• Variation to the Lump Sum Contract: the Deductive Change Directive
  • June 26, 2015 | Author: Andrew N. Felice
  • Law Firm: Rees Broome, PC - Tysons Corner Office
  • On your current project and like many general contractors, you front end loaded your schedule of values, perhaps excessively. The project has been humming along as planned, with the owner paying all of your payment requests without objection. But now halfway into the project, the owner decides to delete some of the work, and in particular a detail that is only 25 percent complete. As allowed by the contract, the owner issues a deductive change directive in writing to delete the remaining work for this activity and demands a credit. What should you do, and how much credit must you allow?

    First, if your contract includes both a partial termination for convenience (“TFC”) and a changes clause, you must determine whether the deletion should be treated as a partial TFC for the owner or as a deductive change. Unfortunately, there is no bright line separating the appropriateness of one over the other, but the consequences can be significant. For example, whereas the TFC clause limits the amount of any termination settlement, the changes clause does not.

    For federal contracts, which are governed by the Federal Acquisition Regulations (FAR), the contracting officer is tasked with determining whether the deleted work constitutes a deductive change or a partial TFC. If a contractor disputes the contracting officer’s determination, courts and boards will examine the nature of the change to determine the applicable clause. Generally, boards look “to two tests in determining this issue: (1) was there a reduction in the scope of work without the substitution of other work?; and (2) was the reduction major rather than minor?” Accordingly, the deletion of relatively minor and segregable items of work is generally treated as a deductive change, and the deletion of a major portion of the scope of work without replacing it with new substitute work is governed by the TFC clause.

    Where it is determined that the deleted scope or modified specification should be treated as a “change,” the contract price is subject to a downward equitable adjustment, which is calculated by obtaining the difference between the reasonable cost of performing the contract work before and after the change. In essence, the government uses the same principles to determine deductive changes as it does to price additive changes. Depending on the circumstance, such deductive credits may include overhead and profit.

    Where it is determined that the deletion should be treated as a “partial TFC,” the contractor is free to negotiate any settlement amount, provided it is reasonable and the total payments to the contractor will not exceed the contract price for that work. The guidelines for such allowable costs, and reasonable profit, are outlined within FAR Part 31.
    For unmodified versions of the standard AIA contract between owner and contractor, which include A201-2007 General Conditions of the Contract for Construction, there is no confusion as to which clause applies for deductive changes, because unlike the FAR, there is no partial TFC. The standard AIA TFC clause applies only when the owner terminates the entire contract. Accordingly, the changes clause would apply, and specifically § 7.3.8 applies to deductive change directives:

    § 7.3.8 The amount of credit to be allowed by the Contractor to the Owner for a deletion or change that results in a net decrease in the Contract Sum shall be actual net cost as confirmed by the Architect.

    But what constitutes “actual net cost?”-and how is it calculated? According to the AIA Commentary, “Where the change results in a credit, the amount of the credit is determined by the cost that would have been incurred in executing the change by the contractor without decreasing the contractor’s overhead and profit.” In other words, “actual net cost” is simply the cost-to-complete, without any overhead or profit mark-ups, the remaining or deleted work. Generally, it would include only the following costs:
    • Labor;
    • Materials, supplies and equipment;
    • Rental costs of machinery and equipment, exclusive of hand tools, whether rented from the Contractor or others;
    • Costs of premiums for all bonds and insurance, permit fees, and sales, use or similar taxes related to the Work; and
    • Costs of supervision and field office personnel directly attributable to the deleted work.
    The same calculation would normally apply if you were a subcontractor and have an agreement with the general contractor, which includes a provision that “flows down” the standard AIA A201 general conditions. However, if the owner’s deductive change results in deleting all of the subcontractor’s remaining work scope, the TFC clause would govern.

    1 Steve Holmes, AGBCA Lexis 4, 90-1 BCA (CCH) 22,628 (1990).
    2 See Appeal of Lionsgate Corp., 90-2 BCA (CCH) 22, 730 (Corps Eng’rs BCA Feb. 28, 1990).
    3 See Nager Elec. Co. v. U.S., 194 Ct. Cl. 835 (Ct. Cl. 1971).
    4 Appeal of G.M. Co. Mfg., Inc., 1957 ASBCA LEXIS 1129 (A.S.B.C.A. Dec. 26, 1957).
    5 Appeal of Keco Indus., Inc., ASBCA No. 15131, 72-1 BCA 9262.
    6 AIA 201 § 14.4.
    7 AIA Document A201-2007 Commentary.