The building blocks of modular construction: contractual and privilege considerations | Cohen Seglias Pallas Greenhall & Furman PC

An emerging trend in the construction industry, modular construction promises improved build quality, greater construction efficiency and lower overall cost, all high goals among any contractor’s project goals. The support of investment leader Warren Buffet for initiatives to develop modular building software attests to the value of this construction method to the industry. However, before seeking the promises of modular construction with increased profitability, contractors should fully understand the contractual risks that this new construction method involves.

Unlike traditional on-site construction, modular (or prefab) construction takes advantage of the assembly of building components at factories or other manufacturing facilities, rather than on-site. This requires transporting large completed building segments to the project site and assembling them there, usually by the precaster or other trades. Although used for decades, modular construction has recently gained in popularity as it offers greater efficiency and lower costs. For example, workers learn skills by performing specialized tasks repeatedly, and assembly work indoors rarely faces weather-related delays. Opponents of the trend, however, point out its limitations when it comes to customization and the high shipping costs for out-of-reach locations.

While these pros and cons may vary from project to project, there are some contractual issues that are pervasive in most, if not all, modular projects:

  • The integration: Since modular construction involves off-site construction, small differences in design, materials, and workmanship could create difficulties in adding the modular component to the on-site structure. The contractual language that describes who bears the risk of such integration issues should appear in all relevant contracts, whether between the owner and the GC, the GC and the manufacturer, or the GC and the installer. The actual allocation of this risk remains at the discretion of the parties, but parties should know how to price their work based on who pays when integration issues arise. In addition, the parties must ensure that the wording of the agreement properly allocates the risks.
  • Delay: The installation of prefabricated components can occupy large spaces on a construction site. Only careful coordination can prevent the installer from dealing with interference from other trades. Accordingly, the relevant agreements should provide for whether and how an installer can recover losses suffered as a result of interference.
  • Assurance: Since bringing prefabricated components to a job site can, and often does, involve interstate transportation, prefabricators should have insurance coverage that applies in all applicable states. Otherwise, coverage may not be available. All parties involved should ensure that the relevant agreements contain the insurance requirements necessary to ensure appropriate coverage.
  • Privilege: Most lien laws allow a GC, subcontractor, or supplier to file a lien on unpaid furnished and completed construction work. Prefabricated components challenge traditional legal conceptions of furnished and completed jobs. On the one hand, the components themselves are completed and, as a single work, supplied to the project since the manufacturer cannot resell them to another buyer, therefore lien rights must exist. On the other hand, components do not involve more labor and materials than a supply of construction products, both of which could be returned to the supplier, rendering a privilege inapplicable.
  • Risk of loss – If prefabricated components are damaged or destroyed in transit, liability for such loss varies by jurisdiction and depends on applicable laws. If the prefabricated components are considered goods, the UCC rules apply and the risk of loss passes to the buyer depending on whether the prefabricator is required to deliver the components to a carrier or to a particular destination. If prefabrication, however, constitutes a service, then UCC would not apply, and the party that bears the risk of loss often depends on traditional negligence concepts related to duty of care. Since modular construction is a relatively new construction method, and concepts of neglect frequently require factual analysis, courts have not had many opportunities to set clear standards regarding applicable laws. To remedy such uncertainty, parties may use carefully crafted contractual language to clarify liability for damage during shipment in advance.

To help solve these and other issues unique to modular construction, all project stakeholders, including prefabricators, installers, GCs, and owners, should ensure their contracts contain appropriate language. Cohen Seglias lawyers are available to assist with contracting and other construction-related needs as they arise.