From RFI to Payment: Navigating the Full Change Order Lifecycle
Author, Anne Wright, Surety Relationship Executive, Rancho Mesa Insurance Services, Inc.
I recently had the pleasure of interviewing Luke Thompson, Esq. who is uniquely qualified to help us understand the nuances of change orders. Based on our conversation, I’ve put together an overview of what all subcontractors should know about change orders.
First, it is important to know what is in the general contract, whether it is a public or a private job, and whether it is a design-build or design-bid-build project.
Most subcontractors understand the basics of a change order, but often times they fail to fully understand how they affect the job’s contract.
A change order is an amendment to an original construction contract or a subcontract that alters a given project’s scope, cost, materials, design, or schedule. These changes are sometimes also called contract modifications or contract supplements. There are subtle differences, but for the purposes of this discussion, “change order” is sufficient.
For most subcontractors, they may only use the change order process when they are seeking additional money for work that was not in the original scope (i.e. scope changes). But, there is a lot more that can and should be done when there is a change order.
The Change Order Process
First, it is important to document all change orders for the entire project. Sometimes, the change request comes from the owner; sometimes, it comes from the general contractor; and sometimes, it is the subcontractor who initiates the change order process. Regardless, there are specific contractual and sub contractual processes that must be followed.
In a typical fixed price, fixed scope project, the owner/agency is usually responsible for the design. Any changes to the original scope, design, or schedule of the project need to be approved by both the design team and the owner (who is typically responsible for the costs related to the change order). However, if the change is the result of the prime or general contractor’s actions (e.g. scope gap in the general contractor’s bid or delays not caused by the owner/agency), then, the general contractor might be responsible for any resulting costs.
In a design-build arrangement, the prime or general contractor is often responsible for the costs if the change is initiated by the owner or agency.
There are budget allocations, contingencies, and many other factors that can affect who is paying for the change. It is critical that the subcontractor understands who is paying for the change order and what other impacts the change will have on the scope, design, or schedule. In the end, the subcontractor ultimately needs to sell the change order to the general contractor, even the zero-dollar ones. And, if the general contractor needs to sell the change order to the project owner, it can be a recipe for delaying payment or even having the change order rejected. While a subcontractor may be able to pursue a claim for the change order, this is often a costly and time-consuming process.
In general, when a subcontractor submits a change order, it goes to the general contractor for initial review. Because the general contractor has to submit the change order request (COR) to the design team and get approval from the owner/agency, a poorly drafted COR will need to be redrafted by the general contractor, something that invites scrutiny and often skepticism. It is much more efficient to have the COR properly formatted and supported than go through the revision process.
If the general contractor accepts the COR, that does NOT mean it is approved. The general contractor must then submit it to the owner/agency for approval. Typically, a general contractor will need to pitch the COR to the owner and design team. A properly structured and supported COR makes this process much easier. Once the owner/agency approves the COR, they issue a change order to the general contractor, often times that change order is bundled with other CORs that were approved. Then, the general contractor issues a change order to the subcontractor. Until that subcontract change order is executed by both parties, there is no official change to the subcontract. That is why a subcontractor cannot bill against a change order until the cycle is complete.
The whole cycle rarely takes less than a month, and often takes much longer to complete. In the meantime, the subcontractor is likely to have been directed to perform and may have already completed the work. Since most subcontracts require subcontractors to perform when directed, a subcontractor needs to be mindful that payment for the subcontract change order may take 30, 60, or 90 days, or longer. The labor costs alone (assuming a subcontractor is holding off on paying vendors until it gets paid) can be crippling.
Change Order Procedures
Perhaps the single biggest mistake subcontractors make when dealing with change orders is that they drag their feet in issuing CORs. The failure to timely submit a COR can result in a rejection of the COR outright, even if the work has been completed. Most contracts and subcontracts have strict timelines (often 5 days or less) when notice and the COR itself must be submitted. Few project managers are aware of these timelines. In most cases, it ends up not being a major problem, especially when it is clearly additional work. But sometimes, particularly with respect to disputed issues involving significant schedule impacts, this can create an enormous problem for everyone.
Read the subcontract carefully. Talk to the on-site foreman daily. And, send notice as soon as the issue is known. When the costs cannot yet be determined, send an email anyway letting the general contractor know that a changed condition has been discovered and that the cost and schedule impact are being investigated. The best way to send notice is typically through a carefully designed request for information (RFI). The RFI is what primes the pump for most change orders and many subcontractors fail to take the opportunity to draft their RFIs in a way that compels the general contractor, owner/agency, and design team to acknowledge that a change order is inescapable.
The Full Potential of a Change Order
The change order does much more than simply capture additional costs for the subcontractor. It can be used to capture additional time, scope changes that favor the subcontractor’s installation, or even credits (i.e. deductive change orders) that might advantage the subcontractor.
While not every change warrants a change order (sometimes it is cheaper to just roll with the change), every change does warrant analysis. Many times, subcontractors are only capturing the direct costs of the changed condition but fail to properly assess the impact on the schedule or the subcontractor’s overall performance. Of course, being overbroad in a COR can get a lot of pushback and skepticism, leaving money or time on the table should never be an option.
What A Proper Change Order Request Should Capture
A proper COR should have all material, equipment, and labor hours involved, obviously. It should also include the schedule impact, which is almost always more than just the time to complete the work. A COR should also include, when allowable, supervision, delivery costs/fees, cleanup, planning, and project management. In addition, a subcontractor should include the allowable overhead and profit.
It is also important to consider that when the frequency or size of the change orders begin to stack up (e.g. more than 10% of the original subcontract value), it is time to meet with the general contractor and discuss inefficiencies. There is a meaningful difference between a project that was bid at $1M and one that is $1.5M, for example. If additional time is provided and the impact is minimal, then there may not be the need to push the issue, but subcontractors should not allow general contractor s to force them into performing subcontracts that are materially different in size or scope without expecting someone to pay for the impact on the subcontractors operations.
CA New Change Order Law
Civil Code 8850 or the Private Works Change Order Fair Payment Act (Senate Bill 440) is designed to establish clear deadlines for change order reviews to prevent contractors and subcontractors from financing disputed extra work. The law requires (in part) that:
The owner must provide a written response within 30 days, identifying approved and disputed items.
Undisputed amounts must be paid within 60 days of the owner’s response.
If the owner fails to respond within 30 days, the contractor or subcontractor may have the right to suspend work without penalty.
This law does require that the claim for extra work be submitted via registered or certified mail, which is an uncommon practice in the digital age but subcontractors should be aware of this requirement.
The full impact of the law on industry practices is yet to be determined. But, if a subcontractor is having a difficult time getting change orders approved, it might be worth evaluating whether or not this law can be used to get the owner to timely respond, approve, and ultimately pay the subcontractor’s change order.
In California, the construction industry has moved, in recent years, to some very specific standards when it comes to change orders. It is critical that subcontractors read their subcontracts and the prime contract carefully to understand the change order requirements. Most subcontracts have very stringent requirements for notices like what can be included and allowable markup. Sadly, in many situations these restrictions make it difficult, if not impossible, to capture all the true costs involved for a subcontractor. In most cases, subcontractors are probably losing money on change orders. The earlier that a subcontractor can submit a properly supported change order request, the greater likelihood of getting it approved as submitted.
This makes it all the more important to try and get ahead of the curve and use the RFI and COR process to your advantage. Set your general contractor up for success by carefully articulating why the COR includes all the costs and impacts it does and then provide as much supporting documentation as possible. Then follow up with friendly phone calls and emails, building relationships and trust. Good luck out there.