but not disrupted i.e., duration of activities may be postponed in commencement, hindered or slowed down in achieving regular progress, and hence prolonged in completion. The following are some of the expenses due to delay:

• Remuneration of site staff and incidental traveling expenses
• Plant and scaffolding retained on site
• Temporary power distribution and lighting
• Temporary office and storage accommodation
• Utility accounts for the delay period
• Telephone account for the delay period including rental and calls
• Additional insurance and Bond premiums
• Attendances on sub-Contractors over a longer period
• Increased costs due to inflation of labor, plant and material
• Profit and overheads on increased costs reimbursed during the extended period
• Watching, lighting and protection
• Safety and welfare measures
• Site clearance and maintenance of temporary roads
• Time-related temporary works
• Lost opportunity due to overdraft facility
• Extended equipment warranties
• Increased maintenance period risk
• Head office overheads
• Finance charges
• Loss of profit.

Disruption or Loss of Productivity

Delays and prolongation are time related, but disruption is resource related. Construction activities may be disrupted in regular progress or logical sequence but the experience of disruption of progress may not result in a delayed completion of activities. It is often that more resources are committed to the activity to achieve completion in time. The following are some of the examples of disruption:

• Fragmented working: lack of utilization of resources
• Reduced production for planned resources
• Planned production from increased resources

Often delay equates to prolongation which invariably requires an Award of Extension of Time for completion of the contract in due time. The Employer’s award of Extension of Time by keeping alive the Penalty or Liquidated Damages clause will not automatically entitle the Contractor for additional money.

Another term for disruption is ‘fragmented working’, in which the claimant contends that the actions of the other party have prevented or hindered the claimant from executing the affected works, reduced output level and/or enforced the same output for an increased level of resources. Due to the burden of proof, and the requirement to show causal link substantiating claims for disruption can be very tedious and difficult.

Costs of Disruption

In order to make claim for the costs of disruption, it must be evident that some planned or orderly sequence of work had been affected by an act of the Employer, of the Engineer, and/or by a variation or variations. It is often the case that individual sections of work may be affected in a way, which does not cause prolongation by themselves. Idle time of plant, tools and equipment; and Loss of Productivity are the two main heads of costs of disruption.

Finance Charges and Interest

Certain breaches of the contract conditions would normally entitle the Contractor to obtain interest. The cost of finance should be calculated on the basis of charges by the Contractor’s bank i.e., using the same rates and compounding accrued interest at the same intervals. Where the Contractor is self-financed or financed from within its corporate group the appropriate rate of interest is that earned by the Contractor (or its group) on monies it has placed on deposit.

6. OVERHEADS AND PROFIT

Site Overheads

Site overheads cover all of those site costs that are not directly related to particular items of work, which may include:

• Salaries and wages of all indirect staff
• Office facilities cost
• Security
• Provision of stores, workshops, latrines, etc.
• Construction, maintenance and removal of site access roads
• Transportation of plant to and from site
• Contract insurances, performance bond, guarantees etc.
• Provision and maintenance of small tools
• Subsistence and traveling costs and allowances

The majority of the above items are of a time-related nature, but there are a few with lumpsum nature. The latter must be excluded when calculating the weekly site on cost, which may be calculated separately.

Head-Office Overheads

Head Office Overheads are the costs incurred by the Contractor in maintaining his head office establishment, and include the cost such as, head office staff, rent of head office premises, Contractor’s all risk insurance, tendering for new projects etc., together with all other global costs. From historical data a Contractor can identify the cost of Head Office Overheads, and his gross turnover (revenue) for the same period. Head Office Overheads can be allocated at the same percentage of historical data in estimation.

Profit

The percentage included for profit in a tender is entirely a management policy decision of a Contractor only. The profit is a function of revenue, where Head Office Overheads is a function of time. ‘Lost opportunity’ is the philosophy behind claims for profit because the Contractor has been denied the opportunity to generate further revenue and profit from other projects by utilizing the resources for the additional time. To claim for this item, the Contractor will show that he would have probably undertaken other contracts by utilizing these resources.

Head-Office Overheads and Profit

Because of the similarities of Head Office Overheads and Profit, as they are both related to the value recovered by the Contractor over a particular period of time, they may be considered together. There are two main methods of calculating Head Office Overheads and Profit (HOOHP), i.e.; by using details of actual additional costs, and by using formulae. Since the true basis of the value of a claim is on ‘actual costs’, then actual method is preferable. But it is not practical for Contractor to record and allocate their head office costs in sufficient details and accuracy to specific project and task.

Different Formulae for calculating the Head Office Overheads and Profit, as follows:

• The Hudson formula
• The Emden formula
• The Eichleay formula.
• Ernstrom Formula
• Manshul Formula
• Carteret Formula
• Allegheny Formula

The Hudson Formula

The Hudson formula states that the loss suffered by the Contractor as a consequence of additional time spent on Site is equivalent to:

Claim Value for HOOHP = P * CV * PD / (100 * CP)

Where, P – Planned HOOH

CV – Contract Value

CP – Contract Period in weeks

PD – Period of excusable delay in weeks

Emden’s Formula

Emden’s Formula is similar to the Hudson formula except that instead of using the percentage included in the Contract for Head Office Overheads and Profit the percentage used is for the company identified from audited accounts, generally the average of the percentage for overheads and profit for the previous 2 – 3 years is used.

Eichleay’s Formula

The Eichleay Formula, although once again following a similar concept to both the Hudson formula and Emden’s formula, is a more sophisticated formula and amount claimed are calculated on the basis of a number of calculations.

