When contractors prepare their budget for a project, they often allocate costs among various line items. This allocation typically takes the form of a schedule of values (“SOV”), which is often presented to the owner (or general contractor, in the case of a subcontractor) for approval prior to submitting the first payment application. The schedule of values is vital in tracking the progress of the work for payment purposes. Many industry contract forms provide for a percent-complete analysis of the work typically on a monthly basis. The cumulative percent complete is then applied to the current contract amount to determine the amount due. But development of line items and allocation of costs among those line items present risks that contractors should consider.
Depending on the type of project and the scopes of work, contractors may attempt to “front-end load” their schedule of values. This practice allocates a larger dollar amount to line items of work being performed early in the construction and aides in creating a positive cash flow for the contractor. Contractors may also utilize this strategy as a means of collecting project fee earlier in the project. In many cases, the parties agree (or the contract requires) that fee be shown as a separate line item and billed either in proportion to the overall percent complete or as a fixed amount every period. In other situations, however, a contractor may allocate its fee or overhead costs among the various line items in the SOV. But what happens in the latter scenario when line items are removed from the contractor’s scope of work? Is the contractor susceptible to losing an allocated portion of its overall project fee in the subsequent deductive change order process?
What the SOV provideth, the SOV may taketh away
A federal district court recently addressed this scenario where a subcontractor provided a lump-sum price for five items of work, four of which were subsequently deducted from the subcontract. In Contract Management, Inc. v. Babcock & Wilson Technical Services Y-12, LLC, 2013 WL 74619 (E.D. Tenn. 2013), the United States District Court for the Eastern District of Tennessee sided with the subcontractor in holding that it did not have to credit the general contractor for its overall fee allocated to the deleted scopes of work.
CMI was awarded a lump-sum subcontract from B&W to clean and rehabilitate five water lines at the Y-12 National Security Complex in Oak Ridge, Tennessee, as part of an overall project for the Department of Energy. CMI was specifically requested to provide a lump-sum proposal comprised of line item unit prices for each of the water lines. CMI was further instructed to allocate its management costs among those five line items. Several months after executing the subcontract and prior to commencing work on site, B&W notified CMI that Congress had only provided enough funds for one of the five water lines to be repaired. Accordingly, B&W issued a deductive change order removing four of the five line items from CMI’s subcontract. But because CMI was still required to perform work on one line, there were still management costs necessary, particularly because of the delays experienced during construction and the contractual requirement to staff the project with specific employees. In addition, CMI and its subcontractor had already incurred various preconstruction costs associated with the four removed lines. CMI’s costs to clean and repair the remaining water line exceeded the amount it allocated to that line item.
In calculating the deductive change order, B&W simply totaled CMI’s four line items and argued that this was the most appropriate manner of determining the credit due. CMI took a “bottom up” approach by calculating the costs saved by virtue of not having to perform any more work on the eliminated water lines. CMI’s approach accounted for costs incurred on those line items prior to elimination and allowed CMI to retain the fee allocated to those four line items. The court agreed that this was the more reasonable method and, thus, CMI did not forfeit approximately 80% of its project fee. The court’s reasoning, however, was largely based on the specific contract language that provided the basis for CMI’s fee allocation and the corresponding pricing procedure for change orders.
Generally, the determination of any deductive change order is based on the “difference between the reasonable cost of performing without the change or deletion and the reasonable cost of performing with the change or deletion.” Administration of Government Contracts, 2d ed. (John Cibinic and Ralph Nash) 1985, Chapter 8, Pricing of Adjustments. In making this determination it is important “to attempt to limit the repricing to the effect of the change alone without altering the basic profit or loss position of the contractor before the change occurred.” Id.
As with most construction disputes, the terms of the applicable contract typically govern. Many contracts include payment provisions, change provisions, and specific fee adjustment provisions which will impact the calculation of amounts due for scope reductions. How the parties agree on those types of provisions, and the type of contract entered into, dictate how a contractor should represent its scope Itemization. To limit disputes over deductive change order pricing based on line items in a schedule of values, contractors should review all of these provisions before submitting lump-sum scope breakdowns for review and approval. Even if the law may appear to be favorable, a contractor’s fee – wherever it may be allocated – does not likely include dispute resolution costs.