Change orders: Meaning, Criticisms & Real-World Uses

What Is Change Orders?

Change orders are formal, written amendments to an existing contract, most commonly used in project management and construction. They represent an agreement among the contracting parties—typically a client or owner and a contractor—to modify the original scope of work, budget, or schedule of a project. These modifications can involve adding, deleting, or altering specific tasks, materials, or project specifications. Change orders fall under the broader financial category of Contract Management, as they are crucial tools for formalizing deviations from the initial contractual terms and managing the financial impact of such adjustments.

History and Origin

The concept of formalizing changes to a project's original agreement has evolved alongside complex undertakings, particularly in construction and engineering. As projects grew in scale and complexity, the need for a structured process to accommodate unforeseen circumstances, client requests, or design errors became apparent. Early forms of contracts likely addressed variations through simple agreements, but as legal frameworks developed, the necessity for standardized documentation increased. The systematic use of change orders, as understood today, solidified with the advent of detailed construction contracts that specify procedures for alterations. Reviews of research indicate that change orders are a common and expected element of construction projects due to their dynamic and complex nature, with formal processes evolving to manage these inevitable variations. Or⁸, ⁹ganizations such as the American Institute of Architects (AIA) have long provided standardized forms and clauses within their contract documents, such as the A201 General Conditions of the Contract for Construction, which specifically define and detail the process for change orders, highlighting their fundamental role in modifying project agreements.

#⁷# Key Takeaways

Change orders are formal amendments to a contract, typically in construction or project management, altering the original scope, cost, or timeline.
They ensure that all parties agree to modifications, maintaining project clarity and legal compliance.
Common causes include unforeseen site conditions, owner-initiated design changes, or regulatory adjustments.
Proper documentation and timely agreement are critical to avoid dispute resolution and project delays.
Change orders impact the project's budget and project timeline, often leading to increased costs or extended completion dates.

Formula and Calculation

While there isn't a single universal "formula" for a change order, its financial calculation typically involves determining the adjusted contract sum based on the original contract value and the value of the added or deleted work.

The adjusted contract sum can be calculated as:

\text{Adjusted Contract Sum} = \text{Original Contract Sum} + \sum (\text{Value of Additive Change Orders}) - \sum (\text{Value of Deductive Change Orders})

Where:

Original Contract Sum represents the initial agreed-upon price for the project.
Value of Additive Change Orders refers to the additional costs associated with new work or increased scope.
Value of Deductive Change Orders refers to cost reductions due to deleted work or reduced scope.

The value of individual change orders is typically derived from:

\text{Value of Change Order} = (\text{Direct Costs} + \text{Indirect Costs}) \times (1 + \text{Markup Percentage})

Where:

Direct Costs include labor, materials, and equipment directly attributable to the changed work.
Indirect Costs cover project management, administrative overhead, and other costs not directly tied to production but necessary for the work.
Markup Percentage is the agreed-upon profit margin and overhead recovery rate applied by the contractor to the costs.

Interpreting Change Orders

Interpreting change orders involves understanding their impact on the project's overall trajectory and financial health. A high number of change orders, or those with significant financial implications, can signal underlying issues such as inadequate initial planning, unclear requirements, unforeseen site conditions, or frequent client scope changes. When evaluating a change order, parties assess whether the proposed modifications are necessary, justified, and priced fairly.

For the client, a change order represents a potential increase in project cost and a shift in the project timeline. For the contractor, it represents an opportunity to adjust the scope and cost to reflect new realities, but also carries the risk of disputes if not properly managed. Effective interpretation involves comparing the proposed change against the original legal agreement, verifying the legitimacy of the request, and confirming the reasonableness of the proposed cost and time adjustments. The goal is to ensure that the change order accurately reflects the new work and maintains a fair balance between the parties, mitigating the potential for cost overrun.

Hypothetical Example

Imagine "Green Valley Developments" (the client) contracts "Summit Builders" (the contractor) to construct a new residential complex for an initial sum of $50 million, with a projected completion in 24 months. During construction, Green Valley decides they want to add a community fitness center to the original plans, which was not included in the initial scope of work.

Summit Builders evaluates the request. They determine the fitness center will require:

Additional Labor: $1.5 million
Materials: $1.0 million (specialized gym equipment, flooring, etc.)
Equipment Rental: $0.2 million
Subcontractor Costs: $0.8 million (for HVAC and electrical specialists)

They calculate direct costs to be $3.5 million. Summit Builders applies a 15% markup for overhead and profit.

