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CHANGE ORDERS: THE
USUAL PROBLEM IN THE PROJECT CONTRACT- HOW TO MINIMIZE THE EFFECT
1.
Introduction:
It is a basic and
perhaps revealing fact that the overwhelming majority of legal cases
involving construction contract disputes arise from change orders (e.g.
requested or required alterations) on the project. An elderly litigator
once told this writer that if it were not for arguments over change
orders he would have had to find another way to make a living.
Why is this so?
There is little in
life as complex as a construction project. Consider the number of
entities involved in a typical “simple” development project: The owner
of the land; the financing institution or institutions; the supervising
governmental agencies, federal, state and local; citizens groups;
neighbors to the land; the architect; the engineer; the developer who
may or may not be the general contractor; the various trades and
subcontractors who may or may not have union personnel involved;
material men of each type of material, the actual manufacturers of the
materials and tools including rental companies for the tools and/or
fencing; the building inspectors; the insurance companies; at times the
bonding companies; the realtors; and, last but not least, the buyers of
all or part of the development and their lessees, associations and own
insurance companies. A typical business agreement has two or three
parties involved in the transaction. A construction project has a dozen
or more.
Note that the
motivations of the myriad persons above are far from uniform. The
developer is concerned about completing a sellable project as soon as
possible since financing costs a sizable amount each day; the architect
wants a project that meets the engineer’s and developer’s demands and
the banks financing limits but undoubtedly also wants a project of
aesthetic and design value; the governmental agencies each have their
own list of criteria and are subject to pressures from local citizen
groups who may not want any project whatsoever, etc, etc. In most
contractual situations, the parties seek a single purpose, e.g. to
exchange money for product, to have a service performed for an
affordable fee, etc. In construction, such singularity of purpose is
seldom achieved.
And months or years
before the above groups of entities have their input and involvement,
various experts seek to create a plan of development and construction
asking their legal counsel to generate the documents that will allow the
banks to finance and the builders to put the matter out for bid and
enter into binding commitments.
Even if the needs of
the particular project were not subject to the vagaries of the site and
alterations in specifications needed by the owners or construction
requirements, the interaction of the above many entities would
invariably result in changes on most projects as they progress.
Even a simple “non
development” project has close to half a dozen entities involved, even
if owner financed, since the general, the building inspectors, material
men, the insurance companies, and the subcontractors, engineers and
architects/designers still are usually involved.
With this complex
system of construction, it is often a wonder that any project ever
finishes on time or even close to what the original plans postulated!
The fact that thousands of projects are completed each month in
California speaks well for the professionalism of the various people in
construction and the fact that the system, while complex, clearly does
manage to accomplish completion in almost every case.
But one invariable
result of the complexities is the need to often and sometimes constantly
alter various aspects of the project. Whether it is adding extra work,
altering existing specifications, altering time lines and critical
paths, or the numerous other changes arising in a project, anyone who
has been in construction for any length of time is aware that projects
often have to be adjusted based on changes in requirements or unpleasant
surprises.
And it is equally
inevitable that confusion not only about what is a change order versus
part of the original bid and how/if to pay for the change order will be
a matter of dispute and, often, litigation.
Many construction
contracts, especially the AIA and other types of “standard” contracts
have long and complex provisions regarding change orders and what
criteria will apply to make them enforceable. Nevertheless, despite
these provisions, perhaps often because of them, change orders remain
matters of dispute.
The reason is that
despite provisions in the contract, the Courts have quite often have
utilized a criteria of “equity” or “fairness” in
determining whether they will apply the rigorous criteria imposed upon
enforceable change orders in contracts and arbitrators are, if anything,
even more loathe to enforce what they consider harsh provisions
eliminating the right for fair payment for changes in labor to be
performed or material to be installed on a contract.
Mechanics liens and
stop notice
rights are “equitable” remedies that grant judges and
arbitrators great leeway in determining whether provisions in a contract
are to be strictly construed. The reader should review the many articles
on change orders on the
Retainer Pages
of this website for the numerous instances of change orders prohibited
by the strict wording of the contract-but allowed by the trier of fact
nevertheless.
And the result is
that judges and arbitrators are constantly called upon to decide many of
the disputes with owners, developers and general contractors or
subcontractors locked in argument over whether a particular alteration
in the project requires an alteration in compensation. (Note that even
speeding up a project can create a claim for additional compensation due
to the need for overtime compensation for workers and the effects of
Impact and Acceleration
on the cost
of the developer or sub.)
