Change Management: Navigating Change With Precision and Purpose
By Brett Williams, CPCM, CFCM
Throughout the execution of a contract, the occurrence of a change is a near certainty. Contract changes occur so frequently that Part 43 of the Federal Acquisition Regulation (FAR), “Contract Modifications,” is dedicated solely to them. Changes to the contract occur regardless of customer, contract type, acquisition phase, or technology readiness level.
Understanding Changes and Regulations
FAR Section 43.103 identifies two types of changes: bilateral and unilateral. These types of changes in a contract document are defined as follows:
(a) “Bilateral – A bilateral modification (supplemental agreement) is a contract modification that is signed by the contractor and the contracting officer. Bilateral modifications are used to:
(1) Make negotiated equitable adjustments resulting from the issuance of a change order;
(2) Definitize letter contracts; and
(3) Reflect other agreements of the parties modifying the terms of contracts.
(a) Unilateral – A unilateral modification is a contract modification that is signed only by the contracting officer. Unilateral modifications
are used, for example, to:
(1) Make administrative changes;
(2) Issue change orders;
(3) Make changes authorized by clauses other than a changes clause (e.g., Property clause, Options clause, or Suspension of Work clause); and
(4) Issue termination notices.”1
Note: While the Contracting Officer may issue a unilateral direction for items 1-4 above, the Seller must take action to preserve their rights in the event that any of the unilateral changes have an impact on cost or attempt to prevent the Seller’s rights to file a Request for Equitable Adjustment or ultimately file a formal claim for damages.
Subsections (a)(1) and (b)(2) above both pertain to the “Changes” clause included in Section 52.243 of the FAR. However, Subsection (a)(1) is associated with bilateral modification after the seller asserts its rights for adjustment in accordance with FAR Section 52.243 and they may submit an equitable adjustment proposal to be negotiated by both parties.
Subsection (b)(2) precedes the equitable adjustment phase, whereby the seller is required to proceed on a unilateral basis in certain instances. Proceeding on a unilateral basis is often referred to as a “directed change.” Instances in which directed changes may be utilized are addressed in the clauses in Figure 1, listed by contract type and scope type.
As it pertains to FAR 52.243-1, requirements concerning directed changes indicate that “the Contracting Officer may at any time, by written order, and without notice to the sureties, if any, make changes within the general scope of this contract in any one or more of the following:
(1) Drawings, designs, or specifications when the supplies to be furnished are to be specially manufactured for the Government in accordance with the drawings, designs, or specifications.
(2) Method of shipment or packing.
(3) Place of delivery.” (1)
The intent of any changes clause, bilateral or unilateral, is to allow the seller to proceed in advance of a modification related to the directed change. The change clause is also predicated on the assumption that time is of the essence and the cost impact, if any, is minimal. To seek reimbursement in the event of a cost and/or schedule impact resulting from a directed change, the seller must assert its right to adjustment within 30 days from its receipt.
Other Change Types
Buyers and sellers at all levels of the supply chain have a responsibility to ensure that the contracted work scope, as the basis of the awarded value, is both upheld and followed. When the buyer issues a directed (unilateral) change consistent with the changes clause, they recognize that additional costs may be incurred from the seller performing the change.
This is ordinarily acceptable given that, as previously established, changes in accordance with FAR Section 52.243 result in minimal cost impacts. However, a complete picture of contract changes cannot be ascertained without understanding two additional types of changes which fall outside the FAR: cardinal changes and constructive changes.
Cardinal Change
Changes that are issued outside the purview of FAR Section 52.243 are identified by the Contract Management Body of Knowledge® (CMBOK®) as cardinal changes. A cardinal change is defined as “a change to a contract that is made outside the scope of the contract and is, therefore, unenforceable by the Government.” (2) This means that the buyer cannot require the seller to perform work outside of the general scope of the contract and is also not responsible for any costs incurred by the seller in the performance of such work. Should the seller incur any costs associated with a cardinal change, it would be deemed unallowable costs.
In order for the seller to perform scope associated with a cardinal change, the contract would require bilateral modification in accordance with Section (a)(3) of FAR 43.103. Such a change would normally be preceded by a request for proposal by the buyer, submittal of a proposal by the seller, performance of fact finding, and then negotiations to finalize the scope and price for the new effort.
Examples of cardinal changes may include when the buyer requests Contract Data Requirement Lists (CDRLs) not specified in the scope of work or when the buyer requests a product from the seller with a capability beyond what is addressed in the scope of work. Cardinal changes are in essence changes that are clearly outside the contractual requirements.
