August 10, 2018
Author: Kenneth Florey
Organization: Robbins Schwartz
Change orders are an integral part of the construction process. In the private sector, the principle of freedom of contract allows the parties broad latitude to tailor the change order process as they see fit: it can be as formal or informal as desired, based on the project’s scope and duration, and considering the project’s financing arrangements. The change order process will also be driven by the parties’ sophistication, level of involvement in the project, risk tolerance, and contractual relationship.
The public arena is different. Because public money and property are implicated in public construction projects, there are several statutory requirements that must be considered before a change order is sought or processed. First, can the change order work simply be delegated to the contractor already mobilized on-site, or must that work be let for bid and awarded to the lowest responsible bidder? Second, if the contractor was required to furnish a payment and performance bond for the original scope of work, should the penal sum of those bonds be increased to reflect the change order, and is the contractor’s existing insurance sufficient to cover the work proposed under the change order? Third, the public owner or its designee must make a certain written determination about the nature of the forthcoming change order as required by Section 33E-9 of the Criminal Code, 720 ILCS 5/33E-9; the knowing failure to comply with this requirement can result in the commission of a Class 4 felony. Fourth, it should be determined whether a change order is proper under the contract documents, and whether the nature of the change order implicates the Public Construction Contract Act, 30 ILCS 557/1, et seq., which contains a procedure for the investigation and processing of change orders related to subsurface conditions, latent physical conditions, and unknown conditions on site; the failure to comply with this procedure may in certain circumstances void the contractor’s entitlement to such a change order. Fifth, and last, the parties should be mindful of the public owner’s board policies and procedures for the processing of change orders. While there may be scheduling pressure to have the public owner’s governing board approve the change order immediately, the public owner will be sensitive to its own policies and procedures, and to its constituents, and will need to take board action that complies with the Open Meetings Act, 5 ILCS 120/1, et seq
II. Bidding Requirements
When the need for a change order arises, the first order of business is usually to obtain from the contractor a proposal and detailed cost estimate for the scope of work, to be included in or attached to the change order. As a practical matter, the contract documents should specify the contractor’s maximum mark-up and minimum mark-down for overhead and profit, and all other percentage-based items that will impact the total cost of the change order. The reason for obtaining an accurate cost estimate at the outset of the analysis is to determine if the change order work must be bid out, or whether, under a statutory bidding exception, it can simply be delegated to a contractor already mobilized on-site.
For instance, the Illinois School Code has a 10% threshold for change orders, such that if the change order work is due to “unforeseen revisions” which are not the fault of the contractor, and the proposed work is not in excess of 10% of the contract price, the work does not have to be bid:
(a) To award all contracts for purchase of supplies and
materials or work involving an expenditure in excess of
$25,000 or a lower amount as required by board policy to
the lowest responsible bidder, considering conformity with
specifications, terms of delivery, quality and serviceability,
after due advertisement, except the following: . . . (v)
contracts for materials and work which have been awarded
to the lowest responsible bidder after due advertisement,
but due to unforeseen revisions, not the fault of the
contractor for materials and work, must be revised causing
expenditures not in excess of 10% of the contract price.
105 ILCS 5/10-20.21 (emphasis added).
Like the School Code, the Community College Act also contains a 10% threshold bidding exception for change orders. See 110 ILCS 805/3-27.1. Several other enabling statutes do not. See the Municipal Code, 65 ILCS 5/1-1-1, et seq.; the Park District Code, 70 ILCS 1205/1, et seq.; the Township Code, 60 ILCS 1/1-1, et seq.; and the Counties Code, 55 ILCS 5/1-1001, et seq.; see also the Illinois Procurement Code, 30 ILCS 500/1- 1, et seq.
When dealing with a public owner, the best practice is to confirm at the outset of the project whether there are any applicable laws that broaden or restrict the bidding requirements as related to change order work. Similar concerns exist when dealing with an association or cooperative of public owners operating pursuant to intergovernmental agreement or another enabling statute: the statutory authority to contract should be confirmed, and any restrictions on contracting for change order work should be identified and analyzed.