\text{Markup Amount} = \$3.5 \text{ million} \times 0.15 = \$0.525 \text{ million}

\text{Total Change Order Value} = \$3.5 \text{ million} + \$0.525 \text{ million} = \$4.025 \text{ million}

Summit Builders also estimates that adding the fitness center will extend the construction schedule by three months.

They submit a formal change order to Green Valley Developments detailing the new scope, the $4.025 million additional cost, and the three-month extension. After negotiation and review, both parties agree and sign the change order. The new total contract sum becomes $54.025 million, and the project completion date is extended by three months. This change order formally amends the original contract, ensuring all parties are aligned on the revised terms.

Practical Applications

Change orders are integral to managing the fluidity of complex projects across various industries. In the construction sector, they are a primary mechanism for adjusting to unforeseen site conditions, such as discovering unsuitable soil, or accommodating client-driven design changes, like altering a building's facade. Si⁵, ⁶milarly, in large-scale infrastructure projects, change orders address design evolution, material availability issues, or new regulatory requirements that emerge during the project lifecycle. These adjustments are critical for maintaining project viability and ensuring compliance with evolving standards. The potential for cost overrun in major projects is a recognized challenge, and change orders play a direct role in formally acknowledging and integrating these additional costs and delays into the project framework. Fo⁴r instance, a Reuters report highlighted how U.S. infrastructure projects, while benefiting from significant investment, face the risk of cost overruns, often stemming from unforeseen issues that necessitate formal changes to the original plans. Be³yond construction, change orders apply in software development for scope creep, in manufacturing for specification changes, and in defense contracting for modifications to military hardware. Across all these domains, effective risk management practices often involve anticipating and planning for potential changes, even if the specifics are unknown at the outset.

Limitations and Criticisms

While essential for project adaptability, change orders also have limitations and can be a source of significant friction. A primary criticism is their potential to lead to substantial cost overrun and project delays, sometimes rendering original budget and schedule estimates nearly irrelevant. Fr²equent or poorly managed change orders can strain relationships between the client and contractor, leading to contentious dispute resolution. Another limitation is the potential for "cardinal changes," where cumulative change orders so fundamentally alter the original scope of work that they effectively constitute a new contract, potentially allowing a contractor to abandon the project without breach. Cr¹itics also point to instances where change orders are used exploitatively, with contractors submitting artificially low initial bids and then adding significant work through change orders post-award. Moreover, inadequate documentation or a lack of clear communication during the change order process can lead to misunderstandings, unauthorized work, or disputes over pricing and liability. Effective negotiation and strict adherence to established change management protocols are crucial to mitigate these drawbacks.

Change Orders vs. Variation Orders

The terms "change order" and "variation order" are often used interchangeably, particularly within global project management and construction industries. Both refer to a formal directive or agreement that alters the original contract terms, scope, cost, or schedule of a project. The primary distinction lies largely in regional terminology rather than fundamental meaning. "Change order" is more commonly used in North America, particularly in the United States, and is prominently featured in standard contract documents by organizations like the American Bar Association. Conversely, "variation order" is widely preferred in the United Kingdom, other Commonwealth countries, and under FIDIC (International Federation of Consulting Engineers) contract forms. Regardless of the term, the underlying purpose remains identical: to provide a legally binding mechanism for modifying the original legal agreement when circumstances necessitate deviations from the initial plan.

FAQs

What triggers a change order?

Change orders can be triggered by various factors, including unforeseen site conditions, errors or omissions in the original design documents, owner-requested alterations to the project scope of work, changes in regulatory requirements, or unexpected material or labor shortages.

Who approves a change order?

The approval process for a change order typically involves all parties whose rights or obligations are affected by the change. This usually includes the client or owner, the contractor, and often the architect or engineer if design modifications are involved. All parties must formally agree to the revised terms, often through signed documentation.

Can a change order be rejected?

Yes, a change order proposal can be rejected by any party if they do not agree with the proposed changes, costs, or schedule impacts. Rejection often leads to further negotiation to reach an acceptable compromise or, in some cases, can escalate to a dispute resolution process if an agreement cannot be reached.

How do change orders affect a project's budget?

Change orders directly impact a project's budget. Additive change orders increase the total contract sum due to additional work or materials, while deductive change orders decrease it. Uncontrolled or numerous change orders are a common cause of cost overrun in projects.

Is a change order a legal document?

Yes, once formally agreed upon and signed by all necessary parties, a change order becomes a legally binding amendment to the original contract. It modifies the terms of the existing legal agreement and holds the same legal weight as the initial contract.