Change Order Mechanisms For Good Contracts – Two Examples

Building in the right change order procedure into a contract can go a long way towards making the contractual relationship stronger and avoiding disagreements down the road.

My elevator speech (as it is now – you never know) emphasizes three attributes that I think any good business-to-business contract should have:

  1. The contract should be a win-win for both parties
  2. It should contain the necessary mechanisms so it works on a day-to-day basis
  3. The contract should last for a long time without requiring major fixes

My last blog covered why I believe contracts should be a win-win. This post focuses on one of the mechanisms.

These mechanisms “impose” policies and procedures on one or both side from which they will benefit. The best way to relate this is with a couple of examples: one from a master services contract and its equivalent from a master sales contract.

Master Service Contract Example

Every master service contract should provide for change orders. Successfully modifying a statement of work requires these documents.

I see some agreements without any provision for change orders, which invites “project creep”. People on both sides make changes, in the field and on the fly, to services and deliverables. The poor service provider may not realize what happened until the once-profitable project comes in at a very low margin or even at a loss. So, every master service agreement should have a requirement that no changes to the services or deliverables take place without a change order, signed by both parties. That’s not optimal, though.

Just saying a change order will be required ignores the issue of how it will come into being. Without a process for negotiating them, the chances that the change order will get created, regardless of the requirement in the contract to do so, decreases substantially.

For this example, let’s assume the client wants to change the services and/or deliverables. Construct the master service contract such the following occur:

  • The client provides that request in writing to the service provider
  • The service provider has time to think about the change, and to calculate a new price to address the financial impact
  • This revised proposal should be provided to the client in writing

    People Around Table Agreeing on Change Order
    © Can Stock Photo / pressmaster
  • The client should have adequate time to consider and accept or reject the proposed revision.
  • There should be mechanisms (with time limits) around negotiating the final change order, which the parties then sign
  • Finally, a procedure is needed in the event of an impasse, in which case the change order does not happen, and the parties agree not to make the change or just part ways

Master Sales Contract Example

The example here is simpler: the buyer wishes to cancel its purchase order before the product ships. The example assumes manufactured products. IP deliverables, such as software, fit the model as well.

  • Within a certain period before shipment, say 120 days, perhaps there should be no penalty for cancelling the purchase order
  • Within a much shorter period prior to shipment, the buyer should have to pay the full price or at least the cost of acquired long lead-time materials plus labor
  • For the times between the two extremes, a good solution is a table with various percentages of the purchase price the buyer must pay, depending on the period before the ship date the order is cancelled. For example:

Days Before Ship Date

Percentage Payment Required

90

25%

60

50%

30

100%

 

Both the change order and order cancellation process may tilt slightly in favor of the service provider or seller. But, if the client does not get a surprise bill for “project creep”, and the buyer does not get a demand for the entire purchase price because of cancelling six months out, they win as well.

If litigation is avoided, both parties save a lot of money.

If drafted properly,these are simple solutions for handling what could become major stumbling blocks in the contract.

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