The Public Works Contract Change Order Act, 50 ILCS 525/1, et seq., must also be considered. The Change Order Act provides:
Sec. 5. Change orders; bidding. If a change order for any
public works contract (i) is entered into by a unit of local
government or school district, (ii) is not procured in
accordance with the Illinois Procurement Code and the
State Finance Act, and (iii) authorizes or necessitates any
increase in the contract price that is 50% or more of the
original contract price or that authorizes or necessitates
any increase in the price of a subcontract under the contract
that is 50% or more of the original subcontract price, then
the portion of the contract that is covered by the change
order must be resubmitted for bidding in the same manner
for which the original contract was bid. Bidding for the
portion of the contract covered by the change order is
subject to any requirements to employ females and
minorities on the public works project that existed at the
bidding for the original contract, together with any later
requirements imposed by law. 50 ILCS 525/5 (emphasis added).
“Unit of local government” is not defined under the Change Order Act. However, the term arguably applies to any governmental body created by local referendum, funded by local property taxes, and run by locally elected officials. See Board of Trustees of Community College District No. 502 v. Department of Professional Regulation, 363 Ill. App. 3d 190, 202, 842 N.E.2d 1255, 299 Ill. Dec. 903 (2nd Dist. 2006) (holding, for the above-stated reasons, that a community college was a “unit of local government” and therefore a “political subdivision” subject to the Local Government Professional Services Selection Act).
Similar to the 10% threshold contained in the School Code and Community College Act, the Change Order Act provides a 50% threshold for the value of change order work; when this threshold is exceeded, the change order work must be let for bidding. While these two thresholds are somewhat duplicative, the Change Order Act’s 50% threshold is derived from the “original contract price” and “original subcontract price,” meaning that previously-executed change orders cannot be utilized to adjust the contract price, and hence the threshold, upward. In contrast, the 10% threshold in the School Code and Community College Act reference only the “contract price,” thus allowing the reasonable interpretation that those 10% thresholds relate to the current contract price as it exists based upon previously-executed change orders. See 105 ILCS 5/10-20.21; 110 ILCS 805/3-27.1.
These principles can be illustrated with two examples:
- Where the original contract price is $100,000, and there are no prior change orders, the 10% threshold requires bidding of any change order to the prime contract that is in excess of $10,000 ($100,000 contract price multiplied by 10%), and the 50% threshold requires bidding of any change order to the prime contract of $50,000 or more ($100,000 original contract price multiplied by 50%).
- Where the original contract price is $100,000, and there were prior change orders totaling, for instance, $10,000, the 10% threshold requires bidding of any change order to the prime contract in excess of $11,000 ($110,000 current contract price multiplied by 10%), while the 50% threshold remains the same, with bidding required for any change order to the prime contract of $50,000 or more ($100,000 original contract price multiplied by 50%).
To characterize these examples, the 10% threshold is a moving target based upon the current contract price, while the 50% threshold is a fixed target based on the original contract price. Finally, use of the term “prime contract” in the prior examples illustrates what is probably the most onerous feature of the Change Order Act: it requires bidding not only in cases where the proposed change order necessitates an increase of 50% or more of the original contract price, but also where the change order necessitates an increase of 50% or more of the original subcontract price. See 50 ILCS 525/5. Consider a $100,000 original contract price with no prior change orders, and a proposed change order in the amount of $5,000: the change order is below the 10% threshold and the 50% threshold. But what if the general contractor has a subcontractor, and this change order will increase that subcontract from $1,000 to $1,800? In this case, the 50% subcontract threshold is triggered, and bidding of the change order work is required because the subcontract price would be increased by $500 or more ($1,000 original subcontract price multiplied by 50%). The 50% threshold for subcontracts is frequently overlooked, and can be the subject of much consternation for those involved in public works projects.
In summary, a careful analysis is required to answer the question whether a public owner’s change order work must be bid out, or may instead be delegated through the normal change order process to a contractor already mobilized on-site. Those members of the project team responsible for initiating and processing change orders are encouraged to consult with legal counsel to make these initial determinations.
III. Bond and Insurance Requirements
Some change orders simply substitute one product for another with no change in the contract price. Others adjust the contract time or the scheduled completion date, but likewise do not affect price. However, most change orders result in an increase or decrease in the contract price, which leads to a discussion of payment and performance bonds, and how they are affected by change orders.
