The Construction Specifications Institute

Change Order Basics: Fundamentals of Construction Contract Modification

Bryan C. Jackson Partner, Allen Matkins Editor, Green Building Update Telephone: 213.955.5575 Facsimile: 213.620.8816 [email protected]

Robert J. “Mike” Cathcart Partner, Allen Matkins Telephone: 213.622.5555 Facsimile: 213.620.8816 [email protected]

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The Construction Specifications Institute is a Registered Provider with The American Institute of Architects Continuing Education Systems. Credit earned on completion of this program will be reported to CES Records for AIA members. Certificates of Completion for non-AIA members available on request. This program is registered with the AIA/CES for continuing professional education. As such, it does not include content that may be deemed or construed to be an approval or endorsement by the AIA of any material of construction or any method or manner of handling, using, distributing, or dealing in any material or product. Questions related to specific materials, methods, and services will be addressed at the conclusion of this presentation.

This program is a registered educational program with the Construction Specifications Institute of Alexandria, VA. The content within this program is not created or endorsed by CSI nor should the content be construed as an approval of any product, building method, or service. Information on the specific content can be addressed at the conclusion of this program, by the Registered Provider. Credit earned for completing this program will automatically be submitted to the CSI CEN. Completion certificates can be obtained by contacting the Provider directly. This logo and statement identify Provider programs registered with the CSI CEN and are limited to the educational program content.

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Three Axioms of Construction Change

1. Change happens 2. Changes cost more than Contract Work 3. Early resolution = reduced cost

Avoiding Claims and Disputes • • • • • •

Complete the design Minimize changes during construction Document the issues Establish and follow a protocol Price changes fairly Recognize schedule impacts fairly

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Change Order Resolution • Recognize changes • Procedure for requesting Change Order • Mechanism for pricing and Scheduling • Prompt and efficient evaluation • Grant/deny properly and fairly • Reservations of rights • Complete the project • Lender and Surety Concerns

Contract Provisions Regarding Change Orders • • •

General provisions regarding process Circumstances entitling Contractor to Change Order? Contractor options if Owner/Architect denies Change Order?

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Benefits of Change Orders • • • • • •

Force parties to adhere to Contract Predictability and certainty Allows parties to control costs and schedule Enables contractor to be paid for extra work Avoids disputes, litigation Allows for schedule adjustments

Dangers of Change Orders • Offensive use of Change Orders: “Pocket Change Orders” • Failure to adhere to Change Order procedure • Construction Loan Balance

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Actual and Constructive Changes • Actual Change: express owner-directed or agreed change to price, time or quality • Constructive Change: scope change resulting from other events or circumstances – Defective design requiring additional Work – Owner-caused delays – Differing Site conditions

Cardinal Change • Constructive or actual changes by Owner AND • Project fundamentally different from job bid/contracted • Fixed price contract can become a time and materials contract • May excuse Contractor’s performance altogether

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Abandonment: Private Works • Excessive number of owner-imposed changes • Scope of Work altered materially • Parties ignore/deviate from Change Order process • Quantum meruit recovery • Federal courts: Cardinal change materially altering original bargain

No Abandonment in Public Works • Amelco Electric v. City of Thousand Oaks, (2002) 27 Cal. 4th 228 • Inconsistent with public bidding requirements • Contract determines how project to be terminated, modified or amended (Public Contract Code §7105) • Amelco did not prove total cost claim: Conceded it caused some of its own inefficiencies

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What is a Change Order? • Modification of a Contract • Requires meeting of the minds – Intent – Offer, acceptance or counter-offer • Consideration • Oral or written – Statute of Frauds (Civil Code §1624) – Oral modification of written contract (See Civil Code §1698) • Binding on the parties

Agreed Modifications to Contract • Time, price or quality terms – Adjustment of time – Adjustment of cost – Change in scope of Work • Authorization and/or agreement to proceed • Reservations of rights

