Modular construction – Risks and considerations

Modular construction, or “MMC” (used interchangeably in this article), is a construction process in which part of the construction is carried out offsite, usually within a factory environment, often realising multiple identical units to be integrated once they reach the site. It can range from large parts of a building (such as individual dwellings) to fitted-out wall panels and fixtures and fittings. The separate units are known as “modules” that upon installation form part of the overall structure as originally designed. Modular construction is featured in the UK government’s Construction Playbook and forms a key part of the UK Government’s Net Zero strategy and the Levelling-Up agenda.

What are the pros of modular construction?

The benefits of modular construction have been demonstrated to be speed and cost – two critical requirements of any construction project. There is also enhanced control of the quality of the products that are being installed in the works, with the advantage of using in-factory technology to produce sustainable, high performing integrated sections.

Assembling units off site can also mean speedier installation, protecting against adverse influences such as weather and labour shortages. It can also be a valuable solution to a site with limited space for the storage of parts to be incorporated in the works.

What are the cons of modular construction?

There are certain notable disadvantages, which are discussed in the context of risks below.  The employer is very reliant on the specialist and expert techniques of both the manufacturer and the installer, and the interface between the overall design and the design of the modular parts can be a problematic practical and legal area. In addition, modular construction is costly at the front-end; leasing factory space; materials for manufacture and personnel all feature as common upfront overheads to be met before work begins.

Modular construction has experienced a problematic recent history.  The liquidation of Urban Splash in 2022, ILKE Homes and Modulous in 2023/2024 creating losses of between £20 and £319 million pounds, have raised alarm that the exciting new technological developments afforded by the prospect of MMC cannot yet be sustained by the current construction market.  There is an irony in that the new construction method of MMC, originally created to tackle the problems of time and cost (brought by various industry factors such as Brexit and economic conditions) has in fact created a rod for the industry’s back.

Broadly speaking, however, modular construction has been well received, growing into the housing, commercial and industrial development markets. Notable success stories include Perspektywa in Gdansk, St Martin’s Place in Birmingham and the well-known Nagakin Capsule Tower in Tokyo.

Legal considerations for modular construction

1. Type of contract

Conventionally, all construction (whether offsite or onsite) will be procured from a single contractor by way of a single construction contract.  It is arguable that the legalities of producing modular units are better served by a supply of goods contract, which will include suitable contractual provisions as to quality, title, and various other important features to govern the sale of the modular units in exchange for cash.  The representations and warranties, dispute resolution options, and payment provisions of conventional construction contracts and supply contracts differ to various degrees.  It may be a heavy burden for a contractor sub-contracting a modular supplier to engage in a supply contract if the supplier does not wish to contract on construction terms; this may result in an uncomfortable mismatch of legal terms for a contractor wishing to pass down back-to-back responsibility for design and build onto its supply chain.  This could spell issues for the contractor in terms of cashflow and exposed design liability that can lead to solvency risks.

2. Design/inspection

In order for modular construction to be incorporated in a contract for design and build, it is vitally important for the parties to incorporate terms requiring inspection of the design and manufacture of the modular units and the gateways at which sign off will be taking place.  There is commonly a “design freeze” before production of the units actually starts; this is in order for the employer to have fully examined both the design and the manufacturing process of the modular units, to approve the same and to commit to initial costs in order for production to commence. This can be addressed legally by adding amendments to the testing and inspection features of standard form contracts (such as clause 41 and 42 of the NEC4 Engineering and Construction Contract). Inspections need to be scheduled throughout the manufacturing process, including at completion of the modular units.  If a defect is discovered too late in a modular unit, the speedy mass production of the same could mean that the cost of multiple identical (defective) modular units falls to the employer to cover.  Once each module is complete, it is much harder to “open it up” for inspection.  It is therefore advisable that the employer employs a monitoring consultant to inspect at regular intervals throughout the manufacturing process.  The employer should also consider inspecting the factory conditions, the location in relation to the actual site, and the working practices for manufacturing and transportation. If the employer has any compliance requirements with which it needs to adhere as a result of its upstream contractual framework (such as lending requirements, public procurement requirements and industry specific legislative requirements), these should also be incorporated in the scope of work to be carried out by the modular unit supplier.

3. Transportation/retention of title

It is rare in conventional construction contracts to pay attention to the transportation requirements, because it is generally a given that raw materials are transported to site and incorporated in the works by the contractor at the point of installation.  The JCT standard form contract states that the employer owns the materials once payment has been made, even if offsite materials are insured by the contractor.  The NEC standard position states that title in the materials passes to the employer upon the marking of the plant and materials as for the project, and the employer has title to anything within the working areas.  The employer may wish to consider, in light of the fact that loss of already constructed modular units would be significant, to rely on more robust retention of title provisions (such as those which confer title while the module is still at the factory, or the date of delivery to site).  It needs also to be borne in mind that whoever owns the materials at any point may not match with who insures them at that time; if the employer owns the modules to be incorporated before they even leave the factory, but the contractor is expected to insure them, this is an onerous insurance burden for a contractor.  The title-vs-risk balance must be examined carefully before committing to legal terms in respect of the same.  Contracting parties may also consider the use of vesting certificates or advance payment bonds to provide alternative legal solutions to this complex problem.