This article shall
briefly suggest various simple ways that the professional or owner on a
construction project can better prepare for the likely emergence of
change orders on a project and minimize the disruption and the
likelihood of litigation. Or, as one of our clients put it, “I’d sure
like to finish a project without you lawyers telling me how much I’m
going to get paid. Have any suggestions?”
We do and that is
the scope of this article.
2. Facing Facts- Change Orders Are
Going To Happen So Make the Contract Fair and Appropriate in How it
Handles Them.
It is a matter of
some surprise to many young lawyers that many in construction do not
create provisions in contracts that deal with change orders in minute
detail. We explain to the novices that many professionals in
construction, anxious to get a bid accepted, do not like to dwell on the
unpleasant fact that bids are often superseded by increased costs due to
changes in the project. Thus change orders are often soft-pedaled, and
not dealt with in detail.
Additionally, many
professionals have often seen carefully structured verbiage in a
contract ignored by the arbitrator or judge who simply insert their own
criteria for fairness and the professionals finally conclude that they
can “relax,” not bother with carefully thought out wording and let the
fairness of the overall situation “handle it.”
Which, in our
opinion, is rather like hoping that that tooth fairy will come along and
pay for your tooth.
Business is business
and the entire purpose of creating expertise in bidding is to hone one’s
skills to accurately and fully create a bid that will get the job done,
make a profit, and beat out the competition. To make a bid but ignore
the likely effect of change orders in superseding much of the bid is to
create a structure in which one’s skill is to be supplanted by the mood
and sense of fairness of a relative novice to construction, the judge or
the arbitrator. Again, a client put it better than this writer can: “If
I depend on the judge and his sense of equity, I am depending on his
mood on the day of the hearing. If he just argued with his wife, I might
find myself working for free!”
But if judges and
arbitrators often will not enforce the tough language of change order
provisions, is there any point in creating them?
Yes, for quite often
a judge or arbitrator will enforce the provision, especially
if it is fair, and inevitably they will read the provisions closely
and use them in determining some aspect of what the consider fair
compensation.
In our opinion, the
vital part is to create not a mindlessly vague or ruthlessly “tough”
provision as to change orders so much as a fair and logical
system for change orders. Vague provisions do not give protection at
all since the parties do not know what they must do to protect their
rights. As for those remarkably one sided provisions seen often in use
by large developers or owners, this writer has seen numerous provisions
that are patently unfair evaded by the Courts or arbitrators who usually
simply are trying to do the “right thing.” This reluctance on the part
of a trier of fact to enforce such a provision creates uncertainty even
in the mind of the party in whose favor the provision was drafted since
it is unclear if the provision will be actually enforced. Thus too much
“power” in one’s provision actually acts to undermine its effectiveness.
A typical example of
the “too strong” provision is the clause which states that the change
order will not be paid for unless an uniquely authorized representative
of the company requested same in a prior writing, even if the company
benefited from the change order and it was requested by an unauthorized
agent. (Typically an emergency situation arises, the job sub foreman who
is not “authorized” begged the subcontractor to do the extra work yet,
since the contract provides that the home office must approve in writing
any change order and the home office, three hours ahead on the East
Coast, was closed at the time, the change order is later contested after
the job is completed. All the other trades were waiting, yet the home
office refuses to pay anything since it was not properly authorized. The
subcontractor may face economic ruin, may have acted the hero of the
entire project, yet the owner or contractor insists on the letter of the
contract which specifically provided for no payment for any unauthorized
change order.
The developer above
may feel that they have placed themselves in a very strong position
given the wording of the contract. Nonsense. This office has invalidated
both in Court and arbitration many such “over powerful” clauses and
ultimately the only ones who benefit from their insertion are the
lawyers. The sad thing is that many subcontractors or contractors do not
realize the fragility of such clauses or simply do not have the
resources to test them in court or arbitration, thus end up losing even
without a fight.
And the fight can be
expensive for both sides, depending on the forum in the contract and the
provisions regarding attorneys fees. The reader should review our
article on Binding
Contracts as well as
Arbitration on this web site.
