New California Supreme Court Decision Will Impact Contractor Public Works Change Order Claims

New California Supreme Court Decision

Will Impact Contractor Public Works Change Order Claims

By

William C. Last, Jr.

Attorney at Law

On February 3, 2002, the California Supreme Court, in the case entitled Amelco Electric v. City of Thousand Oaks, ruled that a public works contractor cannot assert that the public body and the contractor impliedly abandoned their construction contract. Amelco argued that the contract was abandoned since the parties failed to follow the contract change order procedures and the final scope of work substantially differed from the original scope contained in the contract.

The Amelco case also is significant since the California Supreme Court clearly set forth four requirements for using the total cost method for calculating construction breach of contract damages. The total cost method is based upon a comparison of the actual cost of the completed work to the contract amount.

The remainder of this article will review the Amelco case and discuss how the decision may impact the construction industry.

Factual Background

The City of Thousand Oaks (City) solicited bids for electrical work to be performed in the construction of the Civic Arts Plaza. The project included an office building, a dual-purpose 400-seat council chamber and forum theater, an 1,800-seat civic auditorium or performing arts theater, and an outside area (the "project"). The project was managed by a construction manager and was bid as a multi-prime contract. Amelco, one of the largest electrical contractors in the United States, was the lowest electrical contractor with a bid of $6,158,378.00.

Over the two year construction project, the City sent out 1,018 sequentially numbered sketches to the project prime contractors. The sketches were intended to clarify the original contract drawings and to respond to requests for information. The vast majority of the changes were to one building. Approximately, 248 of the sketches affected the electrical cost. As a result, Amelco requested 221 change orders. The City and Amelco agreed upon 32 change orders. The total value of the approved change orders equaled $1,009,728; an increase of nearly 17 percent.

During trial Amelco asserted that the project involved an unusually high number of sketches and, as a result, the scheduling of the various contractors' work became more arduous. In addition, there were occasions when Amelco's performance was delayed and subsequently accelerated. Amelco maintained daily job logs and records that recorded activities and work on a particular day. However, it was unable to produce any significant documentation of instances in which its performance of a work directive or change order was delayed or interfered with by the construction manager's actions or inactions.

Amelco argued that due to the number of changes it was impossible to track their impact on the cost of the work. Amelco asserted that the effect of the numerous change orders was equal to "death by 1,000 cuts."

Amelco then submitted a claim for $1.7 million that was based on the total cost of the work. The City denied the claim. Amelco then sued the City claiming that the contract was abandoned or alternatively the City breached the contract. Amelco's claim sought $2,224,842.00 in damages.

The Issues Before The Court And Their Decision

1. Can A Public Entity and A Contractor Abandon A Contract Thereby Entitling The Contractor To Recover the Reasonable Value of Its Services?

The short answer is no! But since the abandonment argument can be applied to a private contract, it is important to understand the nature of the concept.

The Amelco decision states that: "The question in this case is whether a public entity is liable under an abandonment theory to a contractor when it makes numerous changes to the contract work, and these changes allegedly make it difficult and more costly to perform the contract because of delay, interference with the work of other trades, and other problems not captured in the price of the executed change orders."

The Amelco decision further states that: "Under the abandonment doctrine, once the parties cease to follow the contract's change order process, and the final project has become materially different from the project contracted for, the entire contract -- including its notice, documentation, changes, and cost provisions -- is deemed inapplicable or abandoned, and the plaintiff may recover the reasonable value for all of its work."

Under prior court decisions, parties to a private works contract could impliedly abandon a contract when they fail to follow change order procedures and the final product differs substantially from the original contemplated. In those cases, abandonment could be found when the owner and contractor allowed numerous changes in the scope of work to be made without following the contract change order clauses relative to notification, documentation and pricing changed work.

However, when the Amelco Court reviewed the competitive bidding statutory requirements for California public works projects, it concluded that approval of an abandonment based claim in a public works context, would violate those statutory requirements. For example, the Amelco Court stated: "Public entities would not receive timely notice of claims that would allow them to make project management, budget, or procedural adjustments during the course of construction. Rather, contractors would be permitted to wait until a project was completed before giving notice of "too many" changes, thus creating intolerable uncertainty in the budgeting and financing of construction projects."

