Change Order in Construction; Comprehensive Guide 2024

In each of these scenarios, the contractor ultimately submits a proposal to the architect, documenting the cost and time implications of the proposed changes. It becomes the responsibility of the architect to diligently review this proposal and inform the owner of its reasonableness. An essential aspect is ensuring that the contractor isn’t asserting a claim for work already mandated by the contract documents, or including costs, such as general conditions and overhead, which are encompassed within the OH&P percentage or for other work already contracted.

Furthermore, the architect needs to consider the proposed impact on cost and time. Are the presented costs reasonable? While a detailed estimate might not be mandatory, the architect must assure the owner that the costs are justifiable, the quantities are accurate, and the costs comply with the contract. The architect, even if not experienced in schedule logic, must assess whether the proposed schedule impact is reasonable. When evaluating the time impact, several factors, including critical path analysis and the potential for the contractor to mitigate delays, come into play.

If the architect does not entirely agree with the contractor’s proposal, they must respond in writing, outlining their reasons and making efforts to reach mutually agreeable terms. Upon agreement with the contractor, the architect must notify the owner of the reasons for the change, review the cost and time implications, and seek the owner’s approval for the proposed adjustments to the scope, contract sum, and contract time.

Once all parties are in concurrence, the architect proceeds to prepare the change order in construction. The description within the change order in construction should be unambiguous, concise, and comprehensive, ensuring it’s understandable to a third party. This description should cover three crucial aspects: the scope of the change, its impact on cost, and its effect on the project timeline. The scope should reference the specific Contract Documents that will be altered, as well as the architect’s documents describing the change. As for cost and time, the change order in construction should specify the contractor’s proposed adjustments to the contract sum and schedule, referencing their proposal.

In the final stages, the change order in construction should list any accompanying attachments, including supporting documents, each accompanied by its date. Once the change order form is completed, the architect compiles all attachments and issues the change order in construction. It is customary to produce three copies: one for each signatory. Typically, the architect signs first, followed by the contractor, and then the owner. Alternatively, if agreed upon, the entire process can be handled electronically in PDF format.

Understanding Change Order Costs

As previously mentioned, construction change orders must encompass three distinct categories of costs: direct costs (the most straightforward to comprehend), indirect costs, and consequential costs (the latter two can be notably challenging to quantify).

Direct Costs: These are the expenses directly associated with implementing a change order in construction. Some direct costs are readily apparent, such as materials, labor, and equipment. Others may be less conspicuous and involve professional fees for redesign, fuel for equipment operation, staff hours dedicated to coordinating and communicating the change to engineers and on-site crews, as well as expenses like security, project insurance, sales tax, permit fees, licenses, safety measures, cleanup, and utilities.

The calculation of certain direct costs necessitates consideration of a multitude of factors. Here are the approaches for calculating various direct costs:

• Determining Construction Labor Costs: Labor costs encompass labor hours and rates, labor supervision, project supervision, and benefits like sick pay, insurance, retirement, and employer taxes.
• Pricing Construction Materials: Calculate the base cost of materials by using vendor price quotes or actual costs. To this base cost, add expenses for transporting, storing, handling, and inspecting materials.
• Assessing Costs for Rented and Owned Construction Equipment: When assessing equipment costs related to change orders, various factors come into play. The key consideration is whether the equipment is rented or owned.

For Rented Equipment: Calculate the cost of rented equipment by first determining an hourly rate, which involves multiplying the rental fee by the number of hours required for the change order in construction work. Then, include operating costs like fuel and lubricants.

For Owned Equipment: If you own the equipment, specify your pricing method in the contract, unless you have already established your equipment cost recovery rates for allocating equipment to a project. This recovery rate should encompass factors like purchase price, sales tax, depreciation, ownership costs (e.g., insurance, licensing, maintenance, overhauls, and repairs over the equipment’s expected lifespan), and financing or opportunity costs.

If you lack an established recovery rate, you can calculate one by referencing industry sources like the AED Green Book, Rental Rate Blue Book, and Army Corps of Engineers Equipment Rates. To derive a maximum hourly rate for the change order in construction work, divide the monthly rate by the available working hours in a month (typically 176). Usually, you must cap the rate at 50 percent of the machine’s market value when first used for a change order in construction. In cases of less complexity, a general rule of thumb is to price owned equipment at 50 to 60 percent of the retail rental rate.

Whether you rent or own equipment, it’s essential to add operating costs, which comprise fuel, oil, parts, fluids, shop space, and storage. Moreover, when calculating equipment costs in the context of change orders, you must apply different rates based on the equipment’s status (standby, idle, or active). Your rate for a specific machine should account for its level of wear and tear, encompassing factors like depreciation, capital costs, overhead, indirect costs, labor and parts for scheduled overhauls, and fuel.