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Changes Imposed By • Change Order: Parties agree to the change • Construction Change Directives: Owner directs the change • Order for minor change in the Work: Architect directs the change

Typical Change Order Clause in Contract • •

• • • • • • •

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§ 7.2 CHANGE ORDERS § 7.2.1 A Change Order is a written instrument prepared by the Architect and signed by the Owner, Contractor and Architect after execution of the Agreement, stating their agreement upon all of the following: .1 change in the Work; .2 the amount of the adjustment, if any, in the Contract Sum; and .3 the extent of the adjustment, if any, in the Contract Time. § 7.2.2 Methods used in determining adjustments to the Contract Sum may include those listed in Section 7.3.3. § 7.2.3 Agreement on any Change Order shall constitute a final settlement of all matters relating_ to the change in the Work which is the subject of the Change Order. including, but not limited to. all direct and indirect costs associated with such change and any and all adjustments to the Contract Sum and the Contract Time. The schedule of values shall be modified accordingly for Work covered by Change Orders. § 7.2.4 The Contract Sum and the Contract Time may be adjusted by Change Order or Construction Change Directive Only.

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Changes Without a Change Order • Construction Change Directive – Change nominal without price or time impact – Owner and Contractor disagree on price or time

• Order for minor change in the Work • Contractor must proceed promptly • Contractor should advise Owner/Architect if disagrees with price or time adjustment

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Change Order Process: Scope of Owner’s Right to Make Changes • Owner “owns” the project: Can change anything • Change can impact price or time • Change Order or claim/dispute will determine effect on price, time or quality • Contractor’s right to a Change Order

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Role of the Architect • Coordinate the design and administer the Contract • Prepare Change Orders, construction change directives and orders for minor changes in the Work • Interpret plans and specifications • Decide matters of performance, requirements of Contract documents, disputes

Role of the Contractor • Perform, supervise and/or coordinate the Work • Review documents and field conditions • Request information/clarification • Request Change Orders and/or make claims if cost, time or quality are impacted by changes • Pricing • Scheduling • Value engineering

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Role of the Subcontractors • Provide pricing and scheduling information • Perform portions of the Work • Pass-through obligations • Subcontract Change Orders

Role of the Lender and Surety • Loan imbalance • Surety obligation to cover modified time, cost and quality

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Change Order Formation • “Change event” • Agreement on “change” • Negotiation of effect on price, time or quality • Reservation of rights if cannot agree • Make Change Orders “all inclusive” to avoid later claimed Change Orders for “cumulative effect”.

Negotiating the Change • Agree on entitlement • Agree on pricing method (T&M, unit price, estimate…) • Agree on the scope of change • Prepare an independent estimate • Carefully review Contractor’s estimate – Including all backup

• Resolve it NOW through negotiation

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Management and Administration of Changes • Compliance with contract • Notice; changes; time; reservations • Create issue files • Document control system • Change control system • Records are principal source of proof • 3rd party review / reconstruction • Prepare timely assessment of issues • Time and cost analyses • Negotiation / resolution

Documentation of Change Orders • RFI and response • Request for Change Order (COR, PCO, etc.) • Request for pricing or proposal • Pricing and scheduling information – Unit costs – Labor rates – Estimated time/schedule

EXPLANATION OF REASON FOR CHANGE

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Records to Document CO Work • • • • • •

Delivery tickets Provide daily report form in the Contract Report of labor, materials and equipment by subcontractor: quantity and merit Avoid/minimize disagreement over entries Signature of each party: receipt, agreement or verification, approval for payment Document resolution of the change

Contractor’s Obligation to Continue • Determined by Contract • “Contractor shall have the right to stop Work if…” • “Contractor shall proceed with the performance of the Work pursuant to the Contract without causing any delay or cessation of the Work in the event of any dispute or controversy over any matter whatsoever…” • Otherwise, Contractor may be able to continue and sue, rescind or terminate

