June  29, 2001

Bulletin #48: The Change Order

Things had been a little slow at ZZZ Sheet Metal, and management was getting nervous. The cooling of the economy had caused a number of potential projects to be shelved. Developers were also having difficulty obtaining financing, and vacancy rates on existing projects were up. ZZZ management was considering lay-offs for the first time in years.

Given these business conditions, ZZZ management was ecstatic when presented with the opportunity to install the HVAC system on a large hotel/conference center. The developer was a national firm that had secured a large public subsidy for the project. The general contractor was also a national firm that had done very little work in ZZZ’s market. The sheet metal subcontractor responded promptly to the bid package, and within weeks, learned that its pricing had been accepted.

The general contractor then presented a proprietary subcontract form that contained the following language: The Subcontractor warrants and represents that it has examined all plans and specifications applicable to the Work, and from its own investigation has satisfied itself as to the nature and location of the Work, and all matters which may in any way affect the Work or its performance, and any and all errors, ambiguities and inconsistencies therein have been reported to the Contractor in writing, and resolved to Subcontractor’s satisfaction . . . Should Subcontractor be delayed in the performance of the Work by any cause other than the intentional interference of Contractor, Subcontractor shall be entitled, as Subcontractor’s exclusive remedy, to an extension of time reasonably necessary to compensate for the time lost due to the delay, but only if Subcontractor shall have notified Contractor in writing of the existence of the delay within forty-eight (48) hours of the occurrence of the event giving rise to the delay.

The subcontract was long, complex and seemed fairly one sided, but ZZZ needed the work. The subcontract was signed, and returned to the general contractor. ZZZ set about ordering materials, scheduling its workforce, and preparing to work on the large project. The project was troubled almost from day one. Environmental contamination was discovered during excavation, and the clean-up process pushed the construction schedule back by three months. The city and the developer were simultaneously in court over the huge costs associated with the clean up. With the litigation pending, the city withheld its subsidy funding, and the construction lender refused to fund if the city dollars were not provided. Another three-month period was consumed while the financing problems were resolved. When construction finally began, significant defects in the design of various building systems began to become apparent. With regard to its work, ZZZ had noted, among other things, that the fan motor specifications and duct dimensions appeared grossly inadequate to achieve the project’s air-handling specifications. The ZZZ project manager informed the general contractor’s representative about his concerns with the plans and specifications, but was told to proceed in accordance with the plans.

ZZZ had completed approximately seventy-five percent of its work when its project manager was called in for a meeting with the general contractor. The ZZZ manager was told that deficiencies had been found in the design of the HVAC system that would have to be remedied immediately to maintain the project schedule. The subcontractor was provided with extensively modified plans, and an accelerated schedule. The ZZZ manager requested that a change order be issued for the additional work, and the general contractor assured the subcontractor that a change order would be approved. However, the corrective work had to begin immediately. When ZZZ finally submitted its formal change order request with pricing, it included costs related to the initial delays in the project, along with labor, material, and associated costs for the changed work. The request also included an extension of the construction schedule.

After sitting on the change order request for a number of weeks, the general contractor rejected it. It insisted that the subcontractor had a contractual duty to verify the adequacy of the plans and specifications. It was noted that the subcontractor had actual knowledge of the defects in the design well before it requested the change order, and had provided no formal notice of the defects. An extension of the schedule was approved along with only some of the labor and material costs. ZZZ had little choice but to proceed, although the subcontractor indicated that it was reserving its rights to pursue a claim for additional damages. The work continued, although the relationship between the general contractor and the subcontractor was very negative throughout the remainder of the job.

Following substantial completion, ZZZ asserted its claim for change compensation under the dispute resolution procedures set out in the subcontract. The subcontract form provided that the subcontractor’s first recourse was to the architect. Unfortunately, ZZZ’s claim was based largely upon design defects and deficiencies. The architect was not inclined to approve a claim based at its core upon a condemnation of the architect’s competence. The various claims were rejected primarily on the basis of failure to timely report issues with the design, and failure to give timely notice of claims. ZZZ’s final recourse under the subcontract was binding arbitration, and it commenced an arbitration proceeding. After three days of hearings, the arbitrators determined:

A. That ZZZ’s claim for delay damages related to the initial project start-up was untimely, and would be rejected. B. That the subcontractor had assumed certain design review responsibilities under the subcontract, and most of the design deficiencies in the plans and specifications should have been obvious to an experienced HVAC subcontractor performing a careful review. The arbitrators found that ZZZ could have prevented the work from proceeding under the defective plans and specifications had it exercised reasonable care and competence in its initial evaluation of the plans, and followed through on its reporting obligations concerning the defects. C. That the conversation between the ZZZ project manager and the general contractor’s representative, in which design defects were noted, did not constitute a lawful notice under the terms of the subcontract (any such notice was to be in writing), and would not be considered a fulfillment of the subcontractor’s duty to notify the contractor concerning design defects. D. That the change order, as approved by the general contractor, would be enforced, but no additional compensation would be payable to the subcontractor with regard to the additional work required due to the change.

For ZZZ, it was a stinging defeat. In handling changes to the work, the subcontractor must focus, among other things, upon the following questions:

1. How are changes to be handled under the terms of the subcontract? Is there language in the subcontract that would prevent recovery for delay damages, lost profit, additional overhead expense, and other economic implications of a change beyond direct labor and material costs?

2. What timeline applies for submittal of change order requests, and will the subcontractor lose its right to recover if it fails to comply with that timeline?

3. Has the subcontractor taken into account all of the implications of the change in making its request for compensation? Along with time and materials, has it requested compensation for less obvious implications of the change (including scheduling issues, coordination issues, additional overhead, lost profit, etc.)?

4. What are the implications under the subcontract of failing to agree to a change order? Does the subcontractor have a meaningful remedy if there is no agreement?

Changes orders are a fact of life, and will continue to present contractors and subcontractors with some of their greatest challenges in project administration. Given the likelihood of changes on any project, the subcontractor would be well advised to understand, at the beginning of each project, how it intends to deal with changes in the work, based upon the subcontract it is executing. 


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