Change orders are standard in the construction industry, because no set of plans is perfect, and the project site conditions are rarely what they are portrayed to be. The change order can make for headaches for both the project owner and a contractor, partly because they may not always agree on the change or the project owner won’t approve the change order promptly.
A change order that isn’t approved in a timely manner can put a contractor in a tough position. It forces you to decide whether to proceed with the project, cash flowing the work out of your own pocket, or stop the work entirely, which can escalate into a conflict with the project owner possibly leading the owner to default you. If you’re a contractor who has run into this issue, it’s important to note that the legalities of the steps a contractor should take are outside the scope of this article. We at CSBA are not attorneys and it’s important to consult with your lawyer rather than a surety specialist.
In this article, we will focus on the ways a surety views change orders and the impact it can have on a contractor’s bonding capacity.
Change Orders from a Surety's Perspective
The way a surety views construction change orders depends on the circumstances of the issue. Change order work is often completed by the contractor before the project owner officially approves it. As a contractor, this means you can’t bill an owner for the work that hasn’t been approved, and it creates some uncertainty that it will be fully collected. While the circumstances can vary a great deal, sometimes change orders are agreed upon by all parties and it may amount to little more than a timing issue for an approved change order.
Other times the change order will only be approved in part or the project owner has disapproved the change orders entirely. This leaves the contractor to try and settle the disagreement at the end of the job. These differing circumstances will determine how the surety views the accounts receivable related to the change order. If it’s a simple timing issue, the surety will monitor the situation to ensure the money is collected. If, on the other hand, the change order is disputed, the surety may remove it from the contractor’s financial statement, which impacts the contractor’s financial strength as the contractor has already incurred the cost.
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How Unapproved Change Orders Impact Bonds
Essentially, unapproved change orders will impact the contractor’s ability to get additional bonds from their surety, depending on the size and the situation. The larger the unapproved change order relative to the contractor’s financial strength and the longer the dispute takes to resolve, the more severe the impact and effect the unapproved change orders have on the contractor’s bond program.
Another point to consider, whether the change order is approved or not, is how it will impact the final premium of a performance or payment surety bond. Since premiums are based on the final contract price, if that price goes up, there is an additional premium charge for the difference. If, on the other hand, the contract price decreases, the contractor will receive a return on the premium.
Advice for a Contractor with a Change Order
The most important piece of advice for you to have regarding change orders is to always read your contracts before you sign them and to understand your rights, as well as your responsibilities. Before signing it, you should have your attorneys review your contracts and have them show you what to look for within them so a change order calamity cannot occur, or some other legal mishap. It’s important for a contractor to document files well, including both written and verbal communication, because as the saying goes, “Those with the best paperwork usually win in a legal battle.”. Demonstrating your thoroughness to your surety will also give them more confidence in your chances of prevailing in your dispute with the project owner and may enable your surety to forgo making negative adjustments to your financials that will impact your bonding capacity.
Many contractors don’t want to spend money on legal fees unless they have to, but it can save you headaches and more money down the road if a dispute does happen. Also, consider working with project owners you’re more familiar with where possible as good professional relationships and knowing what to expect go a long way in avoiding disputes around change orders, as well as other areas.
On the financial end, you’ll want to maintain adequate equity in your company as disputes are bound to happen, and the best way to handle them is to ensure you can survive them and are able to pursue your claim against the project owner. To help with that, make sure you have a line of credit with your bank as it will often save contractors who are struggling with working through a claim. This leads to the last piece of advice, working with a surety agent can help you prepare for these events by guiding you to properly set up your internal financials. While some contractors are tempted to use their insurance agent for surety bonds, situations like this require someone deeply familiar with the construction industry and surety bonds. We at CSBA are that kind of surety agent, dedicated to guiding California contractors through a bumpy road and ensuring change orders don’t derail your ability to get the surety bonds you need for your projects.
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bond quote now
We want to know more about how we can help your construction company get the right contractor bond for your next project.