The Amelco Court also was concerned that approving an abandonment based claim would encourage frivolous litigation against public entities who entered into public works contracts.

2. Can the total cost method for calculating damages still be used in California ?

The total cost method is still available, but the prerequisite elements that must be established before using the approach have been clarified by the California Supreme Court.

While the City argued that a total cost recovery based approach to calculating damages could never be asserted against a public agency, the Amelco Court did not decide that issue. Rather the Court decided that the theory was not properly presented to the jury.

Normally, damages for breach of a contract are limited to those types of damages that were within the contemplation of the parties to the contract, or at least resulting from a foreseeable breach of that contract. Under the total cost method, damages are calculated by subtracting the contract amount from the total cost of performance. For years, the total cost method generally has been disfavored by the courts. The courts prefer the actual cost method since that method provides the court with actual documented costs. The actual cost method clearly guarantees that the final amount of damages will be based on the actual costs and not result in an inequitable amount of damages for either the contractor, or the public entity.

The Amelco Court found that the total cost method could be used if certain requirements were satisfied. Specifically, the Court held that in order to use the total cost theory for calculating breach of contract damages, the contractor must establish "(1) the impracticality of proving actual losses directly; (2) the plaintiff's bid was reasonable; (3) its actual costs were reasonable; and (4) it was not responsible for the added costs." In the Amelco case, the Court held that Amelco failed to satisfy the fourth element, i.e. that it was not responsible for the added costs.

3. Can a contractor still argue that a cardinal change has occurred ?

A cardinal change occurs "when the government effects an alteration in the work so drastic that it effectively requires the contractor to perform duties materially different from those originally bargained for." In essence, a cardinal change occurs when the magnitude and quality of the changes, coupled with their impact on the project as a whole, are completely different than what the parties to the contract ever agreed to when they entered into the contract.

While almost every construction contract has a clause that allows for change orders, if the nature and magnitude of the change order is far beyond what the parties anticipated when they entered into the contract, it can be construed to be a cardinal change. However, in the public works context, the governmental entity must order the contractor to perform the cardinal change work. In such a case, the courts can conclude that the government has breached the contract and the contractor is entitled to its additional costs for performing the cardinal change work.

In the Amelco case, the Court did "not reach the issues of whether the cardinal change theory applies in California" and whether the changes at issue were cardinal changes. Thus, the doctrine may still be argued in California. However, it should be noted that the cardinal change doctrine is under severe scrutiny by the federal procurement agencies and the federal courts.

How The Decision Will Impact The Construction Industry

The Amelco decision makes it clear that if a public works contractor fails to comply with the contract change order clauses, that contractor cannot rely on the abandonment theory to escape that contract administration shortfall. Thus, if you are a public works contractor who encounters an inordinate number of changes in the quantity or nature of the scope of the work, you should follow the change order contract clauses.

While the Amelco Court failed to decide whether the cardinal change doctrine is applicable to California public works projects, its holding reinforces the importance of documenting all material changes in the project scope of work. Although cardinal changes, by their very nature, are difficult to identify during the change in work, the impacted contractor should make every reasonable effort to notify the owner of the change and then timely document and price the change once identified.

The Amelco Court's holding as to the total cost method of calculating damages also emphasizes the importance of properly documenting the cost of additional work as it occurs. There is no question that the actual cost method of calculating construction damages is the best method. But the actual cost method can only be based on a contractor's detailed and contemporaneous project records.

In closing, it is the author's opinion that the Amelco case will have a long term affect on public works contractors whose performance is impacted by inadequate plans and specifications. However, that impact can be decreased if the public works contractor properly documents the nature of and the cost of the impacted work.

This article, ©2002, was written by William C. Last, Jr. Mr. Last is an attorney who has been specializing in Construction Law for over 20 years.. In addition to belonging to a number of construction trade associations, Mr. Last holds a California "A" and "B" license. He can be contacted at 415-764-1990 or 650-425-7679. A number of his past articles can be found on his website (lhfconstructlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.