In other articles on this website the basic law and practical aspects of anticipating change orders have been discussed in detail. The reason for such emphasis on change orders is that disputes concerning change orders form the single largest area of litigation or arbitration in the construction field.
Many contracts, including those created by our office, provide stringent requirements for creating change orders and enforcing them and these clauses are of vital import to the professional or owner in a construction project. One client quipped that the average construction contract was a discussion of change order procedure with some other clauses thrown in.
But the concentration on change order terms in a contract often creates false expectations on the part of both owners and builders. In reality, most triers of fact, whether in arbitration or in court, will normally seek to find some way that someone who accomplishes work is paid a fair amount and the clauses in a contract that act to forfeit such fair compensation if no writing occurs are somehow seldom enforced by most courts and arbitrators.
More in construction than in most fields, the concept of “equity,” e.g. “fair payment for labor” will be applied and this writer cannot count the number of times that very tough clauses in contracts that specifically prohibited any payment for any change order are reinterpreted by the judge to somehow allow payment.
Most often, the Court will conclude that some action or inaction by the owner or general contractor misled the claimant thus payment should be made. Other times the Court will interpret the clause as only applying in very narrow circumstances.
Thus it is vital for the professional on the construction job to more fully understand how equity will enforce change orders regardless of contract wording.
This article will discuss:
(1) deductive changes,
(2) changes as a breach of contract,
(3) the requirement for written change orders,
(4) verbal change orders,
(5) whether a contractor is required to sign change
(6) the battle between waiver of rights and
reservation of rights on written change orders.
This article will rely primarily on federal law because federal procurement law has an extremely detailed and comprehensive changes mechanism and because almost all issues relating to changes have arisen and been decided under federal procurement law. Some California law also will be used. Readers should be cautious that the issues might be decided differently in different states.
The reader is advised to first read the article on Contracts before proceeding further with this article.
A survey of how these issues have been decided by individual states is beyond the scope of this article.
When most people think of changes, they think of the owner adding something to the contract or modifying some contract requirement. Changes also can be used to deduct work from a contract. Two primary issues arise when an owner decides to deduct work from a contract:
(1) Should the deduction be accomplished by a change
order or by a partial termination and
(2) how is the deduction priced?
1. Change Order or Partial Termination?
Some contracts contain a termination for convenience clause that allows the owner to terminate a portion of the work for convenience. If such clause exists alongside a typical changes clause, an owner that wants to delete work must decide whether to use a deductive change order or a partial termination for convenience. No standards or prerequisites exist for choosing one method over the other, but two broad considerations can assist in making the choice.
The first consideration is whether the deletion is major or minor. If the deletion is major, it probably should be accomplished by a partial termination for convenience. If the deletion is minor, it probably should be accomplished by a change order. (J. W. Bateson Co. v. United States, 308 F.2d 510 (5th Cir. 1962)).
The second consideration is whether other work will be substituted for the deleted work. If it will be, a change order accomplishing both the deletion of the original work and the addition of the substitute work probably would be the most appropriate mechanism. If work is to be deleted only and no other work is to be added as a substitute, a partial termination for convenience would probably be the most appropriate mechanism. (Frederick Construction Co., ASBCA Nos. 12108, 12241, 68-1 BCA 6832; Manis Drilling, IBCA No. 2658, 93-3 BCA 25, 931).
This last consideration is more in the nature of a traditional change, and probably should not even be considered as a "deletion" of work.
2. Pricing A Deductive Change
Two primary methods exist for pricing the value of deleted work. The simplest method is where the deleted work is a separate contract line item. In that situation, the line item and the line item price are simply deleted. The price of the deletion is the line item price. (See Eugene Lovine, Inc., PSBCA 2867, 92-2 BCA 25, 013).
Although simple, that method can be contentious if the contractor has loaded overhead or other indirect costs into that contract line item price. The contractor may have anticipated that the work would be performed and paid early or perhaps expected the quantity of work under that line item to increase significantly. Unfortunately for the contractor, if a line item price or separate price exists for the deleted work, that price is the proper price to be used for calculating the value of the deleted work. (See Oneida Constr., Inc./David Boland, Inc., Joint Venture, ASBCA 47914, 95-1 BCAN 27, 363).
