Changes and Extra Work – Is There a Limit?

Joseph R. Young | Smith Currie | October 1, 2018

Design and construction changes can be a challenge for everyone involved in a construction project. Designers and contractors endeavor to deliver a project that meets the owner’s needs, budget, and aesthetic considerations. As a project comes to fruition, the project frequently changes, and the parties must address and resolve the financial considerations of those changes and implement the changes at the project level. Often times the most critical aspect of a contractor’s financial success or failure of a construction project is its ability to manage changes. Contractors are sometimes faced with changes that are beyond the reasonable expectation of the original undertaking and have significant planning, scheduling, and cost implications that may not be considered or addressed in the contract’s changes clause. Changes of this magnitude may be considered “cardinal changes” and provide the contractor with recourse beyond restrictions imposed by the contract’s changes clause. But cardinal change is a risky basis for a contractor to refuse to perform additional or changed work. Even major changes can probably be more safely handled within the terms of the contract’s changes clause.

A “cardinal change” is a change or the culmination of changes ordered by the owner that are beyond the scope of the contract and that may constitute a material breach of contract. To be considered a cardinal change, the change or cumulative effect of the changes must be substantially different from the original undertaking such that the contractor is subjected to obligations that far exceed any obligations imposed on the contractor in the original contract or constitute such a drastic modification that result in a new and substantially different undertaking. Some courts have found the owner in material breach of the contract for ordering a cardinal change. The owner’s material breach either excused the contractor from further performance or awarded the contractor with additional compensation to account for the contractor’s damages in implementing the cardinal change.

Under a standard changes clause, the owner generally has the right to change the work or order extra work. In turn, the contractor is generally entitled to additional time and compensation associated with that change or directive.

The devil is in the details. To what extent is the owner entitled to change the work? And how much additional time and compensation is the contractor entitled? The answer is, it depends. There is no bright line rule about what could be considered a cardinal change or what was reasonably contemplated by the parties in the original contract. Unless the contract expressly limits the owner’s right to issue changes, reliance on the cardinal change doctrine is a risky basis to refuse additional or changed work. Clear contract language addressing the scope and magnitude of permissible changes is the most reliable source of addressing significant changes.

An owner generally does not have express restrictions on what can be changed, when the changes can be made, or the extent of the changes. The right to change the work is often only restricted by the owner’s implied duty to carry out its contractual obligations in good faith.  On the other hand, contractor’s rights to additional time and compensation are often limited by provisions restricting how changes must be scheduled or priced. For example, contractors may be restricted to pricing changes based on various pricing structures including, but not limited to, actual costs, specific markups for overhead and profit, specified unit prices, and specified labor rates. Contractors may also have to provide specific proposed schedules and specific time extension requests and schedule analyses demonstrating the additional time associated with the change. In other words, the owner is generally much less restricted in its use of the changes clause and the contractor is often required to provide substantial support to justify entitlement to a change order providing additional time and compensation. This may leave the contractor in a position where the owner believes it is entitled to make substantial changes to the project for which the contractor may be unable to reasonably plan, staff, and price the changes.

However, what if the changes drastically change the type of project or use of the project? What if the contractor agreed to build a single-family residence, and the owner tried to use the changes provision to order a multi-family multi-use project with commercial areas and residential areas? What if the contractor agreed to build a one-story shopping center and the owner changed the project to a multi-story office building? What if the contractor agreed to build a multi-family rental community, and the owner changed the project to a condominium project? What if the contractor agreed to build a hotel, and the owner changed the project to add a casino? There is very limited authority or precedent on how these types of changes may be addressed absent clear contract language, so the question of where these would be considered cardinal changes remains unknown.

From a contractor’s perspective, each type of project has different pricing, staffing, and contracting considerations that are challenging to specifically address in the changes clause. Different types of projects also have significant risk considerations. If at all possible, contractors should seek to address the concept of cardinal changes in the contract. The contract should address some limitations on the extent of changes or place restrictions on material changes in the use of the project or the contractor’s work. The contract should also address when the contractor may refuse to perform changed or additional work. By clearly defining the limitations of the changes clause, parties can minimize the disputes about ambiguities over the legal concept of “cardinal changes”, and the parties can eliminate the risk of an unnecessary dispute as to whether there has been a cardinal change. The best course of action for all parties is to incorporate the cardinal change concept into the contract and follow the terms of the contract in managing and addressing changes.

