Paper on Modular Construction

What is modular construction?

Essentially it is a form of off-site manufacturing in which a building’s components, or modules, are constructed in a factory setting before being transported to site for assembly.

This ranges from traditional “flat-pack” elements to fully finished components and goods, for example bathroom pods, which is common in many residential and hospitality projects.

Recently the market has seen an increase in the use of volumetric construction, and this involves off-site construction of as much of a building as possible before being brought to site. Typically, a complete room with even a bathroom inside that room and in some cases a whole house.

Does the Construction Act apply?

As the goods are manufactured off-site, there is a question as to whether the Housing Grants, Construction and Regeneration Act 1996 applies?

This pivots on whether the modular provider is supplying the components and installing them on site or if the provider is supply only. This is because the Construction Act expressly applies to the “carrying out of construction operations” in England, Wales and Scotland. There is therefore two elements to this, firstly, are the works “construction operations” and secondly, where are they being carried out?

In respect of the first question, section 105(2) of the Construction Act expressly excludes the following from the definition of “construction operations”:

“(d) manufacture or delivery to site of—

(i) building or engineering components or equipment,

(ii) materials, plant or machinery, or

 (iii) components for systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or for security or communications systems,

except under a contract which also provides for their installation”.

Therefore, the Act will not apply to contracts for the manufacture of modular components, unless the contract also provides for their installation.

In respect of the second question, where the pre-fabrication work is produced in the UK but the project is overseas the Construction Act will not apply. In the case of Palmer v ABB Power, it was held that the fabrication of plant on one site, before its transport and erection on another site amounted to “construction operations” as the plant would “form” part of the land once erected. However, the Construction Act would not apply if the plant was installed on a site outside the UK.

Therefore:

• If the modular provider is supply only, the Construction Act will not apply; and
• If the site on which the components are installed is outside the UK, the Contraction Act will not apply.

This is important because the Construction Act includes statutory adjudication as a dispute resolution procedure and has requirements in relation to the payment mechanism and payment notices to be included in the contract. If the Act does not apply to the contract, then the parties need to consider whether they want these provisions incorporated and they need to ensure that there is clear drafting regarding the payment mechanism.

What are the key risks of modular construction?

There is such a broad range of techniques for modular construction and so there is not a “one size fits all” solution to the contracts.  However, some of the key risks to consider are as follows:

• Who owns the modular component prior to transit and delivery and when does ownership transfer to the developer?
• What protection does the developer have for any payments made for modular components whilst they are still off-site? 
• When does risk of damage to the modular components pass to the developer?

What contractual provisions should be considered in a contract involving modular construction?

Ownership

In an un-amended JCT Design and Build Contract 2016, the ownership passes to the developer, if the component is a Listed Item, when payment for the component has been made. However, the JCT assumes that there is a specific Listed Item off-site that can be paid for and then ownership passes. However, the reality of modular construction is that substantial work can be done off-site and the modular contractor may require a number of stage payments where the modular components are at various stages of completion. This needs careful consideration when drafting the contract terms and considering when ownership passes.

Under an NEC4 contract, any title to components stored off-site passes to the developer if the supervisor has marked them as for the contract. Therefore, for components fabricated off-site, the developer will want to secure title to these as soon as possible and so will need to identify the requirements for marking in the Scope to pass title and to protect its position in line with its obligation to pay for the components.

However, in both cases, if the modular provider is a subcontractor, which is usually the case, the developer will need confirmation that ownership from the subcontractor has passed to the main contractor and then will then pass up to the developer, upon payment. 

This can be addressed in a tripartite or back to back vesting certificate, which would usually include the following:

• Confirmation of payment from the developer to the contractor and flowed down to the sub-contractor.
• Confirmation of where the components are stored.
• Warranty that the title in the components unconditionally vests in the contractor and is free from charges and that the contractor, subject to payment, passes ownership to the developer.
• Aright for the developer to inspect the components, at any time.
• That in the event of the subcontractor’s and/or the contractor’s insolvency, the developer can enter the off-site premises and take possession of the components

Protection of stage payments

The traditional payment structure of payment for goods after arrival on site will probably not work for the modular contractor’s cash flow. Therefore, the contractor may require payments to be made before the modular components are delivered to site. However, in the event of the insolvency of the contractor, the developer will potentially be an unsecured creditor for the sums paid for modular components that have not been delivered to site.

The developer could consider the following protections in relation to this risk:

• A vesting certificate would should entitle the developer to demand the components from the relevant insolvency practitioner.  However, the success of such a demand will depend on the developer being able to identify its goods.  The building contract should therefore require the contractor to segregate the components on its premises and to mark them specifically as the developer’s property.  It is important that developers check that such requirements are complied with in practice.
• Such payments could be protected by an advance payment bond.  This should allow a developer to recover payments if the contractor fails to deliver the finished components in accordance with the building contract.  Advance payment bonds have the advantage that they protect the payments made by the developer, rather than the components which are purchased by such payments.  This should avoid any issues with distinguishing ownership of the relevant components, which can be particularly relevant when they cannot be sufficiently identified as belonging to the developer.  In particular, these bonds can be used to protect any deposit payments that may have to be made before there are even any components in existence.
• Another form of security is an off-site materials bond.  This is similar to an advance payment bond and allows the developer to claim under the bond should the off-site components not be delivered to site as required by the building contract.  However, these cannot be used to protect against a “pure” advance payment, where the payment is made before any components are even in existence.

Risk of damage to the modular components

What happens if the components are damaged, either in the factory they are being built in or during transportation to site?

Under the JCT Design and Build Contract 2016, the contractor is responsible for any loss or damage to the components and for the cost of their storage, handling and insurance until they are delivered to site. However, the developer should be named on the policy so that it can claim under the policy directly.

Conclusion

In summary, be cautious when retrofitting existing standard forms as issues with ownership, payment, storage and quality control should all be carefully considered.  Provisions can be included in construction contracts to limit the risks of off-site manufacturing.  However, administering the contract correctly is as important.

This article was written by Rebecca Morjaria following our Construction & Infrastructure Webinar on the 10th June 2020, which discussed topics including:

• Covid-19 – an overview of the relevant health and safety laws for construction sites.
• Whether a company in liquidation can adjudicate? - We will review the recent cases on this question applying the Court of Appeal’s decision in Bresco v Lonsdale.
• Modular construction – are the standard forms suitable?

Please click here to listen to the webinar.