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When is the Total Cost Method of Pricing a Claim Appropriate?

 

To recover on a construction claim, a contractor must prove both the entitlement and quantum aspects of his claim. Entitlement happens when a contractor proves that his theory of recovery – such as different site conditions or suspension of work – is valid under the contract. Once entitlement has been proven, the contractor must then demonstrate the amount he is entitled to recover as a result of the claim theory.

 

While most contractors devote substantial attention to proving entitlement, many neglect the importance of an accurate and organized quantum presentation. Because there are a number of methods of proving quantum and a contractor must make several critical choices at the time that a claim is forthcoming.

 

The most accurate method of pricing a claim is by demonstrating the actual cost of performing the work through the use of cost accounts established by the contractor for the work. When actual costs are not available, the contractor must estimate the costs. A common method of estimating is the “total cost” approach. “Total cost” is the difference between the original estimate and the cost of the project.

 

Many contractors favour a “total cost” approach. This converts the contract from a fixed-price contract to a cost plus a fixed-fee contract, thereby allowing the contractor to recover all of his costs. However, courts and government Boards of Contract Appeals are extremely reluctant to allow the use of “total cost” measure of damages.

 

In fact, before “total cost” can be used to calculate damages, a contractor is generally required to prove that:

 

  1. The nature of the losses make it impossible or highly impracticable to determine them with a reasonable degree of accuracy;
  2. the contractor’s bid or estimate was realistic;
  3. the contractor’s actual costs were reasonable; and
  4. the contractor was not responsible for the added expenses.

 

These four safeguards make it difficult to use a “total cost” approach.

 

Perhaps the best time to use a “total cost” approach is when a project is so disrupted that the contractor’s entire performance is far different than expected. In situations such as these, the base contract work becomes so intermingled with the changed work that it is virtually impossible to use any other pricing method.

 

A recent California case demonstrates how this may occur. In Petersen v Container Corp. of America, 218 CalRptr. 592 (Cal.App.1985), the California Appeal Court ruled that a project owner’s frequent design changes constituted an abandonment and a breach of his construction contract, and that the contractor was entitled to the total cost of completion.

 

The Petersen case involved the construction of a paper mill modernization project. The contractor agreed to a cost-plus contract, with a guaranteed maximum price. The mechanical drawings were inadequate for construction. However, because of time constraints, the drawings were issued in their incomplete form and work began. The owner represented that the drawings would be completed within 2 to 3 weeks after the work started. In fact, the revised drawings were not ready for over a year after construction began. Even when the drawings did arrive, they were so defective that several hundred changes were made as the contract proceeded.

 

Because of the manner and number of changes, the contractor claimed that it was impossible to keep accurate cost records for each of the changes ordered by the owner. The owner and the contractor disputed over the amount of the money the contractor was entitled to for the changes. They agreed to have a referee hear the facts. The referee ruled that the owner had both abandoned and breached the contract and concluded that the contractor was entitled to, among other things, the reasonable value of his work based on a “total cost” approach.

 

The appellate court affirmed the referee’s decision, agreeing that in a construction contract an excessive number of changes may constitute an abandonment or breach of the contract. The court found that the number and frequency of changes were inconsistent with the original scope of work. These changes were evidenced in part by the contractor experiencing a 71% increase over the original contract amount.

 

The court also rejected the owner’s argument that “total cost” was not an appropriate measure of damages. The owner argued that the referee’s award ignored the contractor’s own deficiencies in performance. This argument was rejected by the appellate court, which felt that it would be unfair to permit the owner, whose many changes had resulted in an abandonment of the contract, to claim that the contractor had been deficient in performance. In addition, because the many changes made the contractor incapable of segregating the base contract work from the change work, it had no other means of pricing this work other than on a “total cost” theory.

 

While the contractor in the Petersen case was successful, there are many other cases where the contractors have been denied recovery because they used a “total cost” approach. This occurs when the contractor is partly responsible for the cost overrun and there is another, more accurate method of pricing the claim.

 

Michael C Loulakis

Attorney with

Wickwire, Gavin & Gibbs

Vienna, Va