Change Orders
Change orders cause a lot of trouble on construction projects. The fundamental question is whether the contractor is entitled to additional payment for work they are being asked to perform. Unsurprisingly, there is often a disagreement. It is imperative to negotiate change order provisions before the project and comply with them during a scope of work dispute.
What Qualifies as a Change Order?
A change order is an agreement amongst the parties to change the scope of work of the project. Usually a change order includes a price and/or schedule adjustment. For example, if an owner engages an asbestos abatement contractor to abate a finite quantify of asbestos containing materials and the owner then asks that contractor to abate additional materials, the contractor will prepare a proposed change order quoting a price of the work and adjusting the schedule to complete the same. If the owner signs the change order, it modifies the contract. The contractor is entitled to additional compensation and, usually, additional time to perform the work.
It is often not that simple, however. The parties often disagree about whether the work is within the contractor's original scope. Contracts are laden with provisions imposing a burden on the contractor during the bidding process to inspect and become aware of all conditions on site. Often the response to a change order proposal is: "You should have seen that during your walk through. That is included."
On the front end, contractors should be as specific as possible about what is included in the scope of work. Compare an agreement that defines the scope of work as "remove all asbestos from building" with a scope of work that states "remove 150 sq ft of asbestos containing material from main room ceiling; remove 320 square feet of asbestos containing tile, etc." The more specific the scope of work, the lower the possibility of a change order dispute.
Notice and Approval Requirements.
Because this is such a battleground, there are usually strict provisions in the contract regarding notice. For instance, many contracts require the contractor to provide formal written notice within seventy-two hours of the occurrence or observation of the condition that will increase the scope. The penalties for failure to provide such notice can be harsh (e.g., "If timely notice is not received then such claim shall be conclusively waived."). Once proper notice is provided, the contract usually requires written approval before the contractor can proceed with work. Again, the penalties for failure to obtain such approval can be harsh (e.g., "Contractor shall have no liability to Subcontractor for work relating to changes where such work was undertaken without written authorization from Contractor."). It is also important to know from whom approval must be obtained. Contracts often designate a specific representative.
All of these conditions are intended to address the following scenario: The project is behind schedule. A subcontractor identifies a change in condition. The subcontractor's representative provides notice and indicates he will put together a proposed change order. A supervisor says: "No time for that. I'll make sure its approved. Do the work." The project moves forward. The work turns out to be more expensive than expected. The subcontractor submits the proposed change order. And the general contractor pushes back. "Where is the written notice required by the contract? Where is the written approval required by the contract? What supervisor? Oh, we just fired him. And the contract requires that the superintendent, and only the superintendent, approve changes. He would have told you the work is within your scope."
Needless to say, contractors have to proceed very carefully before moving forward with change order work.
Calculating Compensation.
There are several ways to calculate compensation for extra work, including lump sum pricing, unit pricing, time and materials, cost plus, or any other manner agreed upon by the parties. Many contracts describe all such pricing structures and give the owner or general contractor the sole option to select which to use. Other contracts mandate cost plus pricing, typically including the right to audit direct costs and a dictating a specific overhead and profit percentage, or none at all. It imperative to review and adjust these provisions prior to executing the contract. A lot of contractors consider in their bids whether there will be change order work, where they can often find significant profit. It is a rude awakening when they are forced to perform that work for a small or no margin.
Change Directives/Disputes.
When the parties cannot reach an agreement on a change order, the contract may provide for change directives. For instance, AIA 's standard construction contract (AIA Document A101-2017 - Standard Form of Agreement Between Owner and Contractor) contains a change directive process. Change directives are written orders directing a change in the work. The contractor must perform the work directed. If there is a dispute regarding whether the change directive alters the scope of work or increases cost, the parties have to invoke the dispute resolution process of the contract.
The change directive process is a good method for addressing change order disputes. The AIA standard contract states: "A Construction Change Directive shall be used in the absence of total agreement on the terms of a Change Order." If the contractor submits a proposed change order, the owner can issue a change directive ordering that the contactor proceed with the work and reserving everyone's right to fight about it later. Most large contracts have some form of this procedure, requiring the contractor to proceed with the work even in the event of a dispute regarding entitlement to a change order. This minimizes disruption to the project and removes the ability of the contractor to extort an exorbitant price for the work.
The dispute resolution provisions of a contract typically provide that the parties first attempt to negotiate informally. If that fails, the parties usually have to submit the matter to mediation. If that fails, the claim usually goes to arbitration. While these provisions are intended to minimize litigation costs, there is a potential for abuse. By requiring the contractor to jump through each of these hoops even when the entitlement to a change order is clear, it allows the owner/general contractor to tie up the funds for an extended period of time, which is often the goal.
Allocating Risk of Nonpayment.
Many change order provisions have subtle by serious risk allocation provisions. For instance, such provisions may state that compensation for a change order will only be approved to the extent that the owner approves the change order. The general contractor in that situation is simply acting as a go between. The subcontractor submits the change order. The general contractor passes it along to the owner. The owner's decision is final. The general contractor risks nothing. The subcontractor risks everything. This becomes especially problematic where the work is clearly outside the scope of the subcontract but clearly within the scope of the prime contract. At an absolute minimum, it delays payment and increases costs to the subcontractor.
Similarly, many change order provisions include "pay-if-paid" style contingent language, such as: "Contractor's obligation to pay change requests initiated by the Owner or Architect shall be expressly contingent upon receipt of a corresponding change order from Owner, and the amount payable to Subcontractor shall in no instance exceed the amount paid by Owner to Contractor for the change." Again, the subcontractor bears all the risk. If the work is clearly outside the scope of the subcontract, the subcontractor performs the work after receiving direction, but the owner fails to pay, the subcontractors eats the cost. This is a fundamentally unfair but common result. More on "pay-if-paid" provisions here.
It is incumbent on contractors, especially subcontractors, to forcefully negotiate these provisions on the front end to avoid bearing all of the risk on the project.