Most states,
including California, have statutes that provide doctrines by which the
trier of fact can avoid such “unjust enrichment” to the owner or general
contractor. Using such doctrines as estopple, waiver, unclean hands and
the like, the judge or arbitrator can claim the clause was “waived” by
the owner or that the owner should be estopped from enforcing it.
The result is that
both sides are unclear as to whether the clause will be enforced,
predictability is eliminated, and litigation more likely. What should be
fair provisions for the likely events of a project-change orders-instead
exacerbate the uncertainty and cost of the change order.
Larger entities are
especially enamored of extremely long complex contracts that were
created by large prestigious law firms often decades before and which
are declared to be “a form we cannot alter,” or the like and which they
feel give them tremendous protection due to the often onerous one sided
clauses contained in the contract. Overwhelmed by the pages and the cost
of attorney review, smaller companies often just sign the documents with
a sigh and hope things will go right with the project.
It is a matter of
some grim amusement to our office to note the shock that the larger
entities encounter when arbitrators or judges refuse to enforce clauses
that, while expensive to draft, perhaps, and long used, are simply
outrageously unfair. It is equally revealing to note how the smaller
entities, once they finally read the clauses or have them explained to
them by counsel, are both shocked and somewhat embarrassed that they
would have agreed to such remarkable provisions.
In reality, neither
party is served by truly unfair contracts though it may require tens if
not hundreds of thousands of dollars in attorneys fees to demonstrate
that to those unused to the real world of construction litigation.
Better by far to
create a contract that is realistic; is fair; and that both parties can
live with.
3. Know Your Contract and Its Change
Order Provisions.
First
rule:
read any contract provided to you and read it closely. Read the change
order procedures twice. You will undoubtedly need to use them.
Second
rule:
if you don’t understand a provision, get a lawyer to explain it to you
and perhaps suggest an alternative one. Yes, it will cost you some
money. It will cost you more if you find out what it really means after
you have relied on what you thought it might mean. A lawyer’s opinion
before a fight is like checking your oil before you drive your car into
the desert.
Third
rule:
Insist on fair change order provisions. We suggest criteria in the
section below. Insist on provisions that make sense and are not so
complex that no one will read much less comply with them.
Fourth
rule:
If your other party insists on an unfair provision, decide if you want
to do business with someone who is not only unfair, but begins with a
gun to your head.
Fifth
rule:
If you want a job or someone to work on your job so much you have to
agree to unfair provisions, begin your “defensive planning” as described
in that section below and treat the job differently than you would the
typical job. Remember: people insist upon unfair provisions for a
reason.
Sixth
Rule:
If a fight has begun and you did sign one of those unfair provisions, do
not give up but get good tough legal advice before you surrender. You
might have more power than you think by using the tools such as
mechanics liens and stop notices or claims on bonds or warranties which
utilize equitable principles not necessarily ruled by the contract
terms. Be sure to consult with an attorney who has been in those types
of fights before.
4. SUGGESTED CLAUSE CRITERIA: WHAT IS
FAIR?
Get in line with
realities on a job site concerning change orders. Most occur at the last
minute or in a tense situation. An efficient clause would be to provide
that written authorization for change orders will be required but in an
emergency situation the subcontractor can proceed with written authority
from the job foreman on site but only will be paid the reasonable value
of its services which are precisely defined by a fair formula inserted
into the contract. Any trier of fact is going to enforce that clause,
both sides know the formula, and the reality of the conditions of the
job site are not distorted by the wording of a contract which seeks to
impose unfair conditions on the parties. (Typical formula: cost of labor
and materials plus ten percent if not overtime and fifteen percent if
overtime.)
One would think such
a clause, which any good attorney would draft, would be in most
contracts. It is not. Instead, in a mistaken notion that more powerful
clauses which give tremendous advantage to an owner or developer will
somehow allow them to avoid fair payments, one sided contracts are the
norm in many forms used by the larger companies.
A fair system for
evaluating change orders allows not only fairness but predictability to
enter the relationships but that does not mean that the builder is
allowed to alter at will. It still must be provided in the contract that
change orders must be approved in writing and in advance. Change orders
without prior approval can not be allowed since it would allow the
contractor or sub to ignore the contract entirely and convert much of it
to a time and materials contract.