HOOHP allocated in Original Contract, OAC = VCP * TOC / TO

Where, VCP – Value of work invoiced during the contract period

TO – Turnover of the company during the contract

TOC – Total overheads of the company during the contract period

Claim Value for HOOHP = OAC * PD / CP

Where, OAC – HOOH allocated in Original Contract

CP – Contract Period in weeks

PD – Period of excusable delay in weeks

7. GLOBAL CLAIMS

The correct way of presenting a claim to the Engineer or before a Court or Arbitrator is by using causation, i.e., rational and logical linking of the effect with the cause. If the Engineer is 14 days late in issuing the drawings for the foundations and as a result the completion of the work is delayed by 14 days, will illustrate cause and effect linkage.

Nowadays, the Contractors and Subcontractors are practicing a method known as the global or ‘Rolled up’ claim by giving less importance to the classical cause and effect linking. All causes of loss and/or delay under the global claim method are compiled together and one overall delay given as a consequence. In this global claim method, the classical method of linking each effect with its cause ignores the synergic effect of additional cost and/or delay.

While such rolled up claims may be acceptable in respect of financial claims, cause and effect will still have to be linked in respect of delay claims, as a matter of evidence. While it is impractical to assign individual cause to a particular effect, the principles of global claim method can be used successfully. If a rolled up claim is appropriate, the events on which it was evolved should be described in sufficient detail to indicate how they might be causative of the entitlement claimed and why the other party was responsible for them.

To avoid a great deal of argument over a global claim, Contractors and Subcontractors are advised to establish the linkage between cause and effect of every event, which may lead to a claim, at the time of occurrence itself. As well as producing the cause and effect matrix, it will be appropriate to highlight major delaying events in the text of the claim by making reference to progress of works and effect on other trades. Particulars about the implied link between cause and effect also shall be given with sufficient details such as:

• The unwritten assumptions on which such a claim is often based
• The reasonableness of the original tender price, program and resources
• The absence of other explanations for the delay and disruption suffered.

A rolled up claim is unlikely to succeed unless detailed factual evidence is available to explain the disruptive nature of the events on which it is based, and the Engineer or Tribunal is satisfied that there are no other explanations, such as over optimistic programming, unrealistic pricing, and a Contractor’s inefficiency for the resulting delays, disruption and loss, etc.

Total cost method of claim

‘Total cost method of claim’ is an extreme form of a Global claim, consisting of evidence offered by the Contractor, often from internal sources, as to the total cost of executing the contract, and then claiming the difference between that total cost and the contract price. This is very frequently used in support of perfectly ordinary breaches of contract or variations, where dis­ruption is alleged.

A claim so presented dispenses with the requirement of identifying precisely the breaches or causes of action relied on, or of connecting the amount claimed, as a matter of causation, to the individual causes of action. A total cost claim may be advanced in relation to the performance of the contract as a whole, or used as the basic underlying principle, subject to adjustment, of the computation of the damages for a particular individual part of the contract. As a matter of first principle, the obvious objections to the use of the total cost computation are as follows:

Standing by itself, an over-run of cost is evidence of nothing, and certainly not of a change or breach of contract by the owner

Coupled with convincing evidence of a breach or change, it is still not evidence that any damage or additional cost has been caused by that breach or change

Coupled with evidence of a change or breach, and evidence that at least some damage or expenditure must have been incurred as a result of the change or breach, it is not evidence as to what that damage is, since there are so many other possible explanations of the cost over-run

If there is more than one cause of action involved, or one cause of expenditure for which the owner cannot be responsible, the owner’s advisers, and any tribunal, have no material for valuing or examin­ing the case on those parts of the claim which they are disposed to accept or concede

A function of such claim is to impose an absolute upper limit on any claim or group of claims which a Contractor may wish to bring, since a total loss claim rep­resents the maximum theoretical damage or additional expenditure attributable to all proven changes or breaches affecting the perfor­mance of a contract.

8. PREPARATION AND SUBMISSION OF CLAIM

Usually, the Contractor or the Subcontractor will produce a claim document to the Engineer, Employer or Main Contractor. A claim presented in a tidy and professional manner will often result in a better settlement than an unprofessional one. It shall be structured logically into sections, and each one can be divided into subsections having sufficient details. The following are the most common sections in a general sense:

• Introduction
• Contractual basis of the claim
• The details of the claim
• The evaluation of the claim
• Appendices

Introduction

As the person, who is responsible for the final assessment may not be totally familiar with the contract, it is important to give background details in order to make the document a complete entity in itself. The minimum required details should be as follows:

• Names of the parties to the contract and the consultants
• Details of the conditions of contract governing the contract
• The tender date
• The original contract sum
• Dates for possession and completion
• Details of extensions of time claimed
• Details and amounts of money claimed
• Details of extensions of time awarded
• Details of amounts certified

Basis of the claim

It is important to state precisely about contractual basis of the claim. The claim will fall under one or both of the following categories:

• A claim for loss and expense or extra costs or expense flowing from a remedy contained within the conditions themselves
• A claim for damages resultant upon a breach of the express or implied terms of the contract or the law

It is essential to state clearly the event or events pertaining to the claim. It is also good practice in this section of the claim to make reference to notifications which have been made during the contract.

Details of the claim

This section of the claim should provide the complete details as much as possible of all delays with reasons, responsibility and effect on progress as a whole. Assistance can be gained to prove this cause and effect by the use of critical path method (CPM) or any other graphical method.

Evaluation of the claim

In most cases the evaluation will fall into two sections, i.e., costs associated with prolongation and costs associated with disruption. Methodology of heads of claim has been described earlier in this Paper.

Appendices

A well prepared claim usually has a large volume of backup documentation to substantiate the case such as correspondence, records, photographs, video and programs. Inclusion of all the details in the main body will make the presentation bulky and distract the reader. Hence it is advisable to attach as appendices.