Constructive Change
Up to this point, this article has discussed changes as a dichotomy – those in accordance with FAR Section 52.243, directed changes and bilateral changes, and those that fall outside the purview of FAR section 52.234, cardinal changes. However, there is one additional type of change that this binary view does not account for; it is known as a constructive change.
The CMBOK defines a constructive change as “a change resulting from the Government’s actions or directives that impacts the cost or schedule for performance that is construed to have the same effect as a formal change order.”2 The concept of a constructive change is not addressed in FAR Section 52.243 but is one that is routinely encountered during program execution; it introduces shades of gray to contract management.
As previously indicated, the scope of work on a contract often changes over the course of performance. This program evolution typically occurs on development through Low-Rate Initial Production (LRIP) type efforts, which may be influenced by any number of factors, including the changing needs of the ultimate mission, engineering or manufacturing constraints, or what has been learned by both parties over the course of performance.
Such changes are driven by necessity, but unfortunately often result in the contract being outpaced by the way the program is being performed. As the emphasis on making progress to meet the mission becomes the primary focus, the likelihood of the contract scope becoming out of line (in some cases irreparably) with the program increases. The impacts of such instances may be profound on the performance of the contract.
Examples of constructive changes vary from contract to contract, but a constructive change is essentially a “change” to the way that the work is to be performed. This may be driven by the buyer or the seller (with buyer concurrence). A need for a constructive change might occur during performance of a follow-on production contract, such as when the buyer requires a modification to a previously established and agreed upon Acceptance Test Procedure (ATP) that formed the basis of how the seller would perform ATPs under the follow-on contract.
Even if the change is warranted, the buyer has changed the way that the seller is performing the work and, in turn, the seller can prove that hardware deliverable(s) are “known good” and can be “accepted” (i.e., title transfer). This change might drive the seller’s cost and/or schedule. As a result, the seller may seek equitable adjustment from the buyer to account for the change requested by the buyer.
Note that when the seller is operating as a subcontractor, many prime contractors will attempt to include language in excess of FAR Section 52.243 requirements. It should be recognized that a subcontractor is not obligated to accept the expanded language from a prime contractor and is able to negotiate the changes clause as it applies to their scope of work.
Impacts of Poorly Controlled Change Management
On the Seller
Unlike an Undefinitized Contract Action (UCA)/Letter Subcontract that implements a 180-day definitization schedule per FAR 16.603-2 (unless modified by the prime contractor issuing a subcontract), a Request for Equitable Adjustment (REA) submitted in response to a unilateral (i.e. directed) change does not have a definitization period.
As a result, the seller is required to perform and incur the costs related with the directed change for an indetermined period of time. The same is true even if the seller agreed with buyer’s language in excess of FAR Section 52.243 requirements.
In a cost-type environment, the seller may only incur costs within the authorized funding and may lead to the funded value being reached prematurely, causing a stoppage of work through an increased burn rate from the performance of both in and out of scope efforts at the same time. This situation essentially propels the seller toward the funding ceiling.
In the event the program is fully funded, a stoppage of work would continue until both the contract value and funding are increased, potentially having a negative impact on the program due to loss of resources and increased costs attributable to restarting it.
In a firm-fixed-price environment, the seller may be at more risk than in a cost-type environment given fixed-priced contracts normally lack funding ceilings (i.e., an incrementally funded fixed-price contract) to force a stoppage of work when the funding/contract value is reached.
This creates a situation where the seller is paying for the continuation of work until the change is ultimately awarded. In some organizations, there is a formalized process for company funds to support efforts outside the general scope of the contract; in others there is not. Whatever the case may be, contact funds are specific to the awarded scope of work and the performance of work beyond the awarded scope effectively requires the use of company funds to perform through an indeterminate period of time.
In either scenario, the performance of work not in alignment with FAR Section 52.243 creates a situation where the financial baseline (i.e., the program budget) is out of sync with the costs being incurred by the program. The baseline cannot “catch up” until the out-of-scope effort is awarded via modification to the contract. It is usually unclear when this will occur. This situation makes the program more difficult to manage and predict as financial, schedule, and resource issues that would ordinarily be apparent are masked.
In both a firm-fixed-price and cost-type environment, the seller is unable to invoice the costs associated with the directed change until the contract is modified to reflect award of the definitized directed change. As time and/or the performance of cardinal or constructive changes increase, the cash impact is more pronounced and impactful to the seller.
On the Buyer
As contract management professionals working with higher-tier contractors are aware, subcontract terms and conditions issued to a contractor’s supply chain often provide the buyer change authorities well in excess of the government’s. These greater authorities are exercised in the form of directed changes that, unless negotiated out, require the seller to proceed with performance.