Indirect Costs: Indirect costs encompass overhead, profit, and markup. While these costs are indirectly linked to change orders, they must be factored into the pricing of change order in construction.

Overhead: This pertains to administrative expenses incurred in the overall operation of your business, but that cannot be allocated to any single project. It includes costs like office rent, office equipment, utilities, salaries and benefits of management and administrative staff, advertising, taxes, training, business licenses, vehicle insurance for staff, legal and accounting fees, association dues, and service or warranty work on current equipment and structures.

Typically, larger companies have higher overhead costs than smaller firms. To calculate your overhead percentage, divide your total company revenue by total overhead costs.

Net Profit and Gross Profit: Net profit is the amount left after subtracting all expenses and costs, including overhead. The average net profit typically ranges from five to ten percent of total revenue. Gross profit, on the other hand, is the amount before deducting costs and expenses, including overhead.

Markup: Markup involves adding a specified percentage to costs (both direct and overhead) to establish a profitable selling price. This markup must also be considered when setting change order prices. A common industry standard for markup is 15 percent. To achieve a desired profit margin, the markup percentage must exceed the profit margin percentage. For instance, to attain a 20 percent profit margin, you would need to mark up costs by 25 percent and price the change order in construction accordingly.

The difference in these percentages arises because the profit margin increases linearly, while the markup percentage increases at a higher rate. The competitive market and economic conditions influence pricing, and the markup and profit margins applied to bids should be carried over to the pricing in change order in construction.

In highly competitive markets or during economic downturns, contractors may price their bids with lower profit margins. Similarly, when competition and transparency push owners to resist higher markups on standard items, contractors may apply nominal markups to materials.

Consequential Costs: These are the indirect costs, comprising both hard and soft expenses, arising as a result of a change order in construction. These costs are referred to as “consequential” because they are the direct consequences or cumulative effects of the change order itself. Consequential costs encompass factors such as project delays, overtime, training, morale, crew reallocations, and inefficiency.

They also include labor productivity losses due to the stacking of trades, where multiple subcontractors work in a confined space, introducing safety risks and challenges in accessing materials. Industry literature, surveys, court cases, and case studies provide guidance on calculating the impact of these change order-related factors.

Methods like the Cumulative Impact Approach, Measured Mile Approach, and quantifying the impact of trade stacking have been developed by experts to determine the probability and costs of change order in construction impacts. To estimate the cost of these factors, you should consider their impact levels, such as minor, average, or severe.

For example, severe stacking of trades may result in a 30 percent productivity loss, while minor fatigue could lead to an eight percent reduction in productivity, as reported by research from ELECTRI International. When calculating consequential costs for a change order in construction, it’s essential to substantiate your figures with authoritative references. This ensures that, in case of disputes, your calculations are demonstrated as fair and reasonable.

Pricing Models: Forward vs. Backward Pricing for Construction Change Orders The pricing strategy for construction change orders is highly dependent on timing. Forward pricing occurs before the commencement of change order in construction work, while backward pricing occurs after at least some of the work has been carried out.

In backward pricing, you have the advantage of firsthand experience to calculate the price, whereas forward pricing relies on estimates and industry norms. Both pricing approaches factor in direct, indirect, and consequential costs. Whether you choose forward or backward pricing for your construction change order in construction, it’s crucial to identify the time and productivity impacts on costs.

In cases where actual data is unavailable, the cost flow technique can assist in forward pricing. Often presented graphically, cost flow examines the distribution of construction expenditures over time, illustrating the budgetary requirements at key milestones to ensure the project’s successful completion. These calculations should encompass both direct and consequential costs.

It’s important to distinguish cost flow from cash flow, which deals with the inflow and outflow of funds over time. By comparing cash flow to cost flow in a construction project, you can determine whether sufficient funds will be available as costs are incurred. If a deficit is identified, project adjustments may be necessary.

In the context of a change order in construction, owners and contractors can compare the revised cost flow to the original cost flow to gauge the impact of the change, aiding in the pricing process. However, to make this comparison meaningful, detailed data on productivity changes resulting from the change order in construction is essential.

Avoiding Disputes

Change order in construction often become the subject of legal disputes, primarily due to disagreements between contractors and owners regarding the need for compensation or schedule adjustments, or whether the change falls under the original contract provisions.

According to the Arcadis 2020 Global Construction Disputes Report, the average value of construction disputes globally was $30.7 million, with an average dispute duration of 15 months. Consequently, both owners and builders have a strong incentive to understand the typical causes of disputes to prevent them.