Constructive Changes – A Primer

Jonathan R. Mayo | Smith Currie | September 10, 2018

A “constructive change” occurs when an owner action or omission not formally acknowledged by the owner to be a change in the contact’s scope of work forces the contractor to perform additional work. Constructive changes are not formal change orders, but informal changes that could have been ordered under a contract’s changes clause if the change had been recognized by the owner. The constructive change doctrine recognizes that being informally required to do extra work is similar to a formal change order and should be governed by similar principles. Thus, if it is found that a constructive change order did occur, the contractor may be entitled to payment for additional costs incurred, and an extension to the contract performance period.

Constructive changes most often arise where there is a dispute regarding contract interpretation, defective plans and specifications, acceleration or suspension of work, interference or failure to cooperate with the contractor, misrepresentation or nondisclosure of superior knowledge or technical information, over inspection, or a delay in providing requested information crucial to the contractor’s ability to continue work.

There are four general categories of constructive changes for both public and private contracts. The first occurs when an owner informally directs or orders extra work. This happens any time an authorized representative of the owner directs a contractor, verbally or in writing, to perform work beyond the original scope of the contract, but does not issue a formal change order. If this informal order is determined to be a constructive change, the contractor may be entitled to recover its additional costs incurred and possibly an extension of the contract time. However, it is important to not confuse informal change orders with advice, comments, or suggestions that are offered by technical representatives of the owner. In order to prevail under this category, a contractor should provide proper notice to the owner that the directive is considered to be a change. Special attention should be given to the required notice period for such a change in the contract, and the contractor should document all additional costs expended and delays experienced.

The second category of constructive changes occurs when the contractor is required to expend extra effort because drawings or specifications are defective. This category is based on the Spearin doctrine, which provides that when an owner supplies the plans and specifications for a construction project, the contractor cannot be held liable for an unsatisfactory final result attributable solely to defects or insufficiencies in the plans and specifications. The theory is owner-supplied plans and specifications have an implied warranty that if the contractor complies with the plans or specifications, then a satisfactory product will result. Therefore, the delivery of defective plans and specifications is a breach of the warranty. A contractor can recover its additional costs when defective plans and specifications cause extra or remedial work. For example, if owner-provided specifications understated the amount of material needing to be excavated, the owner breached its implied warranty of the adequacy of the plans and specifications, and the contractor may recover its extra costs under the constructive change doctrine if the contractor reasonably relied on the plans and specifications.

The third constructive change category occurs when the owner or its representative misinterprets the contract and erroneously rejects work that satisfies contractual requirements or requires an unreasonably high standard of performance. Specifically, this category may arise from the owner’s implied duty not to hinder or delay the contractor in the performance of its work, which is an implied obligation contained in every contract. Such interference by over inspection would be a constructive change if unacknowledged by the owner. For example, when the contract provides for a certain method of performance or material, or states the contractor can choose a method of performance or material, but the owner requires the contractor to use a method or material that is more complicated and expensive than what the contractor planned in its bid, the owner has constructively changed the contract. This third category can also arise when the owner interprets a contract ambiguity in its favor. An example of this would be when the plans indicate the contractor only needs to “rough in” piping, but the owner directs the contractor to supply and install all internal piping. In order to prevail in either situation, the contractor must establish that its interpretation was a reasonable one and that it relied on its interpretation during the bidding phase. Failure to prove the latter element may defeat an otherwise valid claim.

The fourth category of constructive changes occurs when the owner denies the contractor an otherwise justified time extension, thereby forcing the contractor to accelerate performance. Also known as “constructive acceleration,” this occurs when the owner does not explicitly direct acceleration, but instead refuses a valid request for a time extension or threatens other action so the contractor must accelerate to complete work within the originally specified time to avoid liquidated damages or other loss. The constructive acceleration doctrine allows recovery for extra expenses incurred as a result of the contractor accelerating after the owner’s refusal to grant the warranted time extension. To prevail on such a claim, the contractor must show 1) that an excusable delay existed, 2) timely notice of the delay and a proper request for an extension was given, 3) the time extension request was postponed or refused, 4) the owner ordered either by coercion, direction, or other manner that the project must be completed within its original performance period, and 5) the contractor made efforts to accelerate its performance and incurred costs as a result.

