Don’t Let Disputed Change Orders Derail Your Construction Project

Originally published by the Daily Journal of Commerce on November 16, 2023.

Change orders are a fact of life for construction projects. They can be challenging even when the owner and contractor agree on the scope, price, and schedule impacts associated with the change. Change orders are far more difficult when the owner and contractor disagree, especially when the job is still in progress. For example, the owner may believe the scope of work at issue was included in the existing contract price, and the contractor may respond that it never contemplated that scope of work and has no costs in its price to cover the work. What should the parties do in this situation?

The contract likely has a dispute resolution clause that provides for claims to be handled in court or arbitration. While this approach may need to be invoked, it would involve many months of effort with an uncertain outcome. Another option is mediation. However, even the best mediators cannot resolve all disputes, and mediation would take time to organize and schedule. In the intervening months, the project clock keeps ticking. The contractor may be financially unable or unwilling to spend its own money on work that wasn’t included in its price. The contractor may refuse to proceed without pay even in the face of another contract clause requiring the contractor to continue work while a dispute is pending. Conversely, the owner is unlikely to be able to await an arbitration outcome because the work must proceed to keep the project on schedule.

Enter the disputed change order clause. This clause is surprisingly absent from many standard form agreements. Where absent, parties can amend their existing contract to add this clause and temporarily defuse a change order problem until mediation or arbitration can resolve it.

Here are the key elements of a disputed change order clause:

First, the clause requires the contractor to submit a reasonable cost estimate for the changed work with adequate substantiation for the owner to vet the proposed price. The parties may agree that the estimate will be reconciled with actual costs later, or they may agree that the estimate becomes the final price for the work, without admitting who is responsible for payment.

Second, the clause specifies that the owner must specifically order the contractor to perform the disputed work after seeing the contractor’s cost estimate. The order should explain in writing the owner’s interpretation of the disputed work, including its precise scope and why the owner believes the work is already covered under the existing contract price.

Third, the owner must agree to pay a percentage of the substantiated cost estimate plus the contractor’s normal percentage fee. The percentage paid by the owner is usually between 40% and 80% and is subject to negotiation at the outset. The contractor then bills for the work as it would for an agreed change order, and the owner pays as it normally would, except that it pays only the agreed upon percentage. This same process applies to any time extension associated with the work. The agreed upon percentage is applied to the reasonable time extension requested and substantiated by the contractor. The resulting days are, at least temporarily, added to the contract time.

Fourth, the disputed change order clause explains that the owner’s agreement to pay a percentage and the contractor’s agreement to accept that percentage is under a “reservation of rights.” In the ensuing mediation and arbitration process, the owner reserves the right to claim back all the money it paid and the time it added to the contract. The contractor reserves the right to seek the full amount of its costs and fee and the full time extension it initially proposed.

Fifth, the percentage of money paid and time allotted are specified in the disputed change order clause to be inadmissible in the arbitration process, meaning each party presents its position to the arbitrator without the arbitrator knowing about the tentative partial payment, the partial time extension, and each parties’ reservation of rights. The arbitrator’s final decision is then reconciled with the parties’ temporary arrangement under the disputed change order clause.

The disputed change order clause is not perfect and neither party will be happy with the partial—but temporary—concession they make. In the bigger picture, however, this concession allows the work to proceed, it avoids escalating damages from project delay if a change order standoff ensues, and it allows both parties to present their full position in arbitration.