Many of these disputes can be traced back to deficiencies in the contract and bid documents, as their implications may not be fully evident to the parties at the time of signing. In cases where certain project aspects aren’t clearly defined from the outset, issues often arise when plans, designs, specifications, and more require modifications at a later stage.

Here are some common factors that contribute to construction change order-related disputes:

1. Incomplete Design: Plans and specifications may contain errors, inconsistencies, or insufficient details, making it challenging for contractors to accurately price or execute the work. This could involve inconsistencies among specifications, such as those between initial and final finish schedules.
2. Poor Design Coordination: Architects, engineers, and consultants may assume that others are responsible for certain aspects of the work, leading to gaps in plans or conflicting designs that contractors struggle to interpret or resolve.
3. Specification Issues: Problems with specifications often arise from using generic language, not accounting for variations among manufacturers, relying on outdated specifications, or specifying requirements that do not align with available products.
4. Schedule Changes or Delays: After the project begins, owners might seek an earlier completion date without wanting to pay extra for acceleration. Conversely, contractors might fail to meet deadlines but argue for full compensation, citing extenuating circumstances.
5. Inadequate Disclosure and Unknown Conditions: Discovery of an issue during construction, whether due to a lack of disclosure or a genuine lack of prior knowledge, can lead to disputes. For example, poor subsurface conditions may not have been apparent during bidding.
6. Owner-Initiated Changes: While contracts typically allow owners to request changes while compensating the contractor for added costs, disputes can arise when owners claim such changes don’t warrant additional compensation.
7. Unfair Restrictions: Unjust regulations in government or public projects can impose constraints on contractors, such as mandating the use of specific proprietary options or limiting supply sources, leading to disputes.
8. Unwritten Orders: Contractors should ideally include contract provisions requiring written change orders for any revisions or additional work. However, field conditions, urgency, or oversight may lead to verbal orders, potentially waiving certain contractual rights.
9. Incorporate Realistic Change Order Clauses: Ensure that the authorization clause for change orders is practical. This clause often requires approval from someone who may be off-site or in a different time zone. Therefore, it’s wise to include an alternative procedure that designates a secondary authorization contact for urgent changes. This provision allows for timely contractor payments during unforeseen circumstances while protecting the owner from excessive costs.
10. Promote Peacekeeping Measures: Delays and work stoppages are major contributors to change order in construction disputes. These interruptions often occur because most contracts force contractors to implement changes, regardless of compensation terms. This puts considerable financial strain on contractors, which can lead to disputes. To mitigate such issues, consider incorporating language in the contract that specifies the owner’s commitment to pay a certain percentage of change order in construction disputes occurring during construction. Additionally, both parties should retain the right to dispute each matter.
11. Establish Pricing Standards: Once an owner enters into an agreement with a contractor, they relinquish the ability to seek competitive bids from other contractors. Consequently, contractors determine their own change order prices, which may lead to accusations of price gouging. To prevent disputes, include a comprehensive schedule in the contract detailing labor, profit, overhead, and markup rates for the project.
12. Pre-Project Issue Identification: Before commencing the project, thoroughly review the plans and specifications to address any ambiguities, errors, omissions, or conflicts. Submit any change orders promptly, as delaying them after construction begins increases the risk of cost overruns, schedule delays, and friction between the owner and contractor.
13. Understand Legal Remedies: If you’re a contractor facing difficulties in resolving a change order in construction dispute, you have several legal options at your disposal, such as using a mechanic’s lien, a stop notice, a bond, or a warranty claim within a specified time limit. Different jurisdictions have varying regulations regarding liens, including the requirement for preliminary notices to preserve lien rights. Comprehend the specific laws in your region.
14. Enhance Change Order Efficiency with Technology: Implement construction project management software, takeoff and estimating software, or building information modeling (BIM) tools to automate and streamline the change order creation and management process.
15. Maintain Regular Communication: Organize stakeholder meetings at the project’s outset, conclusion, and throughout its duration to ensure that everyone remains informed about the scheduled work. Stakeholders include the owner/client, general contractor, and subcontractors.
16. Seek External Input: Arrange for peer or third-party reviews of drawings, specifications, and other critical documents to ensure completeness and accuracy.
17. Stay Organized: Develop and utilize checklists to ensure all necessary information is included in drawings, specifications, and contracts.
18. Continuous Learning and Training: Attend workshops and training sessions on document quality and development to educate team members on the appropriate processes and information requirements.
19. Enforce Accountability: Avoid proposing or accepting open-ended change order in construction without predefined deadlines or budget limits.
20. Demand Clear Documentation from Contractors and Subcontractors: Ensure subcontractors provide transparent documentation of hourly rates, material costs, and quantities for extra work. If feasible, request visual documentation, such as photos and videos, of their work throughout the project.