Shipyards: Dealing with Disruption Claims

Shipyards that are building or repairing ships operate in a very complicated marketplace where costs are carefully monitored. Often claims are submitted requesting additional costs above the stated contract amount because problems beyond the shipyard’s control resulted in disruption of their as-planned flow of work. All too often, the alleged problems follow a pattern that becomes apparent when analyzing such claims. Common allegations of disruption include excessive owner changes, delays in approving changes, late responses to inquiries and problems, defective design, late or defective information or equipment supplied by the owner, and over-inspection. Such allegations form the basis for requests for equitable adjustments, claims, and lawsuits. However, many claims overlook problems that may be the responsibility of the shipyard such as underbidding the costs, rework due to poor performance, management and planning inadequacies, detail design errors, procurement problems and labor difficulties.

Changes

Changes to the bid scope of work may originate from several sources. Particularly in defense contracts, changing technology may require modifications to the original design. For example, advancements in electronics and communications may occur so rapidly that a three to six-year contract may involve several changes due to technological advancements. Regulatory agencies may also generate changes in requirements as their improved standards normally apply at ship delivery. There are at least two important regulatory bodies unique to shipbuilding – the American Bureau of Shipping (ABS) and the United States Coast Guard (USCG) which regulates safety, ship design, the ocean environment and other maritime concerns. Their revised regulations are often the sources of contract changes and disputes.

To deal with such changes, most ship construction and repair contracts contain clauses providing for the methods of pricing and implementing changes. Often the effects that individual changes have on labor costs and productivity are negotiated and resolved as part of the normal contract administration. However, the shipyard may allege that the price adjustment for the labor productivity losses due to an individual change order (local disruption) is inadequate to compensate for the overall effect of numerous change orders (cumulative disruption). Shipyards may also claim that there were changes in excess of what could be reasonably expected, straining the available labor pool and putting the planned work flow into disarray. Even for ship repair projects where the contracts may anticipate growth of more than 100% due to “open and inspect” work, allegations of productivity losses due to cumulative disruption are not unusual.

Another common dispute by shipyards relates to the time required to approve pending change orders. It is often claimed that excessive time to process changes results in disruption and labor inefficiencies not compensated by the change order price. Several matters may entangle evaluation of changes: an extremely complicated change requiring a lengthy scoping effort; widely differing cost estimates between the shipyard and the owner; a large number of changes “in the loop” at once; disagreements over the program scheduled; and the need to increase the overall program budget or alter the ship delivery date.

Design Problems

Shipyards frequently argue that numerous changes and performance cost increases are the result of problems with the ship’s design as provided by the owner. Shipyards may allege that the design contains errors, ambiguities, conflicts with other requirements, or fails to provide enough information or detail to allow adequate price or schedule analysis. Often in developing a new class of ships, the shipyard is engaged to design the first ship based upon the performance criteria established by the owner, and then to produce a specified number of units. The design developed by the original shipyard (the “lead shipyard”) is then the basis for the contract documents for the construction of additional ships by a “follow-on” shipyard. It is not unusual for the follow-on shipyard to submit a claim for defective design developed by the lead shipyard although the lead shipyard constructed the first ships without a similar claim. In more than one instance, when the shipyard served as both the lead and follow-on, it submitted claims based upon deficiencies in its own design passed on as contract documents for the follow-on ships.

Late Responses

During performance of a new construction or repair contract, the shipyard may have inquiries concerning problems, details, and ambiguities found in the contract documents. If the responses to the requests are not timely, the shipyard may allege that its performance was disrupted and its costs increased. Timely responses and an agreed to goal for response time may have prevented or reduced such costs.

Over-Inspection

New construction or repair work is subject to ongoing inspections and special reviews at stated milestones such as dock and builder’s trial. A common complaint by shipyards is that the owner’s inspectors imposed a stricter standard of inspection than required by contract or industry practice. Constant interruptions by inspectors and the processing of additional documents allegedly disrupt the productivity of the shipyard’s work crews.

Late Owner Furnished Items

Commonly, in ship repair or new construction work, the owner agrees to furnish the shipyard with items of specialty equipment and related information. If the equipment is delivered late or defective, the shipyard may claim disruption and delay. Similar claims may arise, particularly in the design effort, if the relevant information is inadequate or tardy.

Impact of Claimed Problems

The impact of the possible disruptive events described above varies both in scope and severity depending upon the timing of the event and the shipyard’s program status. A shipyard with financial or scheduling difficulties may claim a full range of impacts. Loss of labor productivity may be claimed due to the following: required overtime and the associated inefficiency, dilution of effective management by the craft supervision, inability to obtain necessary craft talent, doing work out of the most effective sequence, congested work areas, and inability to use advanced outfitting techniques. The list of potential impacts on the productivity of the labor force includes several other theories, depending upon the project and the creativity of the shipyard.

Costs and Damages

A shipyard’s calculation of the alleged costs and damages from disruptive events often lacks exactness and the itemization found in change order back-up. This may be due to the difficult nature of determining the impacts with scientific certainty and mathematical precision, or from the difficulty in determining costs with proper record keeping during construction. Frequently shipyards resort to the use of formulas and factors. For example, one publication that was originally intended to assist in forward pricing of change orders has been used by shipyards to calculate damages on post-contract claims. EntitledGuidelines on Factors Influencing Cost for Forward Pricing Change Order Disruption, Delay a Cumulative Effects. NAVSEA 0283, this publication was based on a study of the application of statistical methods for determining damages for a variety of disruptive events. Known in the industry as the Factor Formula Method, impacts are quantified by factors based on the type of ship, number of trades affected, number of compartments impacted and the timing of the change. Each alleged disruptive event is assigned a factor multiplied by the number of direct labor hours involved in the change order to obtain a price for the disruption.

To our knowledge, use of this approach has not been successful in litigation. There are at least three major problems with the use of such factor formulas in claims and at trial. First, the factors are not based on the actual performance data for the particular contract, and may not be relevant to the specifics of the claimed impacts. Second, the statistical background for the factors may not be reliably established for litigation purposes. Finally, where agreements between the shipyard and the owner allow factors to be used for forward pricing change orders, the agreements often specifically prohibit the use of formulas in claims or litigation.

As an alternative to the factor formulas, labor efficiency variations may be determined by analyzing the detailed labor records for the contract during specific periods and in distinct locations. For example, labor productivity, measured by labor costs/units produced, can be compared for periods of time not subjected to disruptive events against periods affected by disruptive conditions. Difficulties in using this approach may arise if there are no distinct locations or time periods that are unimpacted to compare with the allegedly impacted periods. Other problems arise if there are too many disruptive events or inadequate records concerning the labor hours, activities, or the disruptive events.

Conclusion

The maritime industry is highly competitive and cost-conscious which may be the reason for the frequency of disruption claims. Because these disputes are common, they will likely be subject to increased scrutiny. In particular, the approaches used in calculating the alleged labor disruption losses may be challenged with increasing vigor. For both shipyards and owners, good record keeping is important to resolve labor productivity claims.