The Significance of Change Order Clauses in Construction Agreements

A Guide to Change Order Clauses

A change order clause is a common provision in construction contracts that lays out the contractual framework for modifying the scope of a construction project. Change orders range from minor modifications of the plans and specifications to significant alterations in the project such as redesigns, adding scope, or reductions in scope and can impact all phases and elements of a construction project.
A change order clause is often part of a written order or direction that incorporates the contractual terms and conditions between the owner and the contractor regarding changes in the work, any compensation attributable to such changes, and an adjustment to the contract time . Because of the importance of time, it is critical that the impact of the change in the work on completion schedules are properly taken into account. The change order clause becomes essential as it provides contractual authority for the owner and the contractor to negotiate time extensions, evaluation of the cost of the change, price adjustments and compensation, new work, deleted work items, and advance payment for future work.
The negotiation process of a change order clause is framed by the provisions of the contract, precluding the ability to negotiate, or alter, the change order clause after a dispute arises.

The Necessity of Change Order Clauses

Often considered a standard clause in construction contracts, the change order clause draws attention when external factors lead to inside changes. A change order is a written agreement that establishes a contract modification. Such a modification can range from partial changes or amendments to extensions of time or reasons for increased costs. To be valid, it must be established prior to the changes taking place. Understanding the implications of the clause and how it functions is vital.
A well-drafted change order clause generally confirms that, in the rare event of a change, the work may only proceed after a signed authorization indicating such. Though the change order clause does not create a right to extra compensation, it establishes the grounds under which a contractor may receive payment for alterations, extensions and extra work. The existence of such a provision also introduces the possibility of concurrent delays and offsets which can impact and shift responsibility for performance back to the owner.
Often, as clients (owners) realize the many benefits provided by a change order clause, they hope its absence from the contract will allow them to forego payments to contractors (or to recover certain payments). However, both parties benefit when they agree the change order clause is an integral part of their relationship. Such a clause:
When the clause is negotiated, it typically will be determined whether quantity of changes will affect the cost increase or decrease. The price and delays recognized for these modifications may then be capped. Further, a time frame in which the owner has to object or agree to the changes and fees should be established. As more amendments to the contract take place, owners and contractors continue to benefit because all payments and agreements are tracked and recorded.
It is no secret that the construction industry is susceptible to delays in scheduling, confidentiality and general cooperation between contractors and owners. However, all parties involved in construction projects are required to cooperate and work together. The change order clause encourages this collaboration by providing clear guidelines and established processes. When properly understood and executed, it allows those involved to meet obligations under the contract without incurring additional liability.

The Common Components of a Change Order Clause

While individual change order clauses vary in scope and structure, most share some common elements, outlined below:
Description of Changes: A change order clause will describe the types of changes that may be ordered. Subject to any limitations (discussed below), an order for a change in the Work may include additions, deletions, and other modifications to the work.
Cost Implications: The change order clause may specify that the Owner is to make adjustments in the contract price based upon a change in the Work. Such a provision may, in fact, eliminate claims for changes in the Work that do not cause cost impacts. A change order clause should identify how cost adjustments will be calculated. For example, some change order clauses provide for price adjustments when there is a change in the work resulting from an error in the drawings or specifications. However, in the event the cost of a change order is to be based upon unit prices, then the change order clause should specify the applicable units and prices. Additionally, many standard contract forms provide that the scope of "additional and changed work will be determined by mutual agreement between the Contractor and the Owner … and the Developer."
Time Implications: A change order clause will likely characterize a change as either a "Claim" or a "Construction Change Directive." A "Claim" allows the Extensions of Time provided in the Contract Documents to apply to delays resulting from a change to the Work. In contrast, a "Construction Change Directive" can require the contractor to perform additional or differing work pending final determination of an adjustment in contract price or contract time. A change order clause should provide that a "Claim" must be made within a set period of time following the event giving rise to the Claim, whereas a "Construction Change Directive" may provide for an agreed-upon time period for performance.
Approval Process: The change order clause of certain standard forms may also require acceptance of a change in the Work to be conditioned on approval by the Owner’s governing board or other applicable agency. A change order clause may also provide that the change order must be accepted by the contractor or subcontractor when the change results in a reduction of the scope of the work.

