This article offers the most useful tips for creating a solid construction change order process, including best practices from leading construction law experts.
In construction, a change order refers to the documentation of an agreement to add or subtract work, alter the design, revise the schedule, modify the price, or deviate from the original project in some other way.
In the context of this change order, an owner and a general contractor (or a general contractor and a subcontractor) agree on a particular scope change and record the details in the change order document. The construction change order represents an amendment to the original contract, which defines the project’s scope of work and references plans, drawings, and specifications.
Change orders in construction are very common, and occur in almost every commercial and public project. Still, your goal should be to avoid them as much as possible, because change orders can result in delays and higher costs.
Changes to construction plans tend to negatively impact only one party. For example, an owner may miss the target date for a new building’s opening, or a contractor may end up having to use a more expensive material without receiving additional compensation.
Lots of different circumstances can necessitate change orders: For example, a contractor may discover that site soil conditions are less stable than the designers initially believed. Such a discrepancy will inevitably cause you to change your approach, and will likely require more work, time, and materials.
Another example: After a contractor has installed lighting fixtures, an owner may decide to upgrade the illumination of those fixtures. To formalize this change, the contractor would write a change order that addresses the removal of the original fixtures and the purchase and installation of the new fixtures.
Such changes can cause friction, and disagreements can undermine working relationships.
“Change order disputes can profoundly impact a project, especially if you stop work while the parties dispute the change order,” says construction attorney Colin McCarthy, Principal at Orange, California-based Lanak & Hanna. “If they are not resolved in a timely manner, change order disputes often cascade into project delays and additional costs for both parties.”
The long-term nature of the commercial construction process itself generally creates the need for a change order: significant discrepancies between the initial plans, designs, budgets, etc. and the actual circumstances (once work begins) are inevitable.
(If you are not familiar with the basics of construction management, see “Construction Project Management 101” for a complete introduction.)
In this interim (between the submission of the initial plans and the commencement of construction), more players get involved, including architects, engineers, and other design specialists. They work on different aspects of the project and seek to coordinate their efforts. In spite of these attempts to maintain order, however, once you increase the number of players and roles, you typically increase the complexity of the project. Growing complexity usually means the proliferation of design conflicts, specification gaps, and other disagreements and errors.
As these disagreements and errors accumulate, change orders inevitably pile up. General contractors and subcontractors use these documents not only to help price their bids during the bid prep process, but also to correct omissions, mistakes, and other problems that they discover during construction.
In addition, the need for change orders often arises because large, ongoing construction projects exist in a perpetually fluid environment: An owner’s requirements or financial resources may change; a freak snowstorm may halt work; an economic crisis may affect project funding; or a subcontractor may not be able to find qualified tradespeople. .
Here are the typical construction problems that give rise to change orders:
A change order form should include a highly detailed description of the change and the new terms. It should also include other information, such as the new price, the name and address of the project, the owner’s name, and more.
At a minimum, all change order forms should identify the following:
Because change orders can have a major impact on a construction project’s costs and profitability, all concerned parties must follow a standardized change order process and make sure not to overlook any steps.
Here are the steps to follow when drafting a change order:
1. Use a Standard Process (Including a Template) to Ensure Consistency: You can find downloadable construction change order templates for all purposes by reading “Complete Collection of Free Change Order Forms and Templates.” Below, you’ll find a good example of a change order summary. It includes sections for all pertinent information, such as a description of the necessary change, supporting documents, and specifications of the change.
Download Construction Change Order Request Template
2. Meet with Other Stakeholders: Gather the owner, contractor, and subcontractor to discuss the change before you document it on your form. Try to reach an agreement on how the change will affect the cost and schedule. (Remember that oral agreements are not legally binding, so don’t rely on a conversation with the foreman.)
3. Define the Change: Using your change order form, summarize the revision. Include details regarding the change, any modification in material or technique, the reason for the change, and any new specifications. Make sure to submit the form.
4. Clarify the Impact on the Budget and Schedule. Make sure that the document clearly articulates any change in cost and time that the change will require. Also, show how the change will affect the project’s overall price and timeline. If there is no change in either the former or the latter category, make that clear as well.
5. Present to the Other Party: If you have agreed on the terms of the change, simply present the change order to formalize the addition of the document to the contract.
6. Negotiate More if Necessary: If the parties have not yet agreed on how the change will translate into dollars and days, further negotiations are necessary. These discussions may involve senior project managers, finance executives, and construction lawyers. If you are still unable to agree, the contractor may have to continue the work while reserving the right to seek compensation at the project’s conclusion.
7. Sign Off: Once you’ve reached a consensus, confirm that the change order document accurately reflects the final agreement, and authorize the change by having each party sign the document. Note: If you are unable to achieve a consensus, you must still perform the work (without receiving additional compensation until the project ends), if the contract language includes such a mandate.
