Have you heard the definition of estimating? It is the art of starting from a random point and then proceeding with great accuracy.
That comment may be a little cynical, but it reflects the fact that estimators make assumptions, and sometimes errors, in preparing a bid. Some companies keep records to reflect historic pricing, for example, on labor productivity. They may also consider the circumstances of the project, among them, the current volume of their work, their overall profitability, their desire to get into a new market, their knowledge of local labor conditions and the potential for price escalations.
After the budget is prepared, the contractor may make an informed judgment of a “sell price,” increasing or decreasing the lump sum price to account for home office overhead and profit. The pricing of change orders does not necessarily follow the same estimating pattern.
There has been substantial litigation over the proper method for pricing deductive modifications. The standard, at least in federal government contracting, is “reasonable value.” Generally, whatever price the contractor used in its bid for the deleted item or deleted work scope, the deduct will be the cost the contractor would have incurred if the deleted work had been performed.
The courts are concerned that a contractor’s position not be improved by a deductive modification. If the contractor underbid an item or mistakenly omitted an item entirely, the argument is that the contractor should not be relieved of that error because the owner deleted the item.
In one case, an electrical contractor had budgeted $34,800 for underground duct and cable, and the owner ordered this work changed to overhead cable. The government estimated the deleted underground work at $60,800, and that figure was held to be reasonable. The contractor was not allowed to use its lower figure and thereby reform its underestimate.
This “would have cost” standard for deductions has some parameters that are worth noting. The primary consideration is the contractor’s cost, not the industry’s “reasonable value.” For the same reasons that bids differ among competitors, even without mistakes, some contractors are more efficient or have greater buying power than others.
If you can show that the deduction, as applied to you, should be lower than someone else’s estimate, you should prevail. For that reason, the courts do not like to use prices from industry manuals.
Deletion of a “severable” line item
There are contracts where the owner demands separate pricing for discrete bid items. With some of these contracts, the owner reserves the right to award those bid items separately. In that case, there is a danger for the contractor if it submits an unbalanced bid—the owner may award only the lower priced line items.
When an owner later decides (after award) to deduct or delete an entire severable bid item, the value placed by the contractor on that item will control regardless of the “would have cost” standard.
In Gregory & Reilly Associates Inc., the Federal Aviation Agency issued a contract that had four discrete phases, with a price for each. The deletion of one of the phases resulted in a reduction in price equal to the stipulated amount regardless of the “would have cost” amount.
Keep in mind that a line item in a schedule of values is not necessarily a severable item. The schedule of values is principally to be used for billing and is not an agreement between the parties of the true value of the line items.
Many contracts contain a “termination for convenience” clause that permits the owner to terminate the contract in whole or in part. The question then becomes whether a reduction in scope of work caused by a deductive modification should be treated as a change order or as a partial termination. Determining which of these two concepts applies can translate into a major difference in the deductive price.
A change or a partial termination?
In a recent case, a contractor had completed the major portion of its contract when the owner decided to cancel the remaining work. The contracting parties presented two very different pricing methods. The contractor wanted to keep what it had been paid, based on approved percent completion, and offered the remaining percentage as the deduct. The owner wanted to evaluate the uncompleted work on the basis of what it should have cost the contractor. The difference between the two methods was significant. The court had to decide whether the pricing should be valued under the changes clause or the partial termination clause. If it were considered a termination, the standard to be used in valuation is “equitable adjustment.”
There is no bright line test for determining which clause should apply. A deletion of an entire unit price item or a severable line item may be considered a partial termination, but if there is a substitute of one item for another, it is probably a change. Some court opinions suggest that, if a deletion of work occurs because of a change in the specifications, it will be treated under the changes clause. On the other hand, a specific directive to delete work, without there being a modification of the specifications, will be treated as a partial termination.
The most common criterion is quantitative: Is the deletion major or minor in relation to the contract as a whole? There are cases where the court was influenced simply by whether the owner called the deletion a deduction or a termination.
There are two other ways to analyze this issue:
- Would your bid be reconfigured if the deleted work had not been part of the original bid drawings and specifications?
- To what extent does the deletion affect your overall allocation of manpower, equipment and supervision? With either of these approaches, would your overhead and project management costs increase, decrease or remain the same?