Webinar: Change Orders 101

Projects don’t always go the way they’re planned. More work or materials may be needed than anticipated, mistakes might need to be repaired, or a shift in overall vision may come mid-project. How is payment affected if these aren’t covered by the original contract?

This webinar will give you a deep dive on Change Orders. You’ll learn why unexpected costs happen, fundamentals of Change Orders, and how Change Orders affect current work.

This webinar is co-led by Peter Lindborg, Attorney & Co-Founder of Lindborg & Mazor LLP, and Seth Bloom, Senior Director of Attorney Services at Levelset.

Full Transcript

Seth: All right. Good afternoon or good morning depending on where you are in the country. My name is Seth Bloom and I’m a Senior Director of Attorney Services here at Levelset. I’m broadcasting from New Orleans. What we do is and what I’m doing specifically is I’m building out the Expert Center. This is a national network of construction lawyers. It’s a community to help people in the industry get resources and get the legal advice that they need from lawyers that are specifically in this industry and near them. Today, without further ado, I know we have a big program, Peter Lindborg, who’s from Glendale, California and the law firm of Lindborg and Mazor [inaudible 00:00:48] dealing construction issues. Today’s going to talk about change orders and he’s located in California. So, there’ll be somewhat California specifics. So Peter, without further delay, I will turn it over to you and thank you for hosting this webinar today for us.

Peter: And thank you Seth, very much. And hello to everybody out there as as Seth said, we have a firm here, right outside of downtown Los Angeles where we focus on construction industry clients. And that’s everybody from suppliers all the way up the food chain to owners and everybody in between. Seth has asked me today to focus on the topic of change orders and we’re going to cover three particular topics. Number one, why change orders are necessary? Number two, fundamentals of the change order documents, and number three, how change orders affect current or if you will basic contract work. Turning to the first topic, why are change orders necessary? The answer to that is known, I think by everybody in the construction business, which is one certainty exists on a construction project during the process, external events will require that the contractor’s work be changed in one respect or another, or as every aspiring architect learns on the very first day of school, no design is ever perfect and if you don’t believe it, just ask them.

Peter: So, let’s take a look at the different types of causes of changes if you will. The first one is easy. Most contracts permit in something cleverly called the changes clause, the owner to unilaterally change the scope of work that is add, delete or modify without invalidating the contract. And on top of that most changes clauses contained administrative procedures, where they define how the contractor can or may be reimbursed for added costs. And those can be unit prices which are already set forth in the contract, a lump sum or forward priced if you will, estimate of the cost of the change or the other alternative is often just the time and materials plus the markup. In other words, the contractor is getting paid the cost of the labor, the cost of the materials plus a markup of usually a 15% to compensate him, her or it for the change.

Seth: And Peter, I assume that a change orders and [inaudible 00:03:49], one of the most prevalent things you do as a construction lawyer, the issues that come up [inaudible 00:03:55].

Peter: Oh, for sure Seth, we get questions on change orders all the time. So, if you start with the basics, if you will, number one, virtually every construction contract in the world has a changes clause that allows the contractor to make changes or that allows the owner to make changes and number two also has a provision in it that says if there is a dispute about whether something is a change to the work, which is a fairly common dispute that the contractor will nevertheless proceed with the base contract work while the dispute shakes itself out, so to speak.

Peter: All right, let’s look at the three, I guess basic types of changes. Number one is an actual change. That’s one where the owner comes out or the owner’s rep comes out to the project site and says, “We’re going to move this wall three feet farther East.” Something like that. That’s the basic actual change. There is also a topic of constructive changes and finally we want to talk about a concept that started with federal law, which is called a cardinal change. Actual changes exist when the owner issues a written change order or a directive to change something in either the plans or the specs. Pretty simple. The arguments become when is there been a constructive change? If the owner doesn’t issue a change order or a directive to make a change, are there other things the owner can do that essentially result in a change to the work even though the owner doesn’t expressly say this is a change?