Pursuant to statute, contractors performing work for public owners are typically required to furnish to the public owner performance and payment bonds. These bonds name a bond company as surety, the contractor as principal, and the public owner as obligee. These bonds are, in layman’s terms, the owner’s insurance policy that the contractor will (1) perform the work in accordance with the contract documents; and (2) pay its subcontractors and suppliers. In Illinois, Section 1 of the Public Construction Bond Act provides:
Except as otherwise provided by this Act, all officials,
boards, commissions, or agents of this State, or of any
political subdivision thereof, in making contracts for public
work of any kind costing over $50,0001 to be performed for
the State, or of any political subdivision thereof, shall
require every contractor for the work to furnish, supply and
deliver a bond to the State, or to the political subdivision
thereof entering into the contract, as the case may be, with
good and sufficient sureties. The amount of the bond shall
be fixed by the officials, boards, commissions,
commissioners or agents, and the bond, among other
conditions, shall be conditioned for the completion of the
contract, for the payment of material used in the work and
for all labor performed in the work, whether by
subcontractor or otherwise. 30 ILCS 550/1.
Assuming the $50,000 threshold is triggered, the public owner’s first order of business is to specify for the contractor what is meant by “good and sufficient sureties.” See 30 ILCS 550/1. The custom and practice is to specify in the general conditions of the construction contract the “penal sum” of the performance and payment bonds to be provided by the contractor. The language can be simple:
“Within ten (10) days after award of the Contract,
Contractor shall furnish a performance bond and a
payment bond to the Owner as obligee with a penal sum
equal to the Contract Sum.”
Turning back to the issue of change orders, the question becomes whether the penal sum of the bond must be adjusted when the contract sum or contract price is adjusted by change order. Typically it is not, and thus, throughout the project, the surety’s maximum liability on the performance and payment bonds remains the original penal sum of the bond.
When a modest amount of change orders are executed toward the beginning of a public project, this may not be a problem, because, including the owner’s funds and the bond funds, the owner has nearly 200% of the contract price close at hand to insure the contractor’s performance and payment. As the project moves closer to completion, however, when most of the contract funds have been paid out to the contractor and a significant number of change orders have increased the contract price well beyond the penal sum of the bond, the public owner can find itself significantly exposed. For example, in the event of a post completion defect in the work and a contractor that is defunct or missing, the owner could find itself having to incur a replacement cost in excess of the contract price, with its only recourse being against a surety whose maximum liability on the performance bond relates back to the original contract price, which is much less than current replacement cost.
Given this scenario, public owners may find it desirable to increase the penal sum of the bond as the project progresses and the change order process drives the contract price up. The right to cause the contractor to increase the penal sum of the bonds can be accomplished by simple language in the general conditions:
“If at any time the Owner shall become reasonably
dissatisfied with any surety, or for any other reason such
bonds shall cease to be adequate security for the Owner,
Contractor shall, within five (5) days after notice to do so,
substitute acceptable bonds in such form and sum and
signed by such other surety or sureties as may be
reasonably satisfactory to the Owner.”
If the public owner exercises this right and demands an increase in the penal sum of the contractor’s performance and payment bonds, the contractor will incur additional bond premiums, which will, inevitably, be passed on to the public owner. And when the change order process has driven the contract price (and thus the value of the work) well in excess of the original penal sum of the bonds, these additional bond premiums will be a small price to pay in the event the contractor is missing in action and a post-completion defect requires substantial or total replacement of the work due to a systemic failure or other catastrophic failure in the work. In such case, it is critical to have an adequate performance bond in place, with an adequate penal sum that reflects the value of the work.
Another risk-management topic that arises in the context of change orders is the contractor’s insurance. In the contract documents, it is customary to specify the types and minimum limits of insurance that the contractor will carry in connection with its work. The usual policies procured by the contractor include commercial general liability coverage, automobile coverage, umbrella or excess coverage, worker’s compensation coverage, and, if design or construction management services are included in the contractor’s scope of work, professional liability coverage.