The buyer’s authorization of a directed change consistent with the terms of the contract, regardless of whether it is consistent with FAR Section 52.243, is a recognition that it may incur additional costs due to the seller performing the change.
If the change is ultimately not part of, or later included in, the buyer’s contract with its ultimate buyer (i.e., the prime contractor or government), the buyer would be responsible for the costs incurred by the seller, but the ultimate buyer would not be responsible for the change, leaving the buyer solely responsible for the costs.
As much as the seller utilizes financial data to help manage the contract, the buyer also utilizes the financial data in managing the buyer in the same way, especially in a cost-reimbursement environment. As the seller incurs costs in the performance of changes inconsistent with FAR Section 52.243, the financial data becomes skewed and causes it to become a less reliable early warning system as it’s difficult to discern between in-scope and directed-change performance. In this situation when costs are increasing with little to no progress being made, it may actually be a false alarm that no programmatic progress is being made. In response, certain corrective measures must be taken based on available financial data.
Such measures may include management involvement, issuance of a Supplier Corrective Action Requestion (SCAR), etc., which all result in increased management costs on the part of the buyer. These measures may divert critical buyer resources away from other contracts or programs that may benefit more from this type of involvement.
Why Changes Are a Reality
Much of the information above may seem intuitively obvious, and one may wonder why any contractor would agree to changes that are inconsistent with FAR Section 52.243 or even perform out-of-scope work in the absence of a directed change notification.
The reality is that this path has been paved with the best of intentions for the benefit of the customer at all levels of the supply chain. The intent is to provide flexibility and to allow programs to adapt to changing circumstances. The thought process often boils down to the items below, whether it be the basis for a buyer’s changes clause language, agreement to accept the language, or a desire to proceed without direction:
• Proceed based on discussions/agreement with the program manager/technical team.
• Proceed because doing so will help the customer maintain schedule.
• Proceed because the customer will owe us a favor in the future.
• Proceed given that path makes the most sense.
While the rationale above has the customer’s best interests in mind and is not malicious in intent, it does not account for the fact that a contract is an agreement between parties for the performance of certain work at a specified price.
A regimented approach of the buyer identifying their new desired scope, the seller proposing the new scope, the parties negotiating the price for the new scope, and executing a modification to the contract that increases the value and/or funding along with the new scope ensures that the contract maintains pace with the evolution of programmatic needs. Otherwise, the contract will often take a back seat to the needs of the program, causing it to become a red program – something all contract professionals have experienced at least once in their career.
Nevertheless, the best of intentions will derail any program, regardless of the company, customer, product, experience level, etc., unless change management is considered with precision and purpose. A quote by Terry Goodkind from the “Sword of Truth” series of novels summarizes this best, saying “The greatest harm can result from the best intentions. It sounds like a paradox, but kindness and good intentions can be an insidious path to destruction. Sometimes doing what seems right is wrong and can cause harm.”
In Summary
Contracts professionals must always negotiate and manage the changes clause in higher-tier contractors’ standard terms and conditions in a manner that is consistent with FAR Section 52.243. Doing so ensures that instances of directed changes executed by a buyer are limited to those allowable by the government and that are generally low in dollar value.
Acceptance of language in excess of FAR Section 52.243 opens the seller up to unquantifiable risk as the program changes over time and, depending upon the size of the program, may have implications at the business level in terms of cash constraints, sales issues, and resource availability.
In addition to ensuring a FAR-compliant changes clause baseline, the buyer and seller must be vigilant in upholding the contractual baseline and not fall victim to commencement of performance based on good intentions without having first modified the contract to reflect changes in scope, price, and/or schedule, which requires incorporation through bilateral modifications to the contract.
While it may not be the easiest or quickest way, as Seth Godin once said, “Most people are searching for a path to success that is both easy and certain. Most paths are neither.” CM
Brett Williams is a senior contracts professional in the greater Boston area with extensive Department of Defense and commercial industry contracting experience. He has an undergraduate degree in business from the University of New Hampshire and an MBA from the University of Texas at Arlington. He holds Certified Professional Contracts Manager and Certified Federal Contracts Manager certifications from NCMA.
ENDNOTES
1 Federal Acquisition Regulation. FAR | Acquisition.GOV. (n.d.). https://www.acquisition.gov/browse/index/far
2 Rumbaugh, M. G. (2013). Contract management body of knowledge (CMBOK) (Fourth). National Contract Management Association.