The Procedures Behind Change Orders

Change order procedures are well know and, unfortunately, necessary evils in most construction contracts. A change order is a written agreement between the owner, and the general contractor, entered into to modify the original contract for the performance of work or the supply of materials. The order must be in writing, and include, at minimum, provisions as to the cost of the modification and the time frame for completing the modified work.
The procedure for executing a change order can be found in every construction contract. It is generally agreed to early in the process, and stuck to (as often as possible) throughout the term of the contract. Change orders effects the contractual obligations of all of the parties to the contract, including the owner, general contractor, and subcontractors. Generally speaking, there are three steps to a change order. First, the general contractor submits a claim form or Request for Change Order that details what the costs of the change order will be and the reasons why it is necessary. Second, the owner reviews and approves the change order. Third, the change order is implemented. Because in many instances the change order affects more than just the work scope of the general contractor, change orders must be reviewed by and obtained from each subcontractor.
Contractor may not unilaterally implement the change ordered without the required documentation. When a party executes a change order that has not been previously approved, it run the risk of losing out on a claim for additional compensation related to that work. Further, is does not accept the changes outlined in a change order, and continues to perform the work as originally set forth in the contract, the contractor may become legally bound to that work scope.
In sum, make sure that a change order is strictly complied with. And, take the necessary steps to ensure that the change order is implemented, approved, and documented pursuant to the contract.

The Legal Effects of Change Orders

It was a Tuesday when A Contractor stopped by to see me for a consultation about a project that was going badly. The homeowner had retained B Construction to build the new home. The contract between the construction manager and B Construction required that all change orders be approved by the homeowners in writing and then signed by both A Contractor as the CM and B Construction before any changes (extra work) are undertaken. Indeed, this was the very clause in the contract that A Contractor had suggested, negotiated for, and written into the contract, but which allowed the homeowners to simply refuse to sign a change order if they did not want to pay more money or had simply changed their minds. In short, change orders were not mandatory, but were left to the unilateral discretion of the homeowners who, as is often the case though not always, were not aware of how much was actually due for extras. In fact, their refusal to sign a change order would cause the extra work to not go forward because A Contractor had no authority to contract with B Construction for the extras, and B Construction had no business doing work without an agreement from A Contractor that it would be paid for. A Contractor’s angry phone call on this Tuesday was precipitated by the fact that B Construction had done several hundred dollars worth of extras without approval. A Contractor was confronted by the homeowner a short time later and was told he could either have the extras taken out and the situation returned to the original plan as if the extras had never been done, or A Contractor could have an authorized change order signed and get paid the money owed for the extras. A Contractor and B Construction enjoyed a friendly and quite possibly exclusive working relationship, and A Contractor was eager to protect it. He called B Construction and told them the extra work had to be undone. B Construction told him to take it up with the homeowner, after all , it was in the contract they signed that A Contractor would have to get approval from the homeowner before extra work could be paid. When A Contractor explained the situation further, B Construction still refused to do more work until the changed order was signed. For one family, the contract and the clauses and terms it contained became the center of a lawsuit not handled by this firm. The bottom line is that the homeowner had no legal obligation to pay for changes made without an executed change order because the contract between the CM and the builder required it to be signed before payment would be made. B Construction had been ordered to comply with the contract and the BMP, but did not, and it could have had to pay for damages into the millions of dollars had the case gone to trial. It seems clear that this provision in the contract left both A Contractor and B Construction exposed to liability in the event that B failed to comply with the BMP. Under these circumstances B Construction could be held responsible for the administrative error of not getting the change order signed since the language of the contract required the CM to have the signature of the homeowner on the change order before it could be binding, and B Construction had no right to assume that A Contractor knew he had the homeowners approval, nor should it have proceeded with the work based solely on A Contractors assurance. Thereafter, without the change order, the homeowner had a legal right to order the extra work undone. Then the legal headaches would have multiplied. Disputes would have arisen over the proper measure of damages for the unsatisfactory work. For example, it may have been better to have the extrawork or some portion of it done over rather than ripped out when it was part of the main foundation for the home, or when it was otherwise satisfactory or less expensive to finish. Change orders must be handled carefully and according to the BMP and to the stipulations in contracts.

Effective Methods for Dealing with Change Orders

Prior to contract signing, all parties should clearly understand all of the contract’s change order clauses. Once you’re familiar with how the process should work, follow these tips to reduce the chances of having any disputes over change orders as the project progresses:
Be Specific. Draft the contract with the most specific change order procedure possible. Identify the types of changes that will be eligible for compensation under the change order clause and limit the types of changes that can trigger a price adjustment or schedule extension. For example, establish specific types of "material changes," define "error or ambiguity," and be sure to require proof the change was out of the contractor’s control.
Require Timely Notice. Consistent with best practices, the contract should require the contractor to provide prompt written notice of any event that may justify application of the change order clause. Although many contractors believe they have the right to pursue a change order after the work is complete, failure to give proper notice in a timely fashion will typically result in a waiver of the contractor’s ability to pursue the claim. The contractor should give notice as soon as they suspect the work will be impacted or the price will be affected, before the work is performed so the owner can evaluate whether it really "wants" the change and if it’s worth the expense.
Calculate Costs. Although back charge provisions are often included in the contract, rather than leaving the schedule of values column blank at the time of contract signing, the contractor should identify line items and note the amount of each. The owner should fully understand the schedule of values prior to building them into the contract so there aren’t questions later. Because it’s impossible to know the cost of work that hasn’t been performed yet, most contracts require a cost estimate with the change order request. The contractor should handle pricing like a lawyer – adding only what is necessary and nothing more. They should also consider contingencies when estimating costs. If the contract doesn’t require contingencies – meaning the work is expected to remain within budget – there is no reason to ask for margin on a change order request. Without contingencies, owners are more likely to approve the change order request.
Negotiate. Once the change order request is submitted, the contractor should sit down with the owner to discuss the matter and be receptive to feedback. Negotiation requires broad thinking and creativity, so try to consider the other side’s position before reaching a compromise.

The Art of Negotiating Change Order Terms

An alternative to the "change order" process is to remove it from your contracts. You could replace it with a "differing site conditions" or "changed conditions" clause. That clause would provide for adjustments in the contract price and/or the time of completion in the event that conditions differing materially from those indicated in the contract documents are encountered. This can be a significant benefit on projects that encounter unforeseen conditions, as it will offer you and/or your subcontractors the opportunity to negotiate price adjustments based on the additional work required to address extra work conditions.
Among the most common contract terms that tend to hinder proper increase in costs (for changed conditions) are those that state you "shall look only to the line item bid amounts set forth in your bid" when attempting to recover for any items related to change orders, extra work, or differing site conditions. The intent of such a clause is to require that you/ subcontractors exhaust the value of the line item price without receiving compensation for such overruns at the actual cost of the work, or as to the original bid price. This clause results in you making little-to-no profit on these items after the project is complete. The standard contract terms will typically require that you seek additional compensation after having exhausted either the contract sum or that line item before you can seek to be reimbursed at your actual cost of performing the work (potentially leaving you without hope of recourse on the majority of the contract). Instead, a more equitable provision would require that you be paid the actual cost of performing the work, as added to either the contract sum, or the overrun of that line item. If you can add to the contract sum (if you haven’t hit your cap), you should. If not, the maximum amount of the line item overrun should be taken and used to recompense you for the actual cost of performing the work.
It is important to have the right counsel to review the provisions of your contract and to strategize a plan of negotiation with the contracting/trade partners on the project.

Pitfalls and Solutions on Change Order Clauses

Multiple issues may arise when reviewing a contract’s change order clause: there may be no threshold amount for a change request; it may require the parties to negotiate "reasonably acceptable" terms; or it may leave undefined the scope of work needed to schedule and price the change order.
A broad change order clause invites numerous disputes over many contracts. A change order clause should include a minimum threshold of cost (both construction change and time) for any change request. A threshold amount – usually a specific dollar amount or percentage of the overall contract – will deter contractors from submitting small change requests because they will not be compensated for the time and effort expended in creating the documentation. Further, the threshold ensures that many minor contract changes do not require contractor and owner review or consideration… Often it is these smaller scopes of work which are most frequent. The same reasoning applies to the scheduling issues and added cost required by minor changes. Moreover, many homeowner contracts provide for changes without requiring that the change be in writing (this is prohibited under Virginia Law), and this provision could be used against the owner because the contractor will use an oral change order to establish a claim for compensation. Therefore , the language in Paragraph 12 above is required and must be adhered to in order for the owner to avoid an increased construction cost when the contractor attempts to submit informal, oral change order claims for small changes to the Scope and Schedule.
All written contract change orders define the scope of work to be added to, deleted from, or modified in the existing contract. Changes to the schedule caused by the change order are also required to be defined. But most changes do not have a standard of care by which the change order can be measured and priced. However, there is always some amount of construction cost savings to be achieved through increased competition between subcontractors and suppliers for each change order. This price competition is what drives the cost of a change order down. So even on those occasions when the cost of a change order must be negotiated, the final negotiated price should be reasonable because of the inherent competition between subcontractors and suppliers. Additionally, the Contracting Owner can engage in proper oversight of the work being performed by the Contractor and can require a scope and quantity breakdown on all change orders submitted for approval.