In the context of change orders, the public owner and its project representatives should focus on whether the proposed change order work will be covered by the contractor’s existing insurance. For example, the commercial general liability policy will typically cover the contractor as a named insured, and the public owner as an additional insured, for bodily injury or property damage arising from an “occurrence” during the contractor’s work. However, the policy will also include a laundry list of exclusions from coverage, some of which will be based upon the type of work being performed by the contractor. Thus, when change order work involves unconventional or irregular services (i.e., environmental investigations or cleanup, hazardous waste disposal, or asbestos-related work), the contractor’s insurance policies should be reviewed to determine if the existing policies will cover that change order work
IV. Applicable Criminal Code Provisions
Section 33E-9 of the Illinois Criminal Code provides:
Sec. 33E-9. Change orders. Any change order authorized
under this Section shall be made in writing. Any person
employed by and authorized by any unit of State or local
government to approve a change order to any public
contract who knowingly grants that approval without first
obtaining from the unit of State or local government on
whose behalf the contract was signed, or from a designee
authorized by that unit of State or local government, a
determination in writing that (1) the circumstances said to
necessitate the change in performance were not reasonably
foreseeable at the time the contract was signed, or (2) the
change is germane to the original contract as signed, or (3)
the change order is in the best interest of the unit of State or
local government and authorized by law, commits a Class 4
felony. The written determination and the written change
order resulting from that determination shall be preserved
in the contract's file which shall be open to the public for
inspection. This Section shall only apply to a change order
or series of change orders which authorize or necessitate an
increase or decrease in either the cost of a public contract
by a total of $10,000 or more or the time of completion by
a total of 30 days or more. 720 ILCS 5/33E-9.
At first glance, this provision of the Criminal Code appears onerous: for each and every change order increasing or decreasing the cost of a public contract by a total of $10,000 or more, or the time of completion by a total of 30 days or more, the public owner must, prior to approving the change order, make a written determination that “(1) the circumstances said to necessitate the change in performance were not reasonably foreseeable at the time the contract was signed, or (2) the change is germane to the original contract as signed, or (3) the change order is in the best interest of the unit of State or local government and authorized by law.” 720 ILCS 5/33E-9. If this written finding is “knowingly” not made, “[a]ny person employed by and authorized by” the public owner to approve such change order may have committed a Class 4 felony. Considering the level of authorization typically granted by public owners to design professionals, construction managers, and owner’s representatives, there are a significant number of people who must take care to comply with this requirement.
The best course of action for complying with Section 33E-9 of the Criminal Code is to establish, at the outset of the project, a designee of the public owner who is authorized by the public owner to make the required findings. See 720 ILCS 5/33E-9. The public owner’s authorization of its designee to make the required findings should be made by amendment to the board policies or by other appropriate board action, which should at a minimum be reflected in the official board minutes. This designee should be identified in the contract documents, and should be notified any time a change order is sought. The designee should be provided with all information needed to evaluate the circumstances giving rise to the change order along with the draft change order and supporting documentation. The designee should make the finding required by Section 33E-9 of the Criminal Code before the change order is placed in the owner’s board packet or on its board agenda for approval, and in any event before the change order is approved or signed by the architect, contractor or owner
V. Extra Work Criteria
A contractor is not generally entitled to additional compensation simply because the task it has undertaken turns out to be more difficult due to weather conditions or site conditions; however, the contractor is entitled to rely upon the adequacy of the plans and specifications furnished by the owner, and when a defect in the plans and specifications causes the contractor to incur additional costs, the contractor is entitled to such compensation. W.H. Lyman Construction Co. v. Village of Gurnee, 84 Ill. App. 3d 28, 32-40, 403 N.E.2d 1325, 38 Ill. Dec. 721 (2nd Dist. 1980). When a contractor seeks to recover for “extras,” the contractor has the burden of proving by clear and convincing evidence: (1) that the work was outside the scope of the contract; (2) that the extra items were ordered by the owner; (3) that the owner, by its words or conduct, agreed to pay for the extras; (4) that the extras were not furnished by the voluntary act of the contractor; and (5) that the extras were not rendered necessary by the fault of the contractor. Watson Lumber Co. v. Guennewig, 79 Ill. App. 2d 377, 389- 90, 226 N.E.2d 270 (5th Dist. 1967).
