The construction industry has been long recognized as a challenging business.
Compressed schedules, shrinking profit margins, and a host of unpredictable
market fluctuations and environmental conditions can plague even the most
well-planned projects. Because traditional project delivery methods are
intrinsically vulnerable to each of these risks, a deliberate and project-specific
approach to contracting has always been an essential tool to allocate risk and
avoid, or at least mitigate, potential losses.
However, with the recent boom in offsite prefabrication and modular
construction, traditional construction contracting can create the potential for
ambiguities and project losses not contemplated within the four corners of the
traditional contract. A failure to identify these changing risks, and adapt one’s
contracts accordingly, exposes project owners, contractors and suppliers alike
to a myriad of otherwise preventable liabilities. Therefore, to better protect a
company’s interests in a landscape of increasing modular builds, a similarly
modern approach to contracting is now necessary.
Here are a few factors to consider before contracting your
next modular build:
I. Applicable Law: Common Law or UCC?
Construction contracts are typically interpreted as
service agreements that implicate common law legal
doctrine, while largely ignoring the fundamental reality
that construction of any type requires the provision of
goods, most commonly governed by Articles 2 and 9
of the Uniform Commercial Code (UCC). In other words,
traditional construction contracts contemplate contractors
and subcontractors as performing a service at the project
site, and, from a legal perspective, provide little guidance
for a modular build that arguably involves the buying and
selling of goods (i.e. modular elements or “modules”) to be
incorporated into the finished building.
In disputes concerning both UCC and common law, courts
have applied the “Predominant Factor” test to determine
which law applies. In short, if the provision of goods is the
predominant factor under the contract, the UCC applies
and the party to the contract is considered a manufacturer.
If, however, the provision of services is the predominant
factor under the contract, the common law applies and
the party to the contract is considered a subcontractor.
Although each determination will depend upon the
factual circumstances and how your contract is structured,
provision of services is the prevailing view among courts.
Therefore, unless you structure your contract accordingly,
modular builders will likely be viewed as subcontractors
and common law will apply.
Nevertheless, because modular construction is a hybrid
transaction involving traditional construction services and
the provision of modules manufactured at offsite locations,
understanding the basic distinction in legal authorities
is essential to avoiding potential pitfalls found in key
contractual provisions. Once understood, it is easy to see
why a modular build contract requires greater clarity than
that which is commonly utilized on traditional construction
projects.
One area of contracting that lacks such clarity in the
context of modular construction is the preservation and
transferring of security interests. Under a traditional
construction contract, security interests are traditionally
governed by the statutory lien law of the state in which
the project is located. While every state’s lien law is
different, they all share the same fundamental purpose
of creating a statutory security interest for parties which
have performed labor on, or provided materials or
equipment to, a particular project. The security interest
created pursuant to a lien law typically continues to run
with the labor and materials after they are provided to the
project (subject to statutory timing requirements) and is
not extinguished merely by their subsequent incorporation
into the building being constructed.
Conversely, Article 9 of the UCC extinguishes security
interests in manufactured goods according to entirely
different standards. Although the UCC does not
recognize a security interest in ordinary building materials
incorporated into improvements to real property, UCC §
9-334 does recognize security interests in “goods that are
fixtures or … goods that become fixtures.” Thus, the extent
and duration of one’s security interest in modules may
depend on a mutual understanding as to whether: (i) the
modules constitute fixtures, and (ii) if/when the modules
being incorporated into a building cease to be fixtures.
Further complicating matters, the UCC also extinguishes
security interests according to the “buyer in ordinary
course” standard. Specifically, UCC §9-320(a) states,
“[A] buyer in ordinary course of business…takes free of
a security interest created by the buyer’s seller, even if
the security interest is perfected and the buyer knows of
its existence.” Designed to expedite the continual flow
of commerce, if applied to modular construction, Article
9 of the UCC could a strip a modular manufacturer of
any remaining interest in the modules (e.g., outstanding
payment) after a project owner has paid the prime
contractor and incorporated the modules into finished
building.