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Causes of Change Orders • Differing site conditions • Changes in scope of work • Defective or ambiguous plans and specifications (Design v. Construction coordination…) • Owner’s failure to disclose information • Owner’s interference/micromanagement • Delay • Disruption • Acceleration

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Areas of Concern Necessitating Change Orders • Constructability review and site familiarization • Owner/Architect-directed scope changes/substitutions • Delays • Unknown or concealed conditions • Unit prices materially changing

Differing Site Conditions •

Contract should clearly allocate risk for different site conditions between the parties

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Two Types of Differing Site Conditions • Type I: Subsurface or related physical condition at the site which differs materially from those indicated in the Contract documents • Type II: Unknown physical condition of an unusual nature differing materially from those ordinarily encountered but recognized as inherent in the work of same character as provided for in the Contract

Differing Site Conditions • Statutory requirements for public works contracts with local public entities: Public Contracts Code § 7104 requires that any public works contract with a local public entity which involves excavation deeper than four feet below the surface shall contain a clause that requires a change order for Type I or II Differing Site Conditions

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Defective or Ambiguous Plans and Specifications: The Spearin Doctrine • U.S. v. Spearin, 248 U.S. 132 (1918) • Owner impliedly warrants plans and specifications – free of defects and buildable • Effect of clauses requiring Contractor to visit site, review plans and become informed about requirements of the Work • Ambiguities, errors or omissions

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Ambiguities in Plans and Specifications • Contractor’s duty to review the plans and specifications • Construction Coordination v. Design Coordination

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Procedure • Discovery of ambiguity in plans and specifications • RFI • Clarification and/or change in design • Pricing proposal from Contractor • Change Order • Constructive Change Directive • Notice to proceed

Owner’s Failure to Disclose Information • • • • • • • •

Owner’s contractual obligation to disclose information Financial arrangements to fulfill Owner’s obligations (cf. Civil Code § 3110.5) Approvals, easements, assessments and charges Surveys describing physical characteristics Legal boundaries Utilities Other information in Owner’s “control” as requested by Contractor Misrepresentations?

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Contractor Should Request Change Order • If subsequent discovery of undisclosed information impacts project • Adjustment of time • Adjustment of Contract price • Adjustment of quality

Allowances • Undefined scope of Work, undefined sub-portions of Work, unspecified specific material items • Listed as allowances in Contract documents • Priced basis shown in schedule of values

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Contract Sum Adjusted by Change Order for Allowances • Cost to Contractor of the materials and equipment delivered at the site • Often not including transportation and handling costs • Contract Sum adjusted “accordingly” or “equitably”

Unanticipated Cost Impacts • Escalation of material cost • Prevailing wage requirements • Force majeure event

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Owner’s Interference • Micromanagement of the project • Interference with – Planned sequence – Manpower deployment – Means and methods of performance

• Owner’s separate contractors – Asbestos abatement – Hazardous waste abatement – FF&E installer

Inspection • Required changes • Code criteria and interpretation • Opening Work to permit inspection – Clauses: Owner pays if not required to redo Work • OSHPD (hospital inspector of record requirements)

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Pricing the Change: Actual Costs • • •

• • •

Detailed and documented Fair, reasonable and authorized by Contract Labor, material, equipment and direct costs efficient and not excessive Overhead, profit and markup Contractor responsible for costs? Credits provided and fair?

Pricing by Estimates • •

• • •

Detailed breakdown Take-offs based on quantities and hours for labor, materials, supplies and equipment Indirect cost estimates Subcontractor, vendor or supplier bids or quotes Prices and mark-ups authorized by Contract

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Cost Per Generally Accepted Accounting Principles • • • •

Contractor Cost Accounting System Consistent tracking of changes and costs Reliability of system and records Change and related costs contemporaneously recorded

Costs Must Not Be Falsified •

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Inflated costs, false labor records or invoices, double billing, claiming change for work included in base contract Fraudulent Change Order requests on public contracts: Federal and California False Claims Acts Severe civil penalties up to $10,000 per false claim and criminal penalties

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Equipment Prices •

“No payment shall be made for the use of tools which have a replacement value of $200 or less” Equipment rental rates shall not exceed local rates Equipment in good working condition Maintenance, breakdown and repair costs Published rates

• • • •

Unit Prices • • • •

Stipulated in Contract by Owner and Contractor Submitted on Change Order Bid Form or Proposal by Contractor E.g., earth excavation at specified sum per yard Unit price inclusive of labor, material, services, equipment, overhead & profit

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Pricing: Indirect Costs •

Site overhead & management – –

• • •

Costs related to entire Work Cost attributable only to the change

Contract limits on site or home office overhead costs Costs indirect or direct Indirect costs or overhead already covered in Contract Work

Overhead and Profit on Change Orders • • • • •

Allowed or limited by the Contract Only overhead and not profit? Mark-up allowed on equipment? Mark-up allowed on insurance premiums? Credit Change Orders require credit for overhead and profit

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Ripple Effect • • • • •

Effect of one change on Base Contract Work Change Order may include cost of the change plus change in cost of performance of Base Work Causation: Effect of change on Base Contract Work Can be legitimate extra cost Contract and Change Orders should address Ripple Effect

Cumulative Impact • • •

•

Synergism of numerous changes can impact working environment and cost of the Work Change Orders as Accord and Satisfaction Cumulative impact has been recognized by Federal and State courts as unforeseeable and recoverable subsequently Contract and Change Orders should address Cumulative Impact

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Pricing Cumulative Impact • •

•

Modified Total Cost: Amelco Court did not allow it Most cumulative costs are labor overruns from lost productivity, inefficiency, loss of job momentum, loss of morale Expert opinion usually required

Disruption • • • •

Disruption of planned means and methods, sequence, scheduling Caused by changes, delays, suspension, acceleration Can affect non-changed work and increase cost and time of project Difficult to value

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Disruption to Material and Equipment • • • •

Costs of handling and storage Escalation of prices and rentals Carrying charges and interest Change in available models or products

Disruption to Labor Escalation of labor rates for different union wage agreement periods • Turnover or addition of labor • Additional management, planning or supervision • Stacking trades • Mobilization and demobilization • Availability of labor and materials • Fatigue, morale and momentum • Productivity: More hours than planned to perform Base Work • Weather

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Total Cost Method to Calculate Actual Change Order Cost • •

• •

Contractor claims Owner responsible for total costs Total cost of work over bid of Contract Sum plus reasonable overhead and profit Hard to separately calculate cost of each change Numerous or substantial changes impact entire project

Total Cost Criteria • • • • •

No errors in Contractor’s bid for project or item Contractor’s actual costs were reasonable Contractor is not responsible for any cost overrun Impossible to calculate the extra costs by any other method Owner responsible for the change and resulting extra costs

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Modified Total Cost • • • •

Remove any Contractor caused cost overruns Remaining cost overruns plus reasonable overhead & profit More favorably regarded than total cost Still must show bid free of errors, costs reasonable, and other methods of pricing not feasible

Change Order Cost Problems • • •

Lack of competitive pricing Execution required before Work starts Payment delays if Change Order disputed

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CO Cost Issues: Impasse on Final Price Agreement •

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Owner & Contractor may execute Change Order on agreed costs and agree to settle other costs later Owner may issue a Unilateral Change Order or Construction Change Directive ADR: Architect, “project neutral,” Dispute Resolution Board (DRB), arbitrator

Contingency • Use of contingency • Abuse of contingency • Should Owner allow contingency in Contract? • How might Owner manage the contingency?

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Questions?

This concludes the credit portion of the program for The Construction Specifications Institute Construction Education Network and The American Institute of Architects Continuing Education System

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