Change orders can be expected in construction, including error and omission corrections in the contract documents, changes in design, taking account of changed conditions, and change orders for claims (overtime, delays, and interferences).
Regardless of the motivating cause for the modification, the resulting change is often a net change—something originally contemplated is replaced. Accordingly, the value of the additive change is the price of the new work, which exceeds the price of the original. But what happens when the result is a net reduction in cost?
The basic problems
For additive change orders, the courts tend to look to either the estimated value of the change or to actual costs. Either approach makes sense. However, for deductive change orders, the courts evidence some confusion, as the three following examples demonstrate.
Example 1: The bid documents required the contractor to submit an itemized breakdown of major work components. When a portion of the work was deleted, a dispute arose about its valuation. The contractor had shown a $20,000 value for the deduct, but claimed that the work was only worth $10,000.
The differential reflected an unbalanced bid. Here, the court found that the contractor should be held to its contractual representation of value, and so the owner won. The result: The contractor’s bid was found to be determinative.
Example 2: The owner proved that a reasonable value of the deduct was four times the contractor’s itemized value. There, the court ruled that a deduct should be based on “reasonable value,” and the owner prevailed.
Example 3: At bid, the contractor had reason to believe that a reduction in work would be ordered. Accordingly, the contractor’s low bid was based on this expectation. Later, when the deduct came and the owner wanted a credit, the contractor argued that a further reduction in its price would be unfair as the owner already had the benefit of the savings. The court agreed.
How do you reconcile these cases? Perhaps the best stab at an explanation comes from scholars in the field.
When the contractor has saved costs, deleted work is priced at the amount it would have cost the contractor had it not been deleted....
The major application of the “would have cost” rule occurs in deductive changes or changes where one portion of the work is deleted and other work is added in substitution. (Cibinic and Nash, Administration of Government Contracts [3rd ed. 1995])
This summary of the law helps, but the “would have cost” rule varies from case to case. Mostly, the outcomes of these cases seem to turn on the quality of the evidence presented both using the bid estimate and industry guidelines. The basic problem the courts grapple with is whether the contract should be strictly enforced even if unfairness results to one of the parties.
Is it only a change?
In one interesting case, the owner wanted a wall built around a courthouse. Most of this wall was to be brick, but the wall around the main entrance was to be stone. The contract was based on unit prices.
To get the low bid, the contractor gave under-cost unit rates for the minor stonework. After award, the owner issued a change deleting the brick, and ordering the entire wall to be constructed of the underpriced stone.
The court did not hold the contractor to its contract unit prices, as that would have been enormously unfair, nor did the court use the “would have cost” rule to value the deleted brick. Instead, the ruling stated that there was a material misrepresentation by the owner of quantities, and therefore the contract was void.
Translated: The contractor’s presentation at trial was very good.
Other approaches could have been used. In many contracts, there is a provision for “termination for convenience” (T for C). Such a clause refers to termination “in whole or in part.” Where a major line item or portion of the work is deleted, this type of clause may be available for your use.
Pricing a partial termination is very different from a deductive modification. With a T for C, the contractor may be entitled to internal engineering charges, preparatory expenses relating to the deleted work, costs associated with settling claims of subcontractors and suppliers, and other settlement costs including accounting, clerical, and legal.
The difference between a deductive change order and a T for C is qualitative and quantitative. What is the totality of the effect on the project (cost, labor disruption, schedule, etc.)?
A troublesome issue arises when an owner issues a deductive change order to award that portion of the work to another contractor. Such action could be considered a breach of the changes clause and therefore a breach of contract, entitling you to lost profits.
Suggestions on costing a deduct
What are the effects on your labor, equipment, supervision, and field office overhead? Does the removal of work affect your home office overhead or the completion schedule? Of course. Look at what you have budgeted for the work that was deleted. But it may be wise to re-estimate that part of the work to check the budget.
In some instances, it may be advisable to re-estimate the entire job. And always do a “plan versus actual” comparison. Ask yourself what adjustments need to be made to account for the deduct.
In projects for the federal government, deductive modification issues have been litigated often. As a result, there is substantial case law, which can be used for guidance. With nonpublic construction, the law is less clear, but the federal case law can be influential in helping you analyze your position.
Design/build contracts offer an additional range of considerations. Aside from the deleted work, you have expended hours in design, engineering, negotiating with manufacturers and suppliers, etc. The law concerning design/build is still developing. It is made more complex because each of these kinds of contracts contains unique elements.
Much of the case law on deductive modifications concentrates on the contract language. When you confront this issue, first re-read your agreement. Then, analyze your costs and other potential impacts. For minor deducts, there should be little problem.
For major deducts, you may have options of which you are not aware. Does the issue fall under the changes clause? Is it a T for C? Is it a cardinal change? Is a material misrepresentation involved? Is it a breach of contract?