With respect to certain types of “extras,” the contractor’s entitlement to additional compensation from a public owner may be limited or regulated by the owner’s standard contract documents, or by law. One particular example is the contained in the Public Construction Contract Act, 30 ILCS 557/1, et seq. The Act provides:
Sec. 10. Contract requirements. If a contract between a
contractor and a governmental entity2 for an improvement
exceeds $75,000, all of the following provisions apply to
(1) If a contractor discovers one or both of the following
physical conditions at the surface or subsurface of the site,
the contractor must notify the governmental entity of the
condition, in writing, before disturbing the condition:
(A) A subsurface or latent physical condition at the site
differing materially from conditions indicated in the
(B) An unknown physical condition at the site of an
unusual nature differing materially from the conditions
ordinarily encountered and generally recognized as
inhering in work of the kind provided for in the contract.
(2) If the governmental entity receives notice from the
contractor under subdivision (1), the governmental entity
must promptly investigate the physical condition.
(3) If the governmental entity determines that the physical
condition (i) does materially differ from the conditions
indicated in the contract or ordinarily encountered in the
work of the kind provided for in the contract and (ii) will
cause an increase or decrease in the costs or time needed to
perform the contract, the governmental entity must make an
equitable adjustment to and modify the contract in writing.
(4) The contractor may not make a claim for additional
costs or time because of a physical condition at the site,
unless the contractor has provided notice to the
governmental entity under subdivision (1).
(5) The contractor may not make a claim for an
adjustment after the contractor has received a final payment
under the contract. 30 ILCS 557/10
VI. Approval by Governing Board
Under their enabling statutes, many public owners are vested with authority to enter into contracts for design and construction work. See, e.g., Section 10-20.21 of the School Code and Section 3-27.1 of the Community College Act, 105 ILCS 5/10-20.21, and 110 ILCS 805/3-27.1. Although the public owner may delegate to its officers and administrators some of the responsibility for negotiating and/or procuring design services and construction work, it is the governing board of the public body that ultimately approves the original contract, and in many cases the subsequent change orders as well.
The public owner’s governing board typically has detailed, written policies and procedures for negotiating and procuring professional services and the labor, materials and equipment needed for construction projects. Under the public owner’s board policies, most proposals, bids, contracts, and change orders will come before the board for consideration and approval prior to execution by the public officer or administrator responsible for the work.
All members of a project team involved in a public works project should be aware of the public owner’s board policies and procedures for the review and approval of proposals, bids, contracts, and change orders. Specifically with respect to change orders, the project team should make themselves aware of the following details: the owner’s regular schedule for board meetings; the deadline for submitting documentation to be included in the board packet; what information must be included in the board packet; whether the information must be explained in narrative format; whether the required written findings have been made pursuant to Section 33E-9 of the Criminal Code (see supra); and whether members of the project team will be required to appear at the board meeting to explain the requested change order.
Public owners can only take board action at a public meeting that meets the requirements of the Open Meetings Act, 5 ILCS 120/1, et seq. A quorum of the members of the public body must be physically present at the meeting, 5 ILCS 120/2.01, and the meeting agenda must be posted at the public owner’s principal office and at the location where the meeting is to be held at least 48 hours in advance of the meeting. 5 ILCS 120/2.02. These requirements should be taken into account if and when urgent action from the public owner is needed.
When dealing with public owners, the change order process involves several procedural hurdles which, when not properly managed, can create uncertainty, risk, and delay-related problems for all members of the project team. However, these concerns can be effectively managed with a carefully-implemented change order process that is project-specific, clear and concise, and carefully applied throughout the course of the project.
1 Effective August 9, 2013, Public Act 98-0216 amended the Construction Bond Act by increasing the threshold for performance and payment bonds from $5,000 to $50,000. This means that most political subdivisions, including school districts, community colleges, and other units of local government will not need to require their contractors to procure performance and payment bonds for public works projects unless the contract sum is over $50,000. For smaller jobs, this will save some administrative time and should result in modest cost savings due to bond premiums avoided.
2 "Governmental entity" means a county, a municipality, a township, a public educational institution, a special district, or any political subdivision thereof. 30 ILCS 557/5.