8. Verify the Impact to the Project: Adjust the overall project schedule as necessary and make sure that you update all dependencies (other work that cannot begin until the change order-related job ends) and identify any conflicts.
9. Communicate with All Stakeholders: Share details of the change with all project participants, including field managers, the crew foreman, and subcontractors.
10. Keep Good Records: Retain all documentation and keep a construction change order log for invoices/payments, disputes, or audits. Tax laws, etc. may require you to save these documents for a period of time (a few years to more than a decade, depending on your location and whether or not your building is a government project). You an find a downloadable template for tracking construction documentation, contractor progress reports, and more in “Excel Construction Management Templates.”
There are three types of cost to consider when determining the price for a construction change order form: direct, indirect, and consequential costs. You can calculate those costs using either a forward or backward approach (described in detail below).
Additionally, timing can have a dramatic impact on the cost of a change order. For example, requesting a change order early on in the construction process (before a crew has begun to work on the item in question) will not cost you as much as requesting a change after a team has begun or completed work. Furthermore, the order will cost even more if the team has already completed work that is subsequent to and dependent upon the item in question. In this last scenario, the change will require that you rework the item (and all dependent items) that the team has already installed, thereby creating a chain reaction of additional costs.
In the case of any change order proposal, a contractor should itemize their prices in great detail. When you submit a lump-sum proposal to an owner, you deny them the transparency to do the following: see the reasoning behind the costs; make sure that there are no hidden costs, and confirm that the profit margin of the order doesn’t exceed that of the contract.
As mentioned above, the three cost types that construction change orders must take into account are direct (which is the easiest type to understand), indirect, and consequential (the latter two can be very difficult to quantify).
If you do not have an established recovery rate, you can calculate one by consulting the retail rental rates of such industry references as the AED Green Book, Rental Rate Blue Book, and Army Corps of Engineers Equipment Rates.
To calculate a maximum hourly rate for the change order work, take the monthly rate and divide it by the 176 available working hours in a month. Typically, you must cap the rate at 50 percent of the machine’s market value at the time you first used it for a change order.
If your situation is not complex enough to merit detailed calculations, a good rule of thumb is to price the equipment you own at 50 to 60 percent of the retail rental rate.
Typically, large companies have higher overhead costs than do smaller firms. To calculate your overhead percentage, divide your total company revenue by your total overhead costs:
Total Annual Revenue $ ÷ Total Overhead $ = Overhead %
(You usually spell out the profit and markup percentages in the construction contract.)
But, many contractors lack a strong grasp of their indirect costs and, therefore, underprice them, experts say.
For example, construction cost experts consider 10 percent to be a standard overhead cost. However, a study on change order-guidelines by ELECTRI International (The Foundation for Electrical Construction) found that electrical contractors spend an average of 19.16 percent to run their business.
Using the conversion formula below, this 19.6 percent for general business overhead yields 23.7 percent for the overhead that directly concerns change order costs. This discrepancy between percentages occurs because you are calculating your overhead percentage for direct change order costs on the basis of total sales or revenues:
Overhead % ÷ (1 - Overhead %) = % of Direct Change Order Costs
Plug that 19.6 percent for general business overhead into the above formula, and you will yield that 23.7 percent for the overhead that directly concerns change order costs:
For example, to achieve a 20 percent profit margin, you must mark up costs by 25 percent; then, you price the change order accordingly. The discrepancy between these two percentages exists because, while profit margin percentage increases at a linear rate, the correlating markup percentage increases at a rising rate.
The competitive landscape and the economic climate both influence pricing. Therefore, the markup and profit margins that you apply to your bids should carry over to your change order pricing.
Consequential costs include such factors as project delays, overtime, training, morale, crew reassignments, and inefficiency. These costs also include labor productivity losses from the stacking of trades (the phenomenon in which multiple subcontractors work in a limited space). In turn, trade stacking introduces safety hazards and other obstacles, including increased difficulty in accessing materials.
Industry literature, surveys, court cases, and case studies provide guides for calculating the impact of such change order-related factors. Among these resources are the Mechanical Contractors Association of America’s Toronto Change Order Protocol and Andrew Civitello’s Contractor’s Guide to Change Orders.
Hanna Consulting Group, Inc. and its President, Dr. Awad Hanna, Professor and Chair of the Construction Engineering and Management Program at the University of Wisconsin-Madison, developed a method called the Cumulative Impact Approach. The method determines the probability that a change order will impact an overall project. Hanna also invented the Measured Mile Approach, a method for quantifying the costs of such a change order impact on an overall project. In addition, the firm also worked on a method for quantifying the impact of trade stacking.
The U.S. Army Corps of Engineers and various other industry entities have also developed methods for calculating consequential costs (i.e., the cost of each factor that has an impact on productivity).
You estimate the cost of each of these factors based on their impact: minor, average, or severe. For example, a severe stacking of trades results in a 30 percent loss of productivity, while minor fatigue results in an eight percent reduction in productivity, according to ELECTRI International’s research.
