Let’s start this off with a picture. Below is an image of two boats – one is a large, expensive boat and the other an inflatable dingy the owner uses to ferry out to the big boat from land. The small dingy is named “original contract” while the large, luxurious boat is named “change order”. I first saw this picture in college and laughed, but didn’t quite understand. After working for many years on a variety of commercial projects, it makes a lot more sense. While this picture is funny but obviously way off scale, the point is clear. Regardless of what the original contract consists of, projects can be made or broken by change orders – that goes for clients AND contractors! In this article, we’ll be discussing a variety of change order best practices that will benefit both owners and contractors alike.
A quick disclaimer: While I have worked as a Project Manager in construction for many years, I am not an attorney or any form of legal counsel. I speak from my experience of working with contracts and overseeing the execution of many change orders, but always speak to your own legal counsel for any matters related to contracts, terms/conditions, payment, etc.
What Is A Change Order In Construction?
A change order is a written, legal document that outlines and represents a change of some kind to an existing contract (“base contract”). For a change order to be official and legally-binding, the document must be signed by the Client, Contractor and often a third party such as an Architect hired by the Client. At a minimum, it must be signed by the Client and Contractor to become legitimized.
Why Are Change Orders Important?
Change orders are an important part of a project that both Clients and Contractors need to know about. Sure, change orders are legally-binding additions to the existing base contract, but most people only care about one thing when it comes to change orders: payment.
For Contractors, change orders are an essential part of getting paid for the work you do. If you perform additional work on a project that’s not a part of your base contract, you should be compensated for the time and costs of doing this work. Change orders submitted by Contractors usually claim additional time AND costs – completion timeframes should be increased in many instances, too. In construction, no one wants to do work they aren’t being paid for! However, it’s not as simple as just sending a change order to the Owner and waiting to be paid. We’ll discuss the specifics of change order protocol for contractors below.
For Owners, change orders can account for a large portion of the total construction costs on a project. We hear about this everywhere – people begin a project with a certain budget in mind, and end up spending WAY more than planned when all is said and done. A rule-of-thumb to keep in mind is that on the average construction project, change orders equal about 10% of the original project value. If an original contract is worth $1 Million, it’s reasonable for Owners to anticipate an additional $100,000 worth of change orders in project cost on top of that. Owners must have a contingency fund set aside to pay for changes on their project. The average 10% figure is purely an estimate – your project could have higher or lower percentages depending on the scope of work and nature of the project.
Do All Projects Have Change Orders?
There are construction projects that do not require change orders, but they’re usually the exception.
Simple residential projects, for example, usually don’t require any change orders – the scope of work and terms agreed upon are simple for most repairs and small projects. The work is done for the agreed-upon price in a timely manner because there aren’t surprises or an ill-defined scope of work.
Projects done on a Time & Material basis (T&M) are performed in a “bill-as-you-go” manner. For Contractors, T&M projects have minimal risk of change orders – you’re billing the Client for the work being done as you do it, not billing them against a firm price in a Lump-Sum contract scenario. Owners have more to worry about in the change order department – if the Contractor isn’t done but they’ve exceeded their original budget, they’ll need more money!
What Are The Reasons For Change Orders In Construction?
Change orders can arise on construction projects for many different reasons. Here are a few common scenarios on a construction project that result in a change order being issued to a Contractor by the Client:
- The Client has asked the Contractor to do additional work.
- The Contractor comes across “unforeseen conditions” on the job that require additional time and costs to address.
- A portion of the scope of work is vague and not entirely clear. The Contractor in turn claims additional cost to cover what they feel is not part of their contract.
- The Owner has agreed to pay the Contractor more money for them to work overtime, so the project gets done faster.
- The Contractor requests additional time and costs when delayed outside of their control.
Projects come in all shapes and sizes – so do change orders. There are countless reasons for change orders to arise on construction projects!
Change Order Best Practices: Tips For Owners & Contractors
Contractors and Owners alike can quickly run into many problems when change orders aren’t handled properly. We’ve already outlined the legal and financial importance of change orders in construction, so lets get into some change order best practices!
- Don’t Do ANY Additional Work Without A Signed Change Order! If You Have, Stop Immediately. The Rest Of These Practices Will Be Chronological But This Point Is Extremely Important.
- Account For Some Change In The Original Contract.
- Minimize Risk Of Change By Clearly Defining Variables & Objectives.
