Jun 6 2013

When Is A Lump Sum Contract Not A Lump Sum Contract: Pricing Reduced Scope, Schedules of Values & Unit Prices

Timothy R. Conway ©2013

Pricing Credits for reduced scope on “lump sum” contracts might be complicated where unit prices are involved.

Contractors and owners often spend a lot of time and energy fighting about extras to a contract. But reductions in scope can generate just as many pricing disputes.

These disputes are especially likely if the parties use a contract that combines elements of lump sum and unit price approaches. Here’s a typical example: the owner and contractor enter into a contract with a single lump sum. The contract, however, also contains a breakdown of the work into individual line items. Each line item in this breakdown or schedule of values has a quantity, a unit price, and an extension that multiplies the given units by the unit price to arrive at a dollar amount for each line item. The total of the individual line items equals the single “lump sum.” The schedule of values is then used to process progress payments.

During construction, the owner may delete certain work reflected in the line items in the schedule of values. At the end of the project, the owner may contend that fewer units were actually installed than the estimated quantities shown in the schedule of values. The owner will want a credit based on the unit prices in the schedule of values. Does the contractor have the right to be paid the lump sum price, without downward adjustment? If there is a downward adjustment, are the unit prices and line items in the schedule of values controlling?

What does the Changes clause say about credits?

There may be a Changes provision or other contract language that requires the use of the unit prices to calculate the reduction in price. In these cases, the owner gets a credit based on the unit prices and line items in the schedule of values. Contractors, therefore, need to check for this type of language in the changes clause at the time they submit what they think is a lump sum proposal.

There are cases, however, in which the owner receives no credit, and the contractor is able to recover the full lump sum, without reduction for the lesser quantity actually performed. See Blough v. United States, 17 Cl. Ct. 186 (1989). In such cases, the contractor may find it helpful to explain why its pricing required a lump sum, without adjustment for actual quantities. In Marmer Brothers Construction, Inc. v. Midwest Steel, Inc., 2000 U.S. Dist. LEXIS 13381, *11 (S.D.N.Y. 2000), a subcontractor testified that during contract negotiations, the subcontractor told the contractor that sheet piling work needed to be priced on a lump sum basis, and not based on the actual length of the piles driven. The subcontractor recovered the lump sum price, despite the contractor’s contention that a lesser quantity of sheet piling was installed.

Does the Scope Reduction Require an “Equitable Adjustment”?

More commonly, however, the contract will have a changes provision that requires an “equitable adjustment” or cost evaluation. In such cases, the owner is not necessarily allowed to use the unit prices or extended line item values in the schedule of values or breakdown. Instead, the contractor is allowed to identify management, overhead, or other project costs that may have been allocated or distributed to come up with the unit prices in individual line items, but which are not saved or reduced because a lesser quantity is actually performed.

A recent example is Contract Management, Inc. v. Babcock & Wilson Technical Services Y-12, LLC, 2013 U.S. Dist. LEXIS 1673 (E.D.Tenn. Jan. 4, 2013). The subcontractor in Contract Management agreed to clean five water lines for a single lump sum.

The subcontractor, however, also provided unit prices for the pay items required for cleaning the five water lines. The owner and contractor subsequently deleted four of the five water lines from the project because of funding problems. The contractor wanted the credit for the deleted work to be based on the unit prices and line items provided by the subcontractor for each water line.  Upon trial, the court rejected this argument.

The unit prices and line items for each water line were not used because they included management costs that were not saved, even though four of the five water lines were deleted. Id. at *19. Those management costs had been allocated or distributed among the five water lines at the start of the project, but because the subcontractor planned to work on multiple water lines at the same time, the management costs were not in fact linked to any specific line. Id. at *7. The court reasoned that the subcontractor’s original breakdown into unit prices and line items was done “to avoid an unbalanced bid,” and not to reflect the actual costs of each water line. Id. at *8. See also Mid-States General & Mechanical Contracting Corp. v. Town of Goodland, 811 N.E.2d 425, 433 (Ind. App. 2004) (stipulated sum to be broken down for “bookkeeping purposes”). The Contract Management, Inc. general contractor has appealed.

The above examples concern reductions in scope or lesser quantities actually being installed. What if the owner becomes aware that the contractor’s actual costs of performance are less than what the contractor originally planned? Will the owner be entitled to a credit against a lump sum contract? No, according to the court in Randall & Blake, Inc. v. Metro Wastewater Reclamation District, 77 P.3d 804 (Colo. App. 2003). In Randall & Blake, the owner and contractor had a lump sum contract for work on a river that required suitable bedding material. After work began, the owner determined that the existing riverbed material was suitable and could be used. Even though the contractor’s costs to purchase bedding materials were now less, the owner was not entitled to a credit from the original lump sum. The court saw “no deletion of work.”  Id. at 808.

The court also questioned whether, under the Changes clause, the owner had given the contractor timely notice of its intention to issue a deductive change order. Id. This, of course, was an interesting twist on the “notice” issue that typically affects contractors seeking additional compensation.

LESSONS LEARNED: If contractors or subcontractors are submitting a lump sum bid or proposal, and are also asked to submit unit prices or a schedule of values with line item breakdowns, they should ensure they understand why they are being asked to submit the unit prices and line items. Asking a pre-bid question about how the unit prices or line items will be used with the lump sum contract might be appropriate. At a minimum, contractors or subcontractors should check the Changes provision and other contract language to see if the unit prices and line items will be used to determine deductive change orders and, if so, develop your unit prices and line items carefully.