4. Intellectual property

As an innovative product, modular units will generally carry more valuable intellectual property than a simple design of housing units in the conventional sense will attract.  The modular manufacturer will be invested in protecting its rights as regards the intellectual property in its design of the modular units, but this must be considered against the employer’s need to be able to copy and use the design in the modules (and any extension thereof). In addition, the intellectual property licence may need to be passed on to third parties with an interest in the works (such as a lender, purchaser or landlord).  This may result in tension between the contracting parties on the licensing of the intellectual property rights.  It is not necessarily going to be patently clear where the demarcation between the bespoke solution designed by the modular manufacturer for the build in question and the inherent technology that it owns and uses in creating the modular units is. This can be addressed in a bespoke clause preserving the existing intellectual property rights of the modular manufacturer (the “Foreground IP”) and licensing the intellectual property rights and the bespoke design produced for the employer (the “Background IP”) as a starting point.

5. Civil engineering

In most design and build construction contracts, the employer will seek to push the liability for site conditions onto the contractor.  The contractor is therefore tasked with establishing that the site conditions are suitable for the installation of the modular units without any risk of them being damaged, weakened or otherwise affected or rendered unfit for use following their installation in the site.  A civil engineer will need to be consulted by the employer or contractor (whoever carries the liability for the same) to ensure that the modular units are capable of being installed to fit the specification as to durability and longevity, not only to the employer’s and contractor’s satisfaction, but also to the specification of the modular manufacturer.  The parties need to be able to rely on the civil engineer’s expertise so that if an error is made in the assessment of either the site conditions or the intended situation of the modular unit on the site, any ensuing losses are recoverable against the civil engineer. This presents a somewhat tall order for a civil engineer whowill need to be very conversant with the material aspects of the new modular units, and how the intended environment will affect them.

6. Compliance

In response to the slew of recent insolvencies, the British Standards Institution (“BSI”) (in collaboration with the Department for Levelling Up, Housing and Communities) has begun drafting a new industry standard, PAS8700.  The draft was begun on 27 July 2023 and it is intended to focus on MMC related processes and performance.  It will specify requirements relating to the lifecycle of the modular units including those relating to the beginning of assembly.  It is intended to promote confidence in the MMC industry, and is advised to be taken note of within the contracts for both the supply of modular units and their installation in the works.

In May 2022, preceding the Royal Assent of the Building Safety Act 2022, the Chancery Lane Project released the proforma “Madhavi’s clause”.  Amongst other net zero objectives, Madhavi’s clause requires the contractor to co-ordinate all activities and fully and properly integrate the design so as to facilitate the design freeze for MMC.  The contractor is also required that the MMC build is collected, transported, handled, installed and commissioned on site by experienced and specialised professionals using the requisite contractual standard of care and in compliance with any insurance backed guarantee scheme requirements.  This clause not only legalises the MMC-specific design freeze but also holds the contractor to a specific standard of manufacture and installation, and is a useful addition to those procuring works using MMC.

7. Building Safety Act

Modular construction is subject to the same rules as all other buildings under the Building Safety Act.  MMC manufacturers do use combustible materials such as timber or insulated panels, it is not a practice that rules out all building safety risks or necessarily lends itself perfectly to handling the building safety risks that the industry is weathering at the moment.  It is likely to form a very key part of the construction of higher risk buildings (HRBs) and compliance with the Building Safety Act is therefore critical to a project in which MMC is delivered.  Under the Building Safety Act there is a new right for those with an interest in a dwelling to claim against construction product manufacturers where the product doesn’t comply with the requirement or is defective.  If such product causes or contributes to that dwelling being unfit for habitation, there will be a direct cause in action against the manufacturer, which can carry criminal sanctions such as a fine or two year custodial sentence. This presents uncertain territory for MMC manufacturers, and since this duty cannot be eliminated by contractual means, it will be for modular manufacturers currently to examine their likely liabilities should errors or insufficiencies in design and manufacturing cause a dwelling to be unfit for habitation.

The Building Safety Act also poses a practical issue in that the building safety regulator needs to sign off on variations to a project once construction has started, a requirement which is already showing signs of inhibiting the speed of construction.  This is exacerbated if the variations are to the modular units, multiples of which may already have been manufactured.  This will involve the regulator needing to approve multiple units in order for construction to continue.  The consequences of this on delays and/or cost could be catastrophic.

Despite modular construction having been popular since prefabricated post-war buildings, and more recent technological advances having boosted its general acceptance as a construction method, there is some way to go before an entirely bulletproof contract is in the market to meet the legal considerations illustrated above.

This does not mean that forward-thinking, well-advised employers and contractors cannot adequately address the matters above in contract negotiations, provided that both sides carefully consider their position and an equitable balance can be struck in terms of risk. Our team can assist with any queries.