Peter: And the answer to that is, sure. Some of those types constructed changes can be an owner’s directive to correct, “Defective specifications,” in other words, the specs are somehow contradictory and the owner puts it on the contractor to work that out. A revision to the contract drawings, which can be bulletins, field directives, answers to RFIs, et cetera. The perennial favorite of differing site conditions, which were not apparent at the time of contracting or bid. A disputed order to perform corrective work can be a constructive change. A directive to one trade that impacts the work of another trade, in other words, a clash of subcontractors on the job. A damage to the contractor’s work caused by either the owner or other trades on the project site can result in a constructive change to the contractor whose work was damaged.

Peter: Improper inspection, over inspection, inspecting to the wrong, if you will, either plans or codes. Owner’s failure to disclose information that the owner knew about the project but didn’t tell the bidding contractors at the time and an owner’s directive to accelerate work. These can all be types of actions that occur on the job that can result in what the law calls a constructive change and construction contracts often have a provision in them that says essentially if the contractor thinks something has occurred on the job, that constitutes a change, then the contractor is required to give notice to the owner within X amount of time. 24 hours, 48 hours, 72 hours.

Seth: Can you take a live question? We’ve got a couple of questions and I was going to get those in later and I don’t want to interrupt you in midstream, but we do have a participant that wants to ask a question live, so I thought I’d give them a chance and see. We’ll try one of those.

Peter: Sure.

Seth: One moment, and we should all be able to hear one of the participants. Well, we’re not able to get that one right now, but this is a bit more of an… Here’s another question. It seems a little bit more business driven than legal, but maybe having seen so many of these types of agreements, one of the subcontractors is saying that a 15% [inaudible 00:08:47] a 20% markup, excuse me, is really tough in this industry now. Do you have any advice about working with those numbers?

Peter: Well, I mean 15% for a long time has been an article of faith, if you will. It’s almost, “industry standard”, obviously different… When you get right down to it different trades have different profit margins. If you’re working on a big civil job where you’re moving, hundreds of thousands of yards of earth or something like that, you’re looking at an industry where if they make 2% profit, they do backflips and other subtrades particularly finished trade sometimes have an astronomic what you would call “an astronomic profit margin.” Something much higher than 10% for overhead and 5% for profit. So, sometimes they get penalized by a contract that says “The markup on any TNM change will be 10% for overhead and 5% for profit.” In particular, if your profit margin on changes is not something that you want to live with, then obviously the time to handle that is during the contract negotiation process. But 15% is largely an article of faith.

Peter: Moving along after constructed changes, there are also cardinal changes. Like I said, this is a concept that started on federal construction projects, but essentially what a cardinal change is, is that by virtue of the nature or total quantity of the changes, the project constructed is fundamentally different from what the contractor bid. In other words, this project can look just like at the end of the day, what the plans portrayed it to be, but there were so many disruptions, so many tiny little changes on the job that the contractor didn’t end up constructing that which he anticipated. It’s the death by a thousand paper cuts kind of a situation. If you can prove a cardinal change, the contractor is essentially freed from the terms of its bid and is allowed to, is essentially then looking at a job that the contractor can price out at time and materials plus that markup again.

Peter: So, everything converts to either a unit price or a fixed or a hard dollar bid and it gets converted to TNM. Now, couple of things just my one California specific slide here, there’s a couple of cases listed there, Daugherty versus Kimberly Clark and C. Norman Peterson versus Container Corp, which are cases that discussed the cardinal change doctrine in California on private works. The last one is Amelco Electric versus City of Thousand Oaks and in that case, the court said that you cannot claim a cardinal change on any public work in California just because the public entity can only be liable under the terms of the contract it entered into. So, that’s my one of, oh by the way, to everybody listening in California here.

Peter: All right, change order documents. All right, once you’ve decided that there is a change and once you’ve agreed on what the price of that change is, what do you do? Well, if you’re a sub pricing upwards, in other words, you’re submitting a change order to your prime contractor or you’re a prime contractor submitting one to an owner. What you want to see is something that looks like an AIA G701 change order, which is really just, here’s the change, here’s the cost of the change, we’ll perform the change and then we’ll just get on down the road. However, if what you’re looking for is to, and if you’re the uphill party, if you’re the owner or the prime contractor or even a major sub dealing with the second tier sub, what you want to know when you pay for that change is that the change is closed.

Peter: You’re done, you’re getting on down the road. We’re not going to see anything at the end of the job that looks like, “Oh my God, there was all of this impact on my base work by all of these changes.” So, here’s my final change order for a gazillion dollars for all of these impact claims, which we’re going to get to in a second. So, what do you do? You have a change order that looks something like this. At the top half, you’ve got the details of the change or the description of the change, but then at the bottom you have this clever little waiver language that says, “The compensation (time and costs) set forth in the change order comprises the total compensation due to the contractor, all subcontractors, all suppliers for the worker change defined in the change order. By signing the change order, the contractor acknowledges and agrees, on behalf of himself and everybody below him that the stipulated compensation includes payment for all work contained in the change order plus all payment for interruption schedules, extended overhead, delay, all impact, ripple or cumulative impact on the work of this contract.

Peter: Owners, prime contractors. If your lawyer hasn’t given you the form of a change order that says something like this, fire him, hire me. Because you should be because otherwise if you’re giving out a change order that just says, “I’m moving this wall and it’s going to cost me $10,000.” What you’ve done is just signed a receipt for the down payment on the next claim that’s coming. And you don’t want that. On the other hand, subs, if the owner is sending you something that looks like what I’ve described, which is essentially the AIA G701, sign it and go on down the road. Good. If you find something else later, okay, you can claim for it. Now, if you get into the [crosstalk 00:15:58].

Seth: There’s one question I think is on topic or maybe it’s appropriate throughout the entire talk is, how do you make sure you get paid on these change orders? And I know you were getting to some of that, but what’s really the legal mechanism and how does that work?

Peter: Okay. Well if, and I’ve got to assume here that you’re talking about a situation where there’s not an actual change where the owner hasn’t issued a change order. Obviously, if the owner’s issued a change order, you just sign that under the terms that you’ve found to be appropriate and you just build in your next progress payment application. But if you’re talking about a constructive change, what you have to do is document the record, so that you’ve preserve your claim here. That’s the situation on any kind of constructive change. One of the things that who’s ever is ramrodding the job for you, whether that be your project manager, your superintendent or whatever, should sit down and fly spec the contract at the beginning of the job, not just for the, if you will, pardon the pun, nuts and bolts of what’s expected by the plans and specifications, but also the business terms.

Peter: If I think I’ve seen a change out here, what’s my notice provision? How do I have to deliver it? Every lawyer that drafts a construction contract thinks that they built a better mousetrap. So, the notice provisions on any construction contract are different. But if it’s 24 hours, 48 hours, 72 hours, if it’s regular mail, email, carrier or pigeon, it doesn’t matter. Do whatever the contract says and get that notice in there and then start tracking your time. Which brings us to actually this current slide, which is… This is what I expect to see in a good daily report filled out by a contractor, but the same situation would apply to a decent time and material sheet. Because I’ve seen this thing that I deemed to be a change. I give it some sort of a tracking number, whether it’s a COR number or an RFI number or whatever it is. And then, I start recording the time that my folks have spent on this, whether it’s hours or whether it’s materials or whatever.

Peter: You want to have a report that describes the work performed by the trade, the area where that work occurred and the number of guys involved. You want to know the equipment, you want to know the quantities of work you’ve performed, you want even know the weather conditions to see if it was tougher that day to perform that work. You want to know special events such as inspections, tests, visitors, delays, accidents, record, significant conversations, problems encountered, accidents, obviously extra work orders. And then what you should do, and this is typical on a TNM sheet, is that you get the superintendent of the general contractor to sign off on that. Not that he’s recognizing or she’s recognizing that it’s a change, but just that you have spent this time and these materials on this particular issue.

Peter: That way at the end of the day or the end of the project when things are being shook out, if you get the agreement of the owner or the prime that a change did in fact occur. You eliminated the argument of, okay, what’s that change worth? Because you’ve got that type of documentation. They’re lined up and ready to go. Answered your question? Hope so.

Seth: Peter, not to take it too much, but we had another one come in.

Peter: That’s okay.

Seth: This is by Joseph and he asked, exactly how much proof do I need to offer to prove my claim of labor and material?

Peter: That’s actually pretty easy, Joseph. Again, that’s just a time and material sheet and it’s great if you can get the other side to sign it. But if you can’t keep them anyway, literally assign a tracking number to an issue, whatever you want to call it. And then for the crew that you assigned to that particular work, record those hours, what area of the project where you’re working in, record the materials you used, that kind of stuff is the basics. So, once you establish your right to a change, then there’s no question at all about what the change costs you, at least on a direct cost basis.

Peter: Let’s talk about our last topic, which is the effect of change orders on base work. We kind of nodded at that when we talked about the form of the change order, but everybody who’s listening to this presentation undoubtedly understands that if there are one or two change orders on a project, assuming they’re not major changes, but if there are one or two or three change orders on a project, that’s not going to impact your base work much. But if there are, 50, 60, 100 changes on a project, that’s going to affect how you performed your base work.

Peter: It’s going to make your base work more expensive either by way of delay or a decrease in productivity, spreading your resources then requiring you to bring on more equipment, whatever it is. So, what we want to talk about is those kinds of impact claims which if you’re working with a change order that’s got one of those obnoxious waiver provisions into it, you’re going to want to price this into your original change order pricing. Some sort of a factor to compensate you for the impact on the base work. If you’re using a basic change, an AIA change order form, then you can submit this separately. Just as long as you haven’t somehow given your upstream party the argument that you’ve waived your right to these extras.

Peter: Let’s talk about impact claims. They generally fall into one of three categories, delay, disruption, and acceleration. Delay, and I’m going to go over this on a real 10,000 foot level folks, because this is a seminar that I can spend an entire day on just on impact claims. So, but you have to evaluate delay, whether it’s excusable versus inexcusable. In other words, something that you’re responsible for versus something that somebody else is responsible for. And then you have the contractors Valhalla the compensable versus non-compensable delay. And then you have to deal with issues of concurrent delay. In other words, where there are two delays driving the job at the same time, one of them being your fault, one of them being somebody else’s fault. So, you have to look at the way in that framework if you will.

Peter: But you can and frequently are delayed by the issuances of change orders, particularly if you’ve got an owner or more properly or more directly, I suppose, and owner’s architect or engineer that is slow to respond to requests for information. You’re in an area of the job where you absolutely have to get something done. You’re coming out of… You’re doing the basic structural work on the job, let’s say. Obviously that’s driving critical path. Nothing’s going to happen until the structure is in place. You hit something where there’s a conflict between a structural sheet and a mechanical sheet and you ask the question, what are we supposed to do here? Owner and the architect takes 30 days to get back to you. Well, that might only be something that bubbles up through the architect’s inbox, but meanwhile you’re paying five guys to stand around and drink coffee all day long.

Peter: That gets pricey after a while. A delay in responding to requests for information on changes can be a major impact to you that doesn’t appear in, if you will, the hard dollar cost of the change. Disruption claims is any change in the method of performance or in the plan sequence of work contemplated by the contractor at the time of bid, and the contractor is generally speaking entitled to extra compensation for that disruption, as long as the contractors plan method of performance was reasonable. So, if you can prove as a contractor number one, that you bid the job reasonably. Number two that you had a reasonable plan for carrying out the job and number three that a bunch of changes interrupted your sequence and therefore your productivity units in other words, that cost to you of a unit of work was decreased, I suppose. Was negatively impacted by a bunch of changes, then you have an impact claim that you should work into the cost of the change or file a separate claim form.

Peter: The last one I want to talk about today because we’re running out of time, is acceleration. And acceleration can be either directed, obviously or constructive and a constructive acceleration will happen where the owner, for instance, delays the project but doesn’t give you extra time. In that case, the contractor has got something in the nature of a Hobson’s choice. She can work to her original schedule, in which case she’s going to be late in terms of project delivery date or project completion date. Or she can accommodate that delay by doing things such as increasing manpower, working over time, running extra equipment, et cetera, et cetera. But then she’s incurred all of those extra costs in order to make the original completion date. So, that’s a constructive acceleration. Again, those things can occur based on the number of changes issued on a job and when that happens, again, contractors and subcontractors out there, you ought to be pricing that into your change or at least reserving it for a later resolution.

Seth: I guess Peter, and I know we’re running out of time now, but the gentleman that asked earlier about, you said it was a pretty simple answer talking about proof and how does he prove the claim of labor and he just wanted to clarify that that was a timing issue, when is it appropriate to submit that change order?

Peter: Oh, okay. Well, in that case you can submit the change, one of three, I wanted two, I suppose, situations you’ve given your initial notice under the contract, you’re tracking your time and materials. You can submit that if you want on a periodic basis. If it’s a really long change, in other words it’s taking you more than a month to accomplish the change. Or you can just wait until you’ve finished the work of the change and then submit a change order request backed up by your time and material sheets with a nice little summary on the top. Sheet one is here’s why this is a change. See the way we changed the plans or the specs or whatever. And number two, here’s the cost of the change which we’ve documented out in the field on a daily basis. Makes sense?

Seth: Well Peter, I just, it looks like we’re getting close to the end here. I just want to ask our audience, and we’ve had a lot of people today, if there was a quick one or two questions anyone else had [inaudible 00:30:02] to answer one or two. I know we got to respect his time and thank him for all this. So, I’ll see already we have one. What if someone doesn’t agree to the change order? And I guess that’s how we get into this situation.

Peter: Yeah, that’s how we get into this situation. I mean, there are three aspects to my practice. The first we call transactional, which is basically just drafting and negotiating contracts and things like that. The second is what we’re talking about here, which for lack of a better term, I call project administration or contract administration. It’s helping our clients out during the job. But if you can’t resolve these things either during or at least at the very end of the job, then you’re looking at litigation or arbitration. I mean, that’s the nature of the thing. And when you look at something like that then-

Seth: And let me ask one, [inaudible 00:31:06].

Peter: Yeah.

Seth: No, I didn’t mean to cut you off. I was going to allow one more question, but feel free to finish that one if there’s anything else you had to say.

Peter: No, no, no, I mean, we finally refer to construction litigation as global thermonuclear war. So, there are many times, and I’ve been on many projects where the parties were at logger heads, but they were smart enough if you will, to get their lawyers involved during the project. And there’ve been a couple of times when we literally settled up all of the issues on the final day of the project virtually. On the final day of the project because the contractors want to get onto the next job and spending money on a bunch of lawyers litigating something that happened to you five years ago, better be worth your investment. And in a lot of cases people will decide when faced with that situation that it isn’t. So, they’ll settle. Anything else Seth?

Seth: Yeah, I think we’re going to leave it at that because we want to keep it within the 30 minutes of time. But if people ask, there’s a few other questions here. What I’ll do is I’ll try to get them answered or maybe even I can post them on the Expert center and then send them over to you and you can answer them if some of the attendees want to do that today. But again, my name is Seth Bloom. I’m the Senior Director of Attorney Services at Levelset. And what we’re doing is we’re building a huge community of construction lawyers so people in the industry can really come and get some simple answers or to help get them into the proper lawyer that they need to see. Most of our attendees today are going to be from the area where Peter works, so if you do have an issue, I want to thank Peter so much. [inaudible 00:33:03] excellent lawyers and I look forward to continuing to work with Peter and his firm.

Seth: I know they want to participate in another live webinar. I will certainly come out to the Los Angeles area and do a live event and it would be great if the attendees could come and bring even more people and we can get into a little bit more depth. And maybe, a 90 minute or so live presentation. So, that’s something we have looked forward to Peter answering questions along with his partner and associates. And thank you so much, Peter. We really appreciate it and we look forward to working with you again.

Peter: Happy to do it, Seth, and look forward to seeing you in Hollywood.