We have also found
that a useful provision is that there should be a provision that if the
parties cannot agree on a cost overrun for a change order (or reduction)
that the parties can either insert a formula in the contract or agree to
perform the change order at cost and have a “mini” arbitration on the
sole issue of the reasonable value of the change order which can be
accomplished without disruption to the rest of the job. The arbitrator
can be a mutually acceptable expert in the field, paid for at joint
expense, who will hear about the change order and render a written
opinion within ten days of that brief hearing. Meanwhile, all other work
on the project continues. If the parties cannot agree on the name of the
arbitrator, they simply utilize the expedited construction rules of the
American Arbitration Association to select one, using the same procedure
as above. Any good lawyer can write that provision and it is so
manifestly fair that one learns a great deal about any entity that would
reject it-namely that said entity may be a predator in construction, one
of those businesses that relies on hurting others to bolster its own
profits.
5. DEFENSIVE PLANNING: WHAT TO DO AFTER
SIGNING A BAD CLAUSE.
The protection
available depends on the actual clause you have agreed upon. Often
clauses actually do not give the builder or subcontractor the right to
refuse to perform a change order-there are clauses that allow change
orders that reduce the scope of the work (thereby effectively making it
a one way contract by which the contractor must perform but the owner
can effectively terminate or reduce the work at will without having to
pay damages to the contractor.) There are clauses which have a method of
payment by which the job can be accelerated without additional
compensation to the builder thereby effectively making the work not only
without profit but probably being accomplished at a loss. The dangers
are myriad.
Are there steps to
protect oneself in advance even before there is a dispute?
/1/ An initial step
is to truly review the clause, get a legal opinion as to what rights and
remedies remain, and make sure all employees on the job are given clear
written instructions as to procedures to undertake before agreeing to
perform any change orders.
/2/ The next step is
to make sure all records as to the job…including but not limited to
hours worked, materials installed, overtime, impact and acceleration,
etc. are kept in pristine condition since if one seeks equitable
remedies outside of the scope of the contract, proof of actual hours,
materials and overtime will be critical.
/3/ The third step
is to monitor the job and its progress on a continuing constant basis.
The lack of good protection in the contract necessarily requires far
more active and effective protection in supervision of work and progress
of your trade…and all the other trades.
/4/ The fourth step
is to build an excellent written record of all requests, alterations in
specifications, problems with other trades, delays, etc. so that it can
be demonstrated conclusively what is requested and what problems have
occurred. Remember, written evidence is always best. In a conflict of
verbal evidence, one never knows who the trier of fact will believe.
/5/ Assuming a
change order is requested, it is absolutely vital to go into high gear
in proactive protection. Immediately obtain legal advice to walk you
through the process. Know precisely what are your rights and
liabilities. Commence effective written communication with the
other parties (with review by your own legal counsel ahead of time) so
that a record is kept and there can be no later question of who said
what to whom. Do not rely on your “buddy” foreman on the job site to
protect you if the home office seeks to turn on you after you have done
the change order…it may be his job on the line and you will probably
find you are expendable. (So many of our clients come to us sadly
stating words to the effect that “Joe said he would protect us, not to
worry and now he won’t even return our calls.”)
/6/ And if things
begin to go wrong, immediately get advice on what remedies are available
since most equitable remedies in construction projects have rigid and
critical time limits.
6. CONCLUDING THOUGHTS
What every lawyer
would like, of course, is for a perfect clause to be already executed by
the client before the client comes into the office with an existing
problem. In an ideal world this would certainly happen. In reality, we
normally encounter clients already in trouble with clauses of dubious
value.
If you are still
negotiating a contract, concentrate on the change order provisions and
get them right. If you have already executed a poorly drafted clause,
take the proactive steps above and be ready to enforce the rights you
still have left…and next time around, fight for a better clause in your
contract.
What makes
construction an interesting and rewarding field is that something of
value is created or improved by a large group of people working,
hopefully, in concert. Such efforts necessarily require continuous and
active cooperation and inevitably such cooperation will at times cease
to exist.
The role of
contracts is to regularize and make predictable what occurs when other
types of cooperation break down. Given the frequency of such
“breakdowns” with change orders, the professional in construction or the
owner of a project will understand the need to create excellent clauses
that are fair and predictable…and to make advance plans as to what to do
if such clauses are, for one reason or another, not in effect during the
progress of a project.
Change orders will happen and many of them will cause problems. As the
Boy Scouts motto goes: “Be Prepared.”
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