Change Orders For Contracting Projects
Change orders are often required during an ongoing contracting project. This post will help you understand why they are required, how to implement them correctly, and some common gotchas to look out for along the way.
What Is A Change Order?
A change order is a document that specifies any changes from the original contract between a contractor and a client. This can include all manner of changes to the initially specified work and scope of the project. For example, moving a wall, painting using a different color, or adding more lights to a room.
Why do change orders need to exist?
Change orders are a critical part of the contracting process because most jobs evolve in scope over time. In an ideal world, all work would be completely specified and agreed to initially, however, this is very rarely the case. Changes to work scope impact both sides of the agreement, the client and the contractor, and as such, they need to be formally agreed to in the form of a change order.
Is a change order a good or a bad thing?
There are potentially both pros and cons to any change orders. Let’s look at some of them below.
• Firstly and most importantly, change orders generally reflect a revised outcome that is what the client now wants. This should lead to a result the client is ultimately happier with.
• Correctly accounting for cost and scheduling overruns. Studies have shown that the average cost overrun from change orders is 11-15% of the original contract value in large projects. Meanwhile, the average schedule overrun is 10-20% of the original project timeline. If these overruns were never agreed to as change orders, it’s possible they may never be recouped.
• Change orders typically represent more work. As long as this is done at an agreed rate that is profitable for the contractor, more work is generally always a good thing.
• Displaying flexibility in an organized and fair manner is a great way to improve your relationship with the client, potentially earning more work from them or referral work from others in the future.
• Increased admin time and bookkeeping. Because all change orders should be formally noted and agreed to by both the client and contractor, this can lead to a natural tendency to cut corners with verbal agreements.
• Scheduling conflicts leading to expensive casual labor. There are times when contractors are simply booked to capacity, and more work will require additional casual labor. In these situations, contractors need to be extremely careful to bill the extra work at a rate that is still profitable to them. Failure to do so can result in unprofitable jobs. This is a tricky balancing act for any contractor, as the natural desire is to please the client.
Types of Change Orders
Now that we’ve established what a change order is, let’s look at the different types of change orders in a bit more detail.
A change order can be divided into three different categories:
1. Direct Costs
Direct costs are costs that are directly affected by the change order. The most typical direct costs are materials, labor, equipment, and similar expenses. However, it’s important to note they can also include less obvious expenses like the cost of communication with crew and engineers, cost to redesign the structure, setting up, clean up, etc.
2. Indirect Costs
Indirect costs include overhead costs and can be a fixed or variable part of the construction project. If the indirect costs are a percentage of the overall job, it means that the more expensive the job becomes the higher the indirect cost.
3. Consequential Costs
Consequential costs are costs that are incurred because of the timing of the change order such as during seasonal weather, for example, if it's raining or snowing a lot that specific week. In other words, circumstances that are out of a contractor’s control and which therefore can be very difficult to measure, but nevertheless can have a huge impact on the project and its costs to the contractor.
Common causes for change orders to be created are:
• The project's work was incorrectly estimated initially.
• A change in design, or other requirements from the client.
• The customer or contractor discovers unforeseen obstacles.
• Substitution of material or procedures.
• Lack of initial coordination or a badly written contract.
• New safety considerations.
• Financial problems from either the client or the contractor.
• Some work during the process turns out to be irrelevant; work that is not done is also a change order.
• New government regulations or laws during the process.
• Extreme weather conditions causing delays or requiring additional work to complete construction.
• The contractors are inefficient or incapable of completing their required deliverables within budget, and additional money, time, or resources must be added to the project.
The Importance of Formally Recording Change Orders
Change orders need to be recorded somewhere and agreed to by both the client and contractor in writing. This is an incredibly important and often overlooked process. Any change order can become extremely problematic if not recorded correctly and formally agreed to.
A verbal contract is extremely hard to enforce in a situation where the contractor/client relationship may become sour or contentious.** Correctly recorded change orders can save job profitability, and provide a clear and enforceable legal trail if things go badly**.
Sometimes You Just Forget
Believe it or not, it’s not always so easy to remember what you actually said yourself. Often in disputes, people get surprised when shown what they have said or written down when the proof is shown to them. Also, someone may claim that they don’t recall at all an agreement you had over the phone just days ago. Therefore, the verbal contract or gentlemen’s agreement can destroy even the closest relations.
Client Warning Signs And Red Flags
If a client refuses to agree to change orders formally or pushes to make changes without documentation, this should be considered a red flag. Their proposals may seem appealing at the time, but you may be asking for trouble later in the form of unpaid invoices, reneging on verbal agreements, and even legal issues. The contractor should always say no to additional or altered work without a written change order.
