A Drafter's Checklist: Prefabrication Contracts

Prefabrication continues to show its value in modern construction. The project delivery tool, in use for over 100 years, allows a constructor to utilize off-site production sites to manufacture units of a build. These units are then transferred to the project site for installation with the intent of increasing the speed of the build while decreasing costs. While the construction benefits of prefabrication are undeniable, the legal risks are often overlooked and unaddressed — specifically within contractual agreements. If you are drafting a construction agreement that utilizes prefabrication, you should consider the following factors and how they impact your project:

The Law To Be Applied (UCC or Common Law)

As an initial matter, knowