This was the challenge set to
me by lawyers acting for a Far Eastern shipbuilder pursuing
an arbitration claim against a European ship owner. The task
was further complicated in that all documents were in a foreign
language and unfamiliar script and were located in the Far East,
together with the staff who could explain them (at least in
their own language!) ... and the deadline was tight.
Forensic accountants are frequently required to take an imaginative
approach to assessing quantum in disputes. By “imaginative
approach” I do not mean excessive or biased, as some experts
are accused of being. Any expert worth his or her salt knows
that their integrity and impartiality are qualities to be defended
fiercely. Nevertheless, by their nature, loss of profits claims
require the adoption of methodologies that compare what would
have happened, but for the breach, with what in fact occurred.
The former inevitably requires the exercise of judgement, the
adoption of assumptions and the use of imagination in devising
means of testing and verifying those judgements and assumptions.
A visit to the shipyard was clearly essential in order to understand
the construction process, to identify (and have translated)
the relevant documents and to interview staff. Accordingly my
instructing solicitor and I boarded a plane and spent a busy
week extracting the raw data underlying the shipbuilders claim
which fell into two categories:
the fully mitigated costs already incurred by the shipbuilder
up to the date of termination of the contracts (“the loss
and expense claim”); and
the profits lost by the shipbuilder as a result of the cancellations
(“the loss of profits claim”).
The Loss and Expense Claim
Formulation and verification of the loss and expense claim was
relatively straightforward as it comprised design and engineering
labour costs (which were supported by timesheets), certain subcontracted
component manufacturing costs and sundry brokerage and finance
fees (which were supported by invoices and correspondence).
The principal complication was the establishment of a “fully
absorbed labour rate”. When charging for the costs of
employees’ time, it is common practice to recover not
only the basic employment cost of the individual concerned,
but also a contribution to overheads and profit. For the purpose
of the loss and expense claim, I included an amount of overhead
allocation, but no contribution to profit (as this would have
resulted in double-counting with the loss of profits claim).
I arrived at the labour rate by totalling all of the labour
and overhead costs incurred by the shipyard in the previous
accounting period and dividing this amount by the total number
of man-hours worked in that period. Inflation was low and budgeted
man-hours for the relevant period were similar to those for
the previous period, so it was my opinion that the historical
fully absorbed labour rate was a reasonable estimate for inclusion
within the loss and ex shipbuilder to prepare budgets for each vessel at the tendering
stage and then to refine those budgets at the design stage.
The pro forma budget for each vessel was along the following
lines:
| The materials budget was supported
by a detailed listing of the steel pla architects. Similarly, direct costs, principally classification fees, sea trials and insurance were supported by correspondence and price quotations. When considering direct labour costs, I had to decide on two issues: Were any labour costs saved as a result of the cancellation, or was labour in effect a fixed cost? Were the shipbuilder’s budgets for labour hours reliable? With regard to the first of these, I assumed that labour costs were fully variable through redeployment or reduction in overtime or subcontract labour. I regard this as a conservative assumption as I would have expected there to be some inefficiencies flowing from any redeployment of labour. In order to assess the reliability of labour hours budgets I reviewed the monthly labour efficiency schedules for the relevant period. These schedules compared actual man-hours for each vessel in the yard with those budgeted to have been incurred at the stage of completion reached. My review revealed that, historically, actual hours had on average overrun the original estimate, by 6%. In order to be conservative, I applied an uplift of 10% to budgeted labour hours for the two cancelled vessels. Although each assignment is unique, many of the issues emerging in this case were familiar and are typically encountered in any loss of profits claims: The formation of a damage theory model comparing the situation that would have applied, but for the breach, with that which in fact transpired. The devising of tests to verify the reasonableness of the data and assumptions used in the model. The assessment of which costs truly varied with activity and hence were saved as a result of the cancellation, so that credit should be given in the damage calculation. The extent to which the claimant has fully mitigated its losses. For example, in the case outlined above, lead times for the specification and negotiation of shipbuilding contracts made it impossible to bring in replacement contracts within the necessary timeframe to utilise the shipyard capacity released by the cancellation, even if such contracts had been available. Shortly following the submission of my report the case settled
on terms favourable to the shipbuilder, so I never saw my assumptions
and calculations challenged. However the speed with which the ship
owner moved to settlement gives me some cause to feel they stood
up to scrutiny |