The pricing approach on construction change orders depends a lot on timing. Forward pricing occurs in advance of the change order work, while backward pricing takes place after you’ve performed at least some of the work.
When applying backward pricing, you have access to actual first-hand experience with which to calculate a price; on the other hand, when applying forward pricing, you must rely on estimates and contract norms.
Both pricing approaches take direct, indirect, and consequential costs into consideration. And, regardless of if you use forward or backward pricing for your construction change order, you must also identify the time and productivity impacts on cost.
In the absence of actual data, the cost flow technique can help you calculate your forward pricing. Often represented as a graph, cost flow analyzes construction spending over time, showing you how much you must budget and spend at each crucial juncture in order to complete construction as you’ve planned. Consider both the direct and consequential costs when performing these calculations.
Cost flow is often confused with cash flow, which is money that is coming in to or going out of a business (or, here, a construction project) over time. By comparing cash flow to cost flow in the context of a construction project, you can determine — as you incur costs — whether or not money will be available. If you find that money will not be available, then you may need to make changes to the project.
In the case of a change order, owners and contractors can compare the revised cost flow to the original cost flow in order to identify the impact of the change. Doing this can clarify pricing. But, in order to make this comparison useful, you need to have detailed data on the productivity (or the lack thereof) that results from the change order.
Construction change orders are frequently the subject of litigation, often due to disagreements between contractors and owners over whether the change requires a revision to the compensation or schedule, or whether such change is already covered under the original contract.
According to the Arcadis 2020 Global Construction Disputes Report, the global average value of construction disputes was $30.7 million, and the average duration of those disputes was 15 months. Therefore, both owners and builders are strongly motivated to understand the issues that commonly cause disputes so that they can seek to avoid them.
The seeds of these disputes often lie in the content of the contract and bid documents themselves, because the nature of such content is not apparent to the parties when they sign. When you don’t clearly articulate certain aspects of your project from the outset, you often discover later on that your initial plans, designs, specifications, etc. require changes.
Here are some common causes of construction change order-related disputes:
“Requiring written change orders protects both contractors and owners from future disputes,” explains Houston litigation attorney Robert Burford, Founding Partner of Burford Perry. “Contractual provisions that require any change orders to be in writing are enforceable. Therefore, it’s a best practice for a contractor to include such provisions in their original contract. The contractor must also mandate the following of these provisions throughout construction, or they risk waiving those provisions.”
While every project is unique, following best practices can minimize a wide variety of problems concerning construction change orders. Such problems include disagreements over cost and scope.
Here are some best practices from the field’s top experts:
Other laws regarding liens also vary by jurisdiction. Some states require you to send a preliminary notice to the owner, lender, and general contractor (if applicable), stating that you are working in order to preserve your lien rights. California law requires general contractors to serve a lien 20 days prior to the first provision of materials and labor.
Once you have a mechanic’s lien in place, you then have the right to send a notice of intent to lien, should the owner pay late or fail to pay altogether. The mere act of sending this notice may itself prompt payment.
If the owner does not pay, a general contractor in California has either 90 days from completion of the project or 60 days from when an owner files a notice of completion or cessation (work stoppage for another reason such as a pandemic) to file a mechanics lien with the county recorder in the county where the property is physically located. For subcontractors, this period shortens from 60 days to 30 days.
Construction changes are sometimes too contentious for the owner and contractor to reach an agreement on together. In this situation, the owner and architect may write a construction change directive that they impose on the contractor.
The architect decides the contractor’s compensation for the new scope of work, which may be nothing. This move is also called force account work. Unsurprisingly, construction change directives frequently injure relationships among the parties, cause hostility, and lead to lawsuits.
Contractors often wonder when and under what circumstances they can refuse to accept a change order. The cardinal change doctrine protects contractors in extreme cases: It holds that if the owner imposes changes that fundamentally alter the scope of work, the contractor has the right to break the contract. The contractor has to prove that the change qualifies as a “cardinal change” (a fundamental change to the project) — for example, if an owner hired a contractor to build an ice skating rink, and then decided to build a movie theater instead. Under these circumstances, the contractor can seek damages and is not in breach of the contract.
Courts will generally find these cardinal changes valid if the change substantially increases the amount of work required of the contractor, significantly alters the type of work, and entails a major change in project costs.
”Even though an owner has authority to require changes in the work, it is not unlimited. The cardinal change doctrine offers protection to contractors from overreach,” notes attorney David Reischer, CEO of LegalAdvice.com.
In the context of construction projects, engineers play a leading role. They are responsible for a great deal of the technical work that goes into building a structure, including designing key building systems, determining the right construction method, and ensuring that the work meets quality standards. Engineering-related changes often lead to change orders.
Here are the major reasons for engineering-related change orders:
For more resources, download from our selection of free construction work order templates and forms.
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