Regardless of which category a contractor’s constructive change may fall into, the contractor should pay special attention to the requirements in its contract’s changes clause for presenting a change to the owner, especially change notice submission time frames, support, and format requirements.

Thanks to Washington and Lee law student Christopher Henry for his help with this article.

3 Commercial Construction Issues to Hammer Out Before the Shovel Hits the Ground: Insights from Chris Papavasiliou

Chris Papavasiliou | Nutter McClennen & Fish LLP | September 10, 2018

All of the parties involved on a project should agree on the following: 1) price and method of compensation; 2) the scope of the project; and 3) timing for completion.

Q: What are the three issues that all parties need to agree on before embarking on a commercial construction project? Christopher W. Papavasiliou: Often times, construction projects need to move quickly and there is little time to get a construction contract in place. But, you can do yourself a favor and avoid future disputes by making sure you and your contractor are on the same page on the following: 1) price and method of compensation; 2) the scope of the project; and 3) timing for completion. Even if a project is moving quickly on bare-bones AIA form documents (i.e., form documents created by the American Institute of Architects), those three items will let everyone know who’s doing what by when and what the costs will be.

Q: Could you explain the difference between Lump Sum compensation and Guaranteed Maximum Price compensation? CWP: Guaranteed Maximum Price and Lump Sum contracts share some similarities in that they limit the exposure of the owner for cost overruns, but they differ substantially in practice.

A Guaranteed Maximum Price contract (also known as a GMP Contract) has four main components: 1) The “Cost of the Work,” which is the actual cost to complete the work. There is a give-and-take on what is excluded, i.e., bonuses, main office salaries, and other items; 2) The “Fee,” which is generally a percentage of the Cost of the Work; 3) The “Guaranteed Maximum Price,” which is the maximum amount that the contractor will charge; and 4) “Savings,” in the event of the Cost of the Work being less than the Guaranteed Maximum Price. Savings are allocated between the owner and contractor on a pre-determined percentage breakdown. Because compensation is based on the contractor’s actual costs incurred, a Guaranteed Maximum Price contract requires that the owner review requisitions in detail, including invoices, and is administratively more time consuming for the owner.

On the other hand, a Lump Sum contract (also known as a Stipulated Sum contract) is easier to administer. It boils down to the contractor saying “I’ll build the project for $X.” The owner knows how much the project will cost, and all cost savings inure to the contractor. Lump Sum contracts are often favored due to their simplicity.

Keep in mind that the Guaranteed Maximum Price and Lump Sum amount will increase for change orders.

Q: How can the owner ensure that the project is completed in a timely manner? CWP: Approximately 95% of the time, the construction contract will be based on standard AIA documents. These forms cover the basics, but are a little light on the owner’s recourse if the contractor is late in timely completion. Two options on how to handle timely completion are incentives/cost savings and liquidated damages. Cost savings under a Guaranteed Maximum Price contract often get divvied up between the owner and construction manager. One way to incent the contractor to achieve early completion is to alter the percentage rate of savings going to the contractor based on when substantial completion is reached. Usually, liquidated damages are assessed on a day-for-day basis.

Is My Bid Binding?

Brian Gaudet | International Law Offices | August 13, 2018

For those in the construction industry, you are probably familiar with the concept of negotiating contract terms, either in writing or just a discussion, and when the two parties agree to terms, either in writing or with a handshake, then a deal is a deal. This follows the legal concept of a contract, which requires an offer, acceptance, consideration and a meeting of the minds. What if you are a trade contractor and submit a bid that a general contractor relies on to win a contract. Is that bid a contract? Is it binding? Even if the bid does not meet the elements of a contract, it can still be binding. Courts apply the doctrine of promissory estoppel to hold parties to their bids in the absence of a contract.

