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Types of Construction Contracts and the Change Order Process
Chapter Seven

Types of Construction Contracts and the Change Order Process

In the world of construction projects, there are a few types of contracts used by owners to secure a contractor to provide a service. This depends on the size of the project and the owners risk tolerance. We’ve outlined the three most common below and explained the differences between them. Once a contract has been awarded, inevitably change will occur and requires a change to the original scope of work and the contract. This can be an addition or deduction and you need a way to amend the contract via a formal change order request process. This is can be favorable for you if you run a tight ship and have a formal process in place to track, document and get approval for requested changes. However, this can be unfavorable if you make changes without following the formal process outlined in the contract documents. This can include doing the work on the spot with verbal approval, versus documenting the request and submitting it for written approval and an amended contract before proceeding.

Firm Fixed Price (Lump Sum)

Firm fixed price contracts are commonly used in construction projects where the contractor agrees to deliver a finished product for a fixed price. This includes all labor, material, equipment, and subcontractors needed to complete the agreed upon scope of work. Further, this contract type introduces more risk to the contractor because the contractor’s cost can fluctuate. As a result, there is less risk to the owner because they can control costs. However, this transfer of risk comes at a price. The contractor will likely include some percentage cost associated with carrying that risk as a fixed-price incentive, usually hidden in the fixed price of the contract.

In order to protect the contractor, some lump sum contracts include allowances which designate certain costs to the owner if the contractor goes over budget. Incentives can also be included if they finish early and under budget. But there will be penalties if the project is finished late. This contract is popular with owners who want to control costs with a fixed budget and avoid change orders. In some fixed price contracts, there are delivery incentives for arriving under budget and before or on schedule.

Additionally, clauses can be applied to the contract to protect the contractor in the event of an economic price adjustment. For example, a shortage of copper that causes prices to increase significantly for the item. However, in most cases the contractor usually accepts full responsibility to deliver the project under the total cost of the fixed-price contract.

Cost Plus Contracts

In cost plus contracts, the owner assumes most of the risk because they’re designated to pay for the costs of construction, purchases, and other expenses produced from the project. On top of that, a percentage goes to the contractor for taking on the construction project. In this type of construction contract, the contractor’s risk is minimized because cost overruns whether direct or indirect costs are at the risk for the owner.

There are different variations, including:

  • Cost plus fixed percentage
  • Cost plus with guaranteed maximum price contract
  • Cost plus fixed fee
  • Cost plus with guaranteed maximum price contract and bonus contract

These variations help protect and lower the risk to the owner. This type of contract is most commonly used when the scope of work hasn’t been clearly defined. In this scenario, determining the construction project’s actual costs would be difficult for a contractor and or too much risk to take on. Due to this risk being passed to the owner, this contract type requires more supervision and tracking than a firm fixed price by the owner. This is to ensure project cost, including material and labor cost, and overhead cost are controlled.

Time and Material Contracts

Time and material contracts involve the owner literally paying for the time and materials spent on a project. This usually involves the owner and contractor agreeing upon hourly rates and actual costs that might come up over the course of the project. The owner assumes more of a risk in this situation versus other contract types like fixed price or cost plus—but, to hedge this risk most will include a not to exceed clause where the contractor sets a high price that they will not go above without prior approval. This contract type is commonly used when the scope of work is small or unclear and there’s too much uncertainty to go with a fixed price or cost plus. When invoicing the actual cost, the contractor generally must provide material costs and labor-hour break-out.

The Construction Change Order

Once a construction project has been awarded, inevitably the scope of work will change due to budget, design, or omissions from the original bid documents requiring a pricing change to the construction contract. This process is common in the construction industry and generally requires a formal construction change order request.

Usually, this is accomplished with a change order form created by a project manager assigned to the construction project. This form will outline the change in scope of work and the price increase to the original contract for an addition or a credit should it be a reduction in the scope of work that is turned into to the general contractor. It’s important that you understand the construction change order process outlined in the Division 1 specifications, including who is authorized to approve change orders and what forms are required prior to proceeding.

It’s very common for change orders to be rejected when it’s time to pay the bill due to someone receiving a verbal approval, but they forget about it later or they’re not authorized to approve changes in cost to the approved construction contract.

COMMON CAUSES FOR A CHANGE ORDER:

  • Change directive from the project owner that requires extra work and cost to the contractor
  • Unforeseen conditions or site conditions requiring additional equipment, labor or materials
  • Accelerated schedules or completion dates that require additional man power, after

As a rule of thumb, never proceed with work that is outside the approved contract or a change in original scope of work until you have written approval from an authorized individual on the project ownership team as outlined in the contract documents.

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