Remember: If it's not in writing, it didn't happen
Common Traps And How To Avoid Them
As a contractor, there are a few traps you should watch out for regarding change orders:
1. The client is trying to convince you to start the change orders without the additional signed documents
Sometimes a client may try to persuade or pressure you to bypass the necessary paperwork, insisting that it will hold up the process. They may suggest that you start without it, but you should be adamant on waiting. Without the proper paperwork, you risk not getting paid for the work.
How to avoid it: Never allow a client to force you to do anything without the correct paperwork signed.
2. You want to impress the client with some modifications before getting their approval for the change order
During the working process, you might find aspects of the project that you could improve and feel confident the client would ultimately love, but it’s better not to act on that. Even if the changes are for the better and perfectly suit the client, they have no obligation to pay you back. Unless the changes are written in the original contract or as a change order amendment, there will be no legal argument for the client to reimburse you. Any attempts at legal action will be responded to with a request for the change order documentation, and without it, the argument falls apart.
How to avoid it: Never act on your own – don’t make changes that you haven’t had approved in writing.
3. The client is being a little over-demanding and you are tempted to overcharge them
Sometimes during the working process, a client may want something new that they feel is imperative to the finished project that wasn’t in the original contract and consequently requires a change order. The negotiations that follow thereafter can be important. Try to land on a fair price so that neither you nor the client feel taken advantage of. As a contractor, there is an opportunity to charge the client more than you should, but it’s not a great solution in the long run. There is more value in positive working relationships and reputation than there is in financial gain from one job.
How to avoid it: Never overcharge the client - be fair in your estimated costs for labor.
Does the Contractor Always Have To Undertake the Change Orders?
What does your contract say about change orders? Usually, the contract states that a change order request needs to be submitted and approved before you can officially undertake it. Without it in writing, all work done outside of the contract is considered free work. That’s why it’s best not to do any additional work before you have that signed change order.
In a scenario where the client is trying to pressure you, you can reference the part in the contract that states you cannot do any change orders without a signed document. This will force the client to proceed with the construction change directive or CCD process. A construction change directive is not synonymous with a change order. The CCD recognizes that a change exists but that it lacks the necessary amount of time and money, which will later be negotiated.
As a contractor, you can also decline to make the change order if you lack the time or knowledge for that specific work. But as we mentioned earlier, most contractors don’t like to decline a change order since doing them generally involves extra money.
What to Think About Before Agreeing to a Change Order
1. Read the stipulations carefully.
Make sure that what the client demands is reasonable in terms of schedule and economic compensation.
2. Keep in mind that the client may be stressed out about the changes they want and project that stress onto you.
They may give you the impression that these changes are essential for the project, although that’s pretty unlikely. If the change order had been that important, it wouldn’t have been a change order but a specification in the original contract.
3. Don’t agree on a payment that’s less than you would usually accept.
The client may try to get you to do the changes with a considerable discount, arguing that it’s a small portion of the whole amount. For the client, that may be the case, but it doesn’t make any sense for you. Not only do change orders require more working hours, but they are likely to increase the costs for supplies and other necessary resources that you will need in order to complete them. There’s no need for you to take a hit financially because of a change in the plan.
4. Consider the value of your time when negotiating payment.
Let’s say the change order is going to require an extra week of work; that means that your next project will be postponed a week. You should be paid the same price for your work this week as you would be on that scheduled project. This is something important to keep in perspective when negotiating payment. There’s equal value in every working hour.
Managing Change Orders Effectively
Assign a dedicated change order manager.
Once this person is appointed, it is their responsibility that all the information related to the change order must be in one place. Everyone involved in the change order needs to have the same data and facts, such as signatures, dates, amounts, materials, etc. If the client, architects, construction workers, or anyone else contacts the project manager, they need to have access to the same information. There should be no doubts that lead to the possibility for the construction workers to act on their own regarding the change orders.
It’s recommended that only one person, maybe the contractor or project manager, be allowed to sign change orders to avoid any problems. Make sure to write the authorized name(s) in the original contract. Otherwise, a client may approach the team leader among the construction workers and persuade or trick them into signing something that sounds good and reasonable, even though it wasn’t previously established with somebody of authority.
When information is left out or under discussion, it equates to a time loss. Every time anyone needs to reach someone to get a change order approval, it means the process will delay. This isn’t ideal for anybody. So to avoid it, make sure everything is in order before you start. It’s a good idea to keep a copy of the change order attached to the original contract. Also, it’s important to note that the change order can also refer to work that is no longer needed. Therefore, it’s best to attach the change order documents to show why certain things weren’t done that had originally been specified in the contract.