Because case law concerning modular construction is
limited, the best defense to each of the above issues is
a carefully crafted contract that makes clear not only the
parties’ intent as to whether the UCC applies, but further
provides detailed language concerning the extent of
lien waivers and termination of security interests running
with modules to be incorporated into the building being
constructed.
II. Impact of State Law
Using a traditional or standard form construction contract
on a modular build can also expose project owners and
modular contractors alike to the implications of local laws
and ordinances not otherwise accounted for. Failing to
thoroughly review and account for the possible impact
of contracting where the project and modular contractor
are in different states can have significant consequences
concerning both statutory and administrative law.
For example, modular construction contracts may invoke
differing statutes of limitation and repose. Neglecting to
educate yourself of conflicting statutes and failing to draft
modular construction contracts with appropriate choice
of law provisions can have potentially fatal implications
on the viability of a subsequent claim. Moreover, further
conflict may be found in determining which in-state statute
applies if there exists ambiguity in which type of action
may be appropriately brought (e.g., breach of construction
contract or breach of a contract for the sale of goods
under the UCC).
III. Trade Licensing Requirements, Labor
Agreements, and OSHA
Application of trade licensing requirements and labor
agreements can also be the source of dispute on
a modular construction project. In particular, certain
construction trades or labor groups with a rightful claim
to certain scopes of work at one location may not apply
or be recognized at the opposite site of manufacturer or
installation. Failure to draft modular construction contracts
according to the jurisdictional reach of applicable trade
licenses and labor agreements can lead to debilitating
labor disputes and/or work stoppages.
Special consideration should also be afforded to
jurisdictional issues concerning worker health and
safety. Specifically, parties and their counsel need to
understand whether a modular manufacturing site and
the project site may be subject to different OSHA state
plans, or even different industry standards (e.g. 29 CFR
1926 – Construction Industry Standard; 29 CRF 1910 –
General Industry Standard). It is important to understand
the difference and draft modular construction contracts
accordingly.
IV. Transfer of Liability and Risk of Loss
Contract drafting in the context of modular construction
also demands close attention to the transfer of liability
and risk of loss in the event modules are damaged or
destroyed while in transit from manufacturing locale to
the project site. As a general rule, if a modular builder
is considered a UCC merchant (i.e. manufacturer selling
modules/goods), the risk of loss passes to the buyer
upon receipt. Conversely, if the modular builder is not
considered a merchant (i.e. subcontractor performing
services), the risk of loss passes to the buyer on tender
of delivery. Other important transportation considerations
include, time, and cost associated with customs and
international shipping, truck weight and height limitations,
storage, and insurance. Each of these considerations
require thorough investigation and careful management
of the risk from the point of manufacture through final
delivery to the project site.
V. Delivery Issues
Delivery in modular construction does not conform to the
same requirements of standard construction contracts by requiring a Certificate of Occupancy or Certificates of Substantial/Final
Completion. For that reason, modular construction contracts must establish a
protocol for when and how delivery of modules is to be accepted. Any protocol
concerning delivery of modules to the project site must specify survey and
inspection procedures, as well as any testing, final sign-off or acceptance
procedures.
Of course, the above topics discussed are only a few of the many contractual
issues that could befall a prefabrication or modular construction project and
offer only a prospective view of the changing legal landscape. For that reason,
and because there is little precedence concerning the particulars of commercial
modular construction, contractors must ensure thorough “flow-down” of all
terms and provisions contained in the prime contract to sufficiently allocate
the risk and avoid, or at least mitigate, any foreseeable loss. While modular
construction offers the potential for great savings in time and money, it offers
equal risk of loss if undertaken haphazardly.
About the Author
Ron Ciotti
Ronald Ciotti is an
attorney with Hinkley
Allen in Manchester, NH.
His practice focuses
on all aspects of the
construction industry,
including contractual
disputes, lien work, bond
claims, construction
design and defect claims,
bid disputes, litigations
and dispute resolution.
This article originally appeared in Modular Advantage Fourth Quarter 2018 published in November 2018