Modular Building Institute
Modular Building Institute

Contract Drafting for Modular Construction: A Modern Approach to a Traditional Craft

By Ron Ciotti

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

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