Protect your company from risky change orders

August 11, 2010

Almost all construction projects are faced with changes after contracts are signed and work is begun. That there are few change orders on a project is a true testament to the thought and care expended at the front end by the owner and its design team. Once a job begins, there is precious little time to redesign and define the scope of changes, quantify what needs to be done, and agree upon a price for performance without slowing down the job. In dealing with change orders, while it would be nice to stop a job so that the design and pricing process could continue, there simply is not time to engage in such niceties.

The change order clause is another contractual risk-shifting device. Such clauses do not always provide the necessary contractual safety net that is needed for fast-paced construction projects. Indeed, some contracts contain potentially disastrous clauses if they require all changes be made before there is an agreement on price or methodology for pricing the changes. The problem is obviously exacerbated if the contractor must perform all of the changes without a contractual right to bill for the extra work until there is a change order that has been signed by the owner, architect, general contractor, and subcontractor.

Besides choosing your customer carefully, the best way to protect yourself from potential disaster caused by having to perform excessive amounts of changes without timely compensation, is through careful contract negotiations.

First, contractors should not obligate themselves to perform changes without explicit written instructions recognizing that the work is outside the scope of the base contract and that extra compensation will be due. All too often parties who have requested change order work later defend the claim by saying that the party's signature on the contractor's extra work order ticket simply was confirmation that the work was performed, not that the work constitutes extra work for which extra compensation is due.

Next, it is crucial that the contract agreement provides for a mechanism for compensating change order work. For example, a contract could provide that change order work will be compensated on the basis of either of the following:

  • a mutually agreed-upon lump-sum amount

  • unit prices established in the contract

  • unit prices mutually agreed upon

  • time, material, overhead, and profit.

The most critical part of this clause, often overlooked, is a default mechanism. Such a clause should provide that in the absence of an agreement for either lump-sum or unit prices, the contractor is entitled to be compensated on a time and material basis, plus overhead and profit. Hence, it will be incumbent on the contractor to maintain accurate records.

Who is doing the work?

The amount for overhead and profit should be negotiated on a case-by-case basis, depending on who is doing the work. A subcontractor should not be expected to lose money on change order work because its upstream contractor accepted less than the subcontractor's actual rate of overhead.

Change order clauses should, however, contain reasonable time limits on the amount of time that contractors have to price change order work. Contractors and subcontractors know that they are likely to be asked to price and perform change order work. Thus, their organizations need to be equipped to price this work in a timely fashion.

Many change order clauses obligate the contractor and subcontractor to perform all of the new work before the entire change order process has been completed. However, if the contractor has complied in a timely fashion with the request to price the change order work, but no change order has been executed, the contractor is frequently faced with contractual prohibitions against invoicing for extra work, which has been performed, but not been reduced to a change order. This practice should end so that contractors and subcontractors who have lived up to their obligations have the right to invoice and be paid for their work. It is good financial management to account for these costs from the time they are incurred, not from the time they are converted into a change order. They should even have the right to stop work if they have not been paid in a timely manner for properly performed change order work.

Finally, change order documentation needs to recognize that at the time the initial changes are requested the parties being asked to perform the work are not necessarily aware of how many changes they will be asked to make. An excessive number of changes will result in performing more work in the same amount of time, unless the schedule is extended and will divert the contractor's resources from performance of base contract work as contemplated at bid time. Thus, the documentation needs to preserve the contractor's right to be compensated for these impact costs at the end of the project, depending upon their extent and magnitude.

         
 

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