Paying in sand dollars

In my column last month I discussed an Ohio case on home office overhead. This month I will discuss a recent Interior Board of Contract Appeals decision which allowed a contractor terminated for the government's convenience to recover 10% overhead, despite the contractor's actual overhead costs of 5.05%, and to recover 30% profit. 

Marshall Associated Contractors Inc. was the low bidder on a Bureau of Reclamation (BOR) project to supply approximately 1,061,400 cu yd of sand and coarse aggregate for the construction of the Upper Stillwater Dam in Utah. The contract specifications required Marshall to take materials for aggregate production from a borrow area that BOR represented as containing readily crushable sandstone. Actually, BOR's own boring test results revealed that the borrow area contained extremely hard and abrasive materials that did not meet the specifications. However, Marshall was not given the test results and was not permitted to conduct its own testing prior to bidding for the project. After BOR issued the Notice to Proceed, Marshall conducted its own tests and notified BOR of the problem with the material; however, BOR refused to change the specifications.

Over the next two years, Marshall took extraordinary measures to overcome the problems created by the borrow material. However, Marshall was unable to meet the production quantities called for in the contract, and BOR terminated Marshall for default. While BOR refused to recognize the existence of a differing site condition as asserted by Marshall, the reprocurement contract clearly specified that the rock at the site was hard to very hard.

Marshall filed a certified claim with BOR. Marshall never received a final decision from BOR regarding its differing site condition claim and appealed BOR's default termination decision to the Interior Board of Contract Appeals. In an entitlement decision, the Interior Board found against BOR and converted the default termination to a termination for convenience. After the parties were unable to reach an agreement on the amount of recovery, the Interior Board decided for them.

Soaking it in

Generally, when a contract is terminated for convenience, the terminated contractor is entitled to recover its allowable costs, including profit. Indirect or unabsorbed overhead presents a problem in this situation because it is intended to compensate the contractor for work stoppages, idle facilities and the contractor's inability to fully use available manpower caused by the government. Overhead tends to increase disproportionately. There is less direct cost base over which to allocate costs incurred at the usual rate. 

Among the principal costs Marshall claimed as a result of the differing site condition was unabsorbed overhead. Last month, I discussed the Eichleay formula method of calculating overhead. This case was different in that instead of a delay there was a termination. Here, salaries and expenses went down as Marshall applied all its resources to cover increased construction costs. BOR's auditors allowed 5.05%. Marshall argued that because of the circumstances of the project, overhead should be based on its six- or eight-year historic averages of 9.3% or 10.82%, respectively. The board allowed 10% of direct costs, concluding that the government's misleading contract specifications resulted in Marshall's devoting all its resources to the project, creating a serious distortion of administrative costs.

The board also concluded that Marshall was entitled to 30% profit. The board found Marshall's production rate "truly remarkable" especially when compared to the production rate achieved by the reprocurement contractor, who was fully informed about the conditions prior to bidding. Marshall had scheduled the project to be completed in one year.

It is not unusual for a contractor to encounter site conditions during construction that materially differ from what the owner represented at bid time. An owner's unwillingness to release test results concerning materials required by the specifications may be a forecast of problems that the contractor will encounter during construction. While in Marshall's case the board allowed a recovery of overhead that was almost double the costs Marshall actually incurred, contractors should take note of the exceptional circumstances of this case. 

Barring a substantially similar situation, a contractor should not expect to will be as fortunate.