The Restatement (First) of Contracts, Section 90 describes the legal premise: “A promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promise and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.” In the highly cited case of Drennan v. Star Paving Company 333 P.2d 757 (En Banc 1958), the Supreme Court of California explained “When [the contractor] used [the subcontractor’s] offer in computing his own bid, he bound himself to perform in reliance on [subcontractor’s] terms. Though [the subcontractor] did not bargain for this use of its bid neither did defendant make it idly, indifferent to whether it would be used or not. On the contrary, it is reasonable to suppose that [the subcontractor] submitted its bid to obtain the subcontract…[The Subcontractor] had reason not only to expect [the Contractor] to rely on its bid but to want him to. Given this interest and the fact that [the Contractor] is bound by his own bid, it is only fair that [the Contractor] should have at least an opportunity to accept [Subcontractor’s ] bid after the general contract has been awarded to him.”

As usual, there can be different treatment of this concept in various jurisdictions and differences in the facts of each case which may affect the outcome, but as a general rule, when you submit a bid, you should expect it to be binding.

7 Ways Technology is Changing Construction

Eric Weisbrot | Construction Law in North Carolina | July 5, 2018

It is difficult to argue that technology is having minimal impact on society as a whole. Not only are digital enhancements making waves on the consumer side of the line, but businesses are feeling the effects as much if not more in recent years. The construction industry is no exception to this technological shift, but the influence the change is having on licensed construction contractors and long-standing businesses is far-reaching. Here are several ways technology is disrupting construction on a day to day basis.

 #1.  Autonomous Equipment.  One of the most notable changes in construction is the addition of autonomous equipment on job sites. Several technology-focused companies are currently testing and perfecting construction machines that require no human interaction to operate. The hope behind this shift is to reduce the impact of the labor shortage in the industry while improving efficiency and productivity on each job.

#2.  Wearable Technology.  Technology is also having an impact on individual workers and how they stay safe and productive each day. Wearable technology, including hard hats, protective eyewear, and gloves are all being developed and rolled out to contractors throughout the country. This digital change offers construction management an easy and efficient way to monitor workers’ production and progress from afar.

#3.  Use of Materials.  Technology is also being used to improve the materials used in building and maintaining structures. The most significant shift in this arena is the use of 3D printing to create materials both on- and off-site, faster and in a more cost-effective way than traditional methods. Carbon fiber through 3D printing allows for the simple production of a variety of materials, including turbine blades, lighting, and pavement.

#4.  Productivity.  Construction sites have seen an influx of drone use as well for a variety of reasons. Drones may be used to identify production issues or monitor progress over time, without the need for the site manager to be physically present. The use of drones in construction has also been touted as a more efficient way to recognize hazards and weather issues that often deter job completion. 

[Editor’s note: there are several legal issues involved with the commercial use of drones.  We have a legal presentation on this topic– if you are in North Carolina and want us to present it to your organization, give me a shout out!]

#5.  Training and Safety.  The use of augmented and virtual reality is also making its way to the construction industry. Both technologies give construction workers a realistic view of a project before it even begins, aiding in creating accurate timelines and budgets. However, more importantly, augmented and virtual reality resources are able to provide a method of training for a higher level of safety on each job site. This has the potential to reduce the total cost of operating a construction project and save lives in the process.

 #6.  Analytics.  Big data is a buzzword throughout the technology landscape, but it does have real implications for construction businesses. The ability to gather data from wearable technology, drones, AR and VR platforms, and even autonomous equipment can be a game changer for site managers. The details included in the data may be used for current and future decision-making, helping construction projects run more efficiently.

 #7.  Running the Business.  Finally, technology in construction is making a significant change in how companies are run. Whether large or small, construction businesses have countless digital tools to help with tasks from accounting and payroll to inventory and timeline management. The technology behind these software platforms is becoming less expensive to create as more companies utilize their power, giving most businesses an opportunity to take advantage.

It may seem like a far-fetched idea to see technology influencing nearly every corner of the construction world, but the reality is this shift has already taken place in a significant way. Construction site managers, large companies, and individual contractors alike can and should jump on the digital bandwagon in ways that best suit their needs in an effort to stay profitable and competitive.