- Define What Is NOT In The Contract, Too (Exclusions).
- Outline The Contractor’s Hourly Rates, Overhead & Profit In The Contract.
- Meet With The Client & Review The Work That Must Be Done First.
- Quantify The Additional Work Via Takeoffs, Calculations & Breakdowns.
- Tie The Change Order To The Schedule When Possible.
- Include A Detailed Scope Of Work In The Change Order Documents.
- Backup Documents Are Essential – Payroll, Receipts, Etc.
Notice how many of the above steps take place BEFORE a contract is signed! Preventative action is the best. Let’s discuss each of these steps in a little more detail…
1. Don’t Do ANY Additional Work Without A Signed Change Order!
There’s nothing worse than a Contractor performing (extra) work, finishing it, then dropping a surprise bill in the Owner’s mailbox. This creates confusion, disagreement, stress and even hostility between the Contractor and Owner. Many lawsuits arise from scenarios like this.
The Owner is now strapped with additional costs that they didn’t expect for reasons they don’t fully understand. The Contractor has performed work, spent time/money and is now worried about not being paid.
Even worse, the base contract work will suffer while the Owner and Contractor squabble over the change order work!
It’s a lose-lose either way. This is the fundamental reason why Contractors should NEVER do what they feel is additional work without a signed change order in hand.
2. Account For Some Change In The Original Contract
In construction, change orders are extremely common. It’s important for Owners and Construction Managers to anticipate change orders when budgeting their project.
As we said earlier, it’s not uncommon to exceed the original contract value by 10% when factoring in change orders. While the specific project ultimately dictates what this percentage should be, Owners must ensure that they have the money on-hand to pay for cost increases.
Generally, the more complex, vaguely-defined and high-risk a project is, the more Owners should expect to pay in change orders from the get-go. Having said that…
3. Minimize Risk Of Change By Clearly Defining Variables & Objectives
The more a project’s scope of work is defined up front, the less likely the project will require change orders.
When an Owner is developing a scope of work, it’s absolutely critical to be as specific as possible about what the project’s objectives and deliverables are – taking into account every step that the project will require and identifying the risks associated with doing the job.
What if the project still has unknowns after defining the scope?
In construction, there are many ways to define unknowns in the early stages of a project. Here are a few ways that Owners can implement up-front strategies to save time and costs on their project:
- Hire design professionals (Architects, Engineers) to bring the Owner’s vision to life, while considering aesthetics, structural requirements, building codes, etc.
- Perform a mockup or test run of a finished product before doing all the work.
- Hire expert consultants related to the type of work being done. They can help steer the project in the right direction and make Owners aware of potential risks, etc.
- When renovating a building or structure, open ‘test probes’ in floors, walls, etc. to check out conditions that aren’t visible.
4. Define What Is NOT In The Contract, Too (Exclusions)
One of the easiest change order best practices to implement is to include an “exclusions” list in the final contract.
Simply put, an exclusions list is a summary of everything that the contract does NOT include. This is an easy way to clarify whether or not a particular item is included in the contract value.
Exclusions should be provided to the Client at the time of bid, as opposed to being a last-minute addition to the contract before signing it.
Some items that are often excluded from construction contracts include:
- Hazardous Material Removal
- Change Or Interruption To Existing Utility Services
- Engineering & Design Costs
- Site Survey
- Dept. Of Buildings Filings
- Testing & Inspections
Obviously, every project, client and scope of work will have its’ own unique set of exclusions to consider.
If you’re not sure if a particular item should be excluded or not, make note of it as a discussion point with your client during the bidding phase.
5. Outline The Contractor’s Hourly Rates, Overhead & Profit In The Contract
The construction contract between an Owner and Contractor should include an hourly/daily/weekly rate schedule for field workers, management, overhead and profit. Overhead and profit are often a fixed percentage i.e. 15% added onto labor and material costs. This should be discussed and agreed upon up front, prior to the contract being signed.
When these rates are established, it does two things:
- Owners know what to expect when change orders do come up. They know what an hourly field worker or a manager will cost on a unit-price basis and will be able to understand the price they’re given.
- Schedules and durations take on a whole new dimension when one can estimate the costs (workers, managers, overhead) as well as the profit that will be incurred in the schedule.
Defining these variables is a crucial change order best practice.