The more difficult method for pricing deleted work is where no separate contract line item price exists for the deleted work and instead the deleted work is an unseverable and integral part of the overall project. Examples might include a deletion that would reduce the height of a wall, eliminate a coat of paint, or decrease the depth of paving. In such a situation, the price for the deletion is the actual cost saved by the contractor or conversely, the cost of the deleted work that will not be performed. The difficulty is in determining the actual cost, with the owner and the contractor having significantly different opinions about the actual cost saved by the deletion.
If a dispute arises about the actual cost of deleted work, an owner many times will want to see the amount that the contractor had in its bid for performing the deleted work and, for any number of reasons, the contractor will be extremely reluctant to allow the owner to see its bid documents. To resolve such an impasse, many contracts now require that the documents generated by the contractor in the process of preparing its bid be placed in escrow and be available through escrow when a dispute arises about the price that a contractor included in its bid for a particular item of work.
3. A Word of Caution to Owners About Deleting Work
California, New York, and some other states have an equitable policy leading to cases that often do not allow an owner to delete work and then have that work performed later by another contractor. If an owner does, the original contractor is entitled to recover its profit on the deleted work. (See Hensler v. City of Los Angeles (1954), 124 Cal. App.2d71, 268 F.2d12). In those states, if a private or public owner deletes work, the deletion has to be for the benefit of the project, that is, the owner has decided that it prefers the project without the deleted work. The owner cannot delete the work because it wants another contractor to perform the deleted work or it has encountered some difficulty that may make the deleted work more expensive and would prefer to have the deleted work performed at a later date when the difficulty is resolved. If it does, it may be liable to the contractor for the profit the contractor would have made on the deleted work. (Id.)
CHANGES AS A BREACH OF CONTRACT:
Other articles on this website about change orders described an owner-directed change for work outside of the contract as a breach of contract, which in federal terminology is a "cardinal change." The basic test for a cardinal change is whether it was within the contemplation of the parties when they entered into the contact and whether the job as modified as still the same basic job.
In addition to one significant change that might fit the definition of a cardinal change, a quantity of changes so large that the quantity was not within the contemplation of the parties when they entered into the contract also could cumulatively constitute a cardinal change. (See Saddler v. United States, 152 CT. CL. 557 1961); C. Norman Peterson Co. v. Container Corp. of America, 172 Cal. App.3d 678 (1985)). Even with a large quantity of changes, that large quantity by itself may not be sufficient to constitute a cardinal change. In determining whether a cardinal change occurred, not just the quantity of changes must be considered but also their nature and the impact that they had on the over all project. (Id.)
THE REQUIREMENT FOR WRITTEN CHANGE ORDERS:
Almost all construction contracts (certainly all that are professionally written) require that change orders be in writing. A contractor that ignores that requirement does so at its peril but paradoxically, an owner that refuses to pay a contractor for a change solely because no written change order was issued also does so at its peril.
A contractor that ignores a written change order requirement may find itself before a judge or arbitrator that believes in the strict enforcement of contract requirements, especially if the contract is a public contract with a state or local public agency. Such judges and arbitrators are sometimes not swayed by pleas that it is unfair and inequitable to have the contractor perform work and invest its time and money at the public agency's direction and not be paid for the benefit it bestowed upon the public entity simply because the formal prerequisite of a written change order was not satisfied. Those judges and arbitrators feel it is just as unfair and inequitable for the contractor to receive public money without fully complying with the requirements to receive that money.
Conversely, an owner that refuses to pay for changed work solely because no written change order was issued may find itself before a judge or arbitrator that feels it is unfair and inequitable to deny payment to a contractor solely because the owner failed in its duty to issue a change order for work it directed the contractor to perform.
The safest course for both the owner and the contractor is to comply with all contract requirements for written change orders. The owner can comply simply by issuing the specified written change order. If an owner fails to issue the specified written change order, the contractor should send repeated written requests for the change order and provide notices to the owner that contain all of the elements necessary for the owner to issue a written change order.
This office often hears from contractors who, under pressure from irate owners or general contractors, hurriedly complete change orders with the promise that they will get a written change order in the next few days but “begin now.” Of course the written change order either does not arrive or is significantly different than what the subcontractor would have agreed to either in pricing or in scope, and the fight begins. IT TAKES FIVE MINUTES TO WRITE DOWN WHAT THE CHANGE ORDER IS TO BE. IF A CALL TO THE HOME OFFICE IS NEEDED, THAT ALSO SHOULD NOT TAKE MORE THAN AN HOUR. IF THE PERSON REQUIRING THE CHANGE ORDER WILL NOT PUT IT IN WRITING THE SUBCONTRACTOR SHOULD WONDER WHY THAT PERSON HAS SO LITTLE FAITH IN HIS OWN INSTRUCTIONS THAT HE WILL NOT REDUCE THEM TO WRITING. BE WARNED.
VERBAL CHANGE ORDERS:
Verbal change orders or changes directed verbally can be an extremely vexing problem for both owners and contractors, especially on state and local public projects where adherence to contract administrative requirements is more strictly enforced and where issues of authority of representatives of the public owner are more pronounced. Three primary issues arise with verbal changes:
(1) Did the person that verbally directed the change have the authority to issue a change,
(2) was a verbal change actually directed, and
(3) what were the exact requirements of the verbal change?
Federal contracts specifically anticipate the situation where the federal government makes a change through some method other than a written change order. Most federal contracts contain a constructive changesclause that define a constructive change as: "Any written or oral...direction, instruction, interpretation, or determination [other than an actual change order] . . . that causes a change . . . [provided the contractor gives notice] that the contractor regards the order as a change order." (FAR 52.243-4(b) (1987)).
Although this type of constructive changes clause is rarely found outside federal contracts, the procedure specified by that clause is a good procedure for any contractor faced with verbal changes or other actions by the owner or one of its representatives that constitute changes to the contract.
Under that procedure, the contractor should promptly give notice stating the date, circumstances, and source of the verbal order and that the contractor regards the order as a change. If possible, the contractor if possible should include in the notice an estimate as precise as possible of the time and cost impact of the verbal change.
One old contractor, in the midst of the typical verbal change order dispute, leaned over and whispered to the writer, “It’s simple: most oral change orders are worth the paper they are written on.”
Not always true: we can enforce them quite often. But why take the chance and why risk the loss, the attorney’s fees and the time lost in arbitration or litigation? Put it in writing and you safeguard your profit. Keep it verbal and the job foreman may be happy: but the risk is high.
WHETHER A CONTRACTOR IS REQUIRED TO SIGN CHANGE ORDERS:
This is more of a practical issue than a legal issue. When representing an owner, we normally recommend that owners should never require the signature of the contractor as a prerequisite to the effectiveness of a change order. Such a requirement gives the contractor control of the change order process and the veto power over changes.
The owner wants the sole and exclusive right to make changes to its project. It does not want to grant a contractor a veto right over those changes. In its construction contracts, an owner should always include the requirement that all changes be in writing, but it should never require the contractor's signature as a prerequisite to the effectiveness of the change order.
The change order should be effective upon signature by the owner and delivery to the contractor. The contract should allow the contractor to sign the change order if it agrees with its terms, especially the terms about time and money, and the contract should specify the exact effect of the change order once signed by the contractor. However, the owner should never give the right to the contractor to hold the entire change process hostage by requiring the contractor's signature to make a change order effective.
If you are a builder, instead, of course you do not want to be at the mercy of any whim of the owner to increase…or decrease your scope of work. Recall that the doctrines of impact and acceleration apply to increases in work and can radically affect your ability to perform and profitability. (Impact and acceleration is the full range of effect on a job when the schedule or scope is altered and your entire staff must alter what may have been a carefully planned project. As overtime increases and each worker performs longer hours, the efficiency decreases markedly, errors increase, and time schedules can collapse.
The battle in the contract formation stage as to change orders often involves the question of overtime, impact and acceleration and accounts for the bulk of the truly large litigations. Good legal counsel and expert advice as to impact and acceleration is vital to avoid executing a contract that is inherently dangerous to the builder.
THE BATTLE BETWEEN WAIVER OF RIGHTS AND RESERVATION OF RIGHTS ON WRITTEN CHANGE ORDERS:
Owners and contractors often have diametrically opposing views about whether a contractor's right to impact costs should be waived or should be reserved on written change orders. Owners commonly prepare change orders that contain an express waiver of a contractor's rights to any additional costs or time other than what is allowed in the change order. Those waivers usually require the contractor to waive its rights to any additional delays or extensions of time and any costs for jobsite overhead, home office overhead, loss of productivity, or any other type of indirect cost or impact cost.
A contractor is well advised not to sign a change order with such a broad waiver of its rights unless it is absolutely positive that the change order, in conjunction with other change orders and other events on the project, will not under any circumstances cause additional delays or generate any additional costs.
Despite sophisticated scheduling and cost accounting techniques now available, contractors cannot always with certainty predict the effect that a change order may have on the project schedule or the project cost at the time the change order is issued.
Contractors usually want the opposite. They want a broad reservation of rights to later claim additional time or additional costs of any type resulting from the change order. Owners are reluctant to allow contractors such a broad reservation of rights because they do not want the change order payment to be nothing more than a down payment on an endless series of requests for additional costs and time resulting directly or indirectly from that change order. In return for the payment, the owners want the contractor to analyze the changed work and tell the owner whether that work effects the project schedule or project cost.
Owners routinely reject change orders onto which contractors have inserted a reservation of rights just as contractors routinely refuse to sign change orders onto which owners have inserted a waiver of rights.
Many contractors recognize that an owner has a legitimate concern about managing the time and cost of the project and has a legitimate right to ask the contractor to inform it of the cost and time impact of a change order. At the same time, many owners understand that a contractor might not be able to analyze and predict the exact impact that a change order may have on the project without knowing what subsequent change orders and events may impact the project, its cost, and its critical path.
THE BEST COMPROMISE:
Many owners and contractors recognize that a reasonable compromise is to allow the contractor a reasonable period of time after the change order is signed to analyze and predict its cost and time impact and then inform the owner. That period will vary with the type and magnitude of the project but it could range anywhere from one month to six months. If the contractor does not inform the owner within the designated period of the cost and time impact of the change order, the contractor waives its rights to any additional time or cost resulting from that change order.
Owners can also use scheduling requirements to force contractors to analyze and identify the cost and time impact of change orders. Many contracts contain scheduling requirements in which the contractor is required each month in monthly schedule updates to graphically depict on the updated schedule the impact of any changes issued in the preceding month and to describe any delays and costs associated with those delays in a monthly schedule narrative.
The owner's right to make changes and the procedure for making those changes are a product of the contract between the owner and the contractor. Both the owner and the contractor should carefully read and fully understand the owner's right to make changes and the procedure for making those changes, and both should strictly adhere to the specified procedure.
In addition to understanding the specified contractual process for change orders, owners and contractors should understand the definition of a change, actual changes, constructive changes, cardinal changes, deductive changes, changes as a breach of contract, written change order requirements, verbal change orders, a requirement for the contractor to sign change orders, and the battle between a waiver of rights and reservation of rights.
Even if both the owner and the contractor develop a full understanding of the contractually specified change order process, adhere to that process, and understand the various issues relating to changes, disputes about changes and change orders still will be inevitable, but the number and magnitude of the disputes will be reduced.
The principles of “equity” or “fairness” apply in most construction disputes and in any arbitration involving construction or the enforcement of mechanics liens. This necessarily means that if either party, relying on an unfair contract term, tries to enforce an inherently unfair term, there is a chance the trier of fact, be it judge or arbitrator, will find some way to “do what is right.” Reasonable contractual terms should be the goal of the parties in construction, but they must be terms carefully crafted, fully understood, and clearly explained to each interested party.