Managing Risk from Construction Change Orders
“That project finished exactly as the contract stated,” said no Construction owner, ever.
Managing risk is key to any successful construction project. And while change is to be expected with nearly all projects, change orders can present a significant level of risk.
Change orders are needed where there is a change or adjustment to the original scope of the contract and affect the owner by increasing cost. These types of changes typically involve performing additional work and can include items such as unrealistic cost estimates, changing site conditions, previous delays, increasing material costs, new regulatory rules that come into play or safety concerns.
The key to successfully managing change orders is not only the mechanics but also negotiating and taking command of the issues that can and do cause the change order process to spiral out of control.
When there are errors or omissions that happen at the design or construction level, that would necessitate a change order. Change orders require the agreement of the change by the owner, the architect and the contractor. Change orders normally increase the cost of the original contract but are also used to provide extended time to complete a task. This is important because delay claims for change orders are some of the most litigated and disputed documents in the industry.
There are two kinds of change orders: approved, and unapproved. For unapproved change orders, the key is to document. While email and texts will help with documentation, best-in-class contractors utilize templates and/or change order software.
Digital documents are much easier than paper documents. With the capabilities of construction technology, change orders can easily be created, sent back and forth, electronically signed, automatically date/time stamped and permanently stored in a centralized database. This automation of the change order process will save both parties time and money.
But if you don’t have this capability, change orders need to be approved in writing as they become a part of the contract. If an unapproved change order is performed, it is critical to ensure there is written documentation in the job file to support the oral approval in the event of a dispute later.
The company’s Project Managers are critical in this process. It is their decisions that make or lose money on change orders. A good Project Manager will manage the communication with the accounting department to keep them informed with the status of change orders.
Contractors make money on change orders, so your strategy in negotiation is critical in this process. Because of the inherent risk of change orders, you should ensure that the profitability reflects the degree of risk and pain associated with its execution. Owners should not hesitate to ask for back-up on the estimated costs, contractors should factor in all costs associated, including administrative, in executing the change order, and subcontractors should be diligent in making sure that the general contractor has signed off on all change orders.
Change is inevitable – as are change orders, so the subcontractor needs to make sure that he is ready and able to manage them in an efficient manner. Change orders should be a profit center, so keep it this way.
If you have questions to your change order process or want to explore electronic options, contact your BMF Advisor.
Dale A. Ruther?>
CPA, CIT, CDS, CCIFP
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