Important change order basics — Part I

Few construction projects are completed as planned. Unanticipated problems can and often do arise, like differing site conditions, an incomplete design, or a dwindling budget. This means even the simplest construction project can require scope of work changes to account for these inevitable contingencies. Typically this is accomplished through the change order process, which allows a project owner to unilaterally alter the contractor's scope of work without invalidating the contract. But while change orders may be essential to accommodate the complexities of construction, they seem to generate a large percentage of contract disputes.

There is no law that says that there has to be change orders. Unless they specifically allow the owner to make changes, all construction contracts are changeless contracts. If a contract says "I will pay you X amount of money to do Y scope of work, the contractor can’t be forced to do any more (or be entitled to do less) work than Y, and the owner can’t be forced to pay more (or be entitled to pay less) than X. And if a general contractor does not make a similar agreement with a subcontractor, it can’t force the sub to agree to a change either. Without a changes clause, there can only be a change if both sides agree. This gives a contractor lot of leverage. It could refuse to make the change unless it was paid what it demanded.

Experience tells us that most construction contracts do have changes clauses. This is great for the owner, but contractors don’t want to do work that they won’t be promptly paid for. So the wise contractor will know what steps he or she can take to improve collections on change orders? Some obvious ones are:

• Make sure that you give notice that you consider something to be a “change.” Read your contract. It probably requires that you notify your customer if you think that something is a change, even a no-cost change. If you don’t give this notice, you may never be able to collect a dime. Often, if the owner understands that something is extra, and how much more money and time it will take, he will change his mind about the change entirely.

• Demand a written order to do the change. There is often pressure on the contractor to “just do it” with the assurance that “we’ll work it out later.” Who wants to tell a customer that you don’t believe him and need it in writing from his boss? Yet, that’s what the contract probably says. And you can expect that most courts and arbitrators will enforce this clause. So if you want to get paid, make the owner follow the contract.

• Negotiate contract terms for prompt payment for changes. Contractors aren’t bankers, but they can end up financing a lot of extra work. It is now common for clauses to provide that only the disputed portion of a change can be held back, and even as to the disputed part, the owner is required to front half the estimated cost of the extra work until it can be finalized. Such provisions reduce the risk that the contractor will have to finance the extra work.

• Negotiate contract terms that allow you to verify that the customer has the money to pay for the change. While most owners borrow enough to cover their contract cost, they may not have borrowed enough to cover extras. A contract term that allows a contractor to ask for confirmation from the lender that there are sufficient funds to cover the extra work is no longer unusual. These days banks are more likely than ever to insist that they know about changes and approve them, to protect their investments.

• Take the time impact of a change into account. Contractors who do not think to ask for time extensions as part of changes could end up paying liquidated damages that they don’t owe. Extra time also frequently generates additional field overhead – temporary utilities, storage trailers, insurance, etc. So make sure you account for these less direct costs in the change order. Also, consider reserving the right to evaluate, and possible assert a claim for, the cumulative effect of multiple change orders, often this can't be determined at the time a single change order is signed.

• Make sure all trades are consulted about the impact of a change. Just because the change is to re-route ductwork doesn’t mean that an electrician, plumber, sprinkler or other sub won’t also be affected.

• Reserve lien rights for unresolved changes. Many lien waivers are drafted to give up lien rights for all work as of a certain date. If work has been done on changes, but not yet paid for, signing such a lien waiver could be giving up rights. Make sure that you tailor the lien waiver form to accurately reflect what should or shouldn’t be covered.

• Fully document specific costs of the change. The moment work is to start on a change, the contractor should assign a separate number to that work and record all expenses to that number. A lot of money is lost by contractors who months (or years) later can’t prove how much extra work actually cost.

• Know your state’s prompt-pay law. Most state prompt-pay laws don’t deal with the subject of changes specifically, and admittedly it is a grey area. However, it may be that by tightening up your contract terms, your record-keeping and billing procedures, you can fall within provisions that give you attorney’s fees and steep interest if you have to collect. This alone often prompts an owner to pay up quickly.

• Watch out for unauthorized change orders. Make sure the person ordering the change order is authorized to do so under the contract. You don’t want to get into a situation where you are directed to perform additional work, but the person directing the additional work wasn't authorized to sign the change order. This is more common on public projects, and can lead to harsh results if the contractor does the work but it turns out that the person ordering the change wasn't authorized under the contract.

The bottom line: read your contract carefully and keep these tips in mind. With a little luck, you'll avoid the more common change order disputes.

Michael Callahan is a partner at Stinson Morrison Hecker LLP (the same firm as long-time columnist Susan McGreevy) where he assists clients with all aspects of their construction law needs, including litigation.

TAGS: Management
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