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6. Meet With The Client & Review The Work That Must Be Done First
Whether the Client has asked their contractor to perform additional work, the Contractor has discovered unforeseen conditions or any other reason for a change order, it’s best practice to review the work with the Client before doing anything more.
Not only does this prevent the Contractor from charging the Client after the work was done, but it allows the Client the chance to see the work, understand what they’ve got on their hands and strategize their next steps.
Ultimately, additional work that’s outside your contract is not yours to perform or make decisions about!
For example, a Client may elect to hire a different contractor to do the additional work. Perhaps a speciality contractor will be needed. If the contractor already on the job does the work, they might not complete it as thoroughly, cheaply or efficiently.
If you don’t have access to any sort of field conditions to see the additional work, at least refer to drawings and written specifications for the Owner to review. Speaking of which…
7. Quantify The Additional Work Via Takeoffs, Calculations & Breakdowns
If you hear that a particular car costs $40,000, your first reaction might be that it costs too much money. This is based on seeing the car at a glance and then hearing the price. When that car is presented in detail, with its’ features, performance and reliability on full display, you might feel surprised that the same car costs “ONLY” $40,000.
This is because in the latter scenario, you know exactly what you’re getting in that $40,000. The same can be said for change orders.
This is why all construction change orders should include a breakdown of costs i.e. labor, equipment, materials, etc., drawings outlining the work, quantities of additional work that’ll be performed and any other document that helps the Client understand the work.
The more a change order is quantified to the Client, the more likely that they’ll be agreeable to it, with fewer questions and more trust.
8. Tie The Change Order To The Schedule When Possible
This section mostly refers to managerial and overhead expenses – tie the change order to the schedule!
When including overhead expenses in a change order, the Client will want to understand how the Contractor has priced these expenses. As we said earlier, managerial and overhead are often billed as a percentage on top of the cost to do the work, but can also be agreed upon via hourly/daily/etc. rates.
Here a simplified example: a contractor is doing a large landscaping project for a property owner. The contract states that their project management expenses are $5,000 per week and their overhead expenses are another 15% on top of that.
PROMOTION
The Owner has asked them to do some work in the building’s courtyard. After reviewing the drawings and scope, the Contractor has estimated that the courtyard will be done twelve weeks after the original forecasted completion date.
The Contractor then includes a revised schedule upon submitting the change order proposal. In addition to this, they’ve claimed twelve additional weeks’ worth of time in the C.O., plus $60,000 in management costs [$5,000 x 12 Weeks] and $9,000 in overhead expenses [$60k x 0.15].
For the Contractor to have a leg to stand on, they must be actually hitting milestones and completion dates along the way already! Without this, the Client won’t trust what the schedule says and doesn’t legally need to trust it if there’s a history of delay on the project.
9. Include A Detailed Scope Of Work In The Change Order Documents
This one’s a combination of many points above. A change order submitted by the Contractor should include the following:
- A summary of the scope of work, as understood by the Contractor.
- Marked up drawings, specifications and other project documents.
- An updated schedule showing the impact that the additional work will have.
- Based on this schedule, a time extension request.
- A breakdown of all costs by task and type.
- Specific exclusions related to performing the work.
By including all of this information, the Contractor has covered themselves and is protected from many potential problems later. In turn, the Owner can understand the additional work on a much more comprehensive level.
10. Backup Documents Are Essential – Payroll, Receipts, Photos, Etc.
Last but not least…document, document, document!! This is, of course, after a change order is officially executed.
During the performance of work, contractors MUST take plenty progress showing not only the work in progress, but the conditions before it began, the conditions surrounding/adjacent to the work, and the labor, equipment, materials, tools, etc, in action at various stages of the additional work.
All labor costs should be backed up by payroll reports and other costs associated with it like taxes, benefits, insurance, etc. Material and equipment invoices provide backup for the Contractor to support the work taking place.
If the Client has questions later, needs to review specific costs or even just wants these documents before releasing payment, there will be much less room for speculation, misunderstandings and disagreements when all of this information is clearly documented.
In Summary
Change orders can be scary. They change how a project will move forward, they cost the Owner more money and they increase a Contractor’s time, costs and resources. It’s essential to get change orders right for maximum performance and profitability. Using the change order best practices we’ve discussed in this article, you’ll stay protected from change-orders-gone-bad and will be prepared the next time a change order arises – whether you’re an owner or contractor! I hope you’ve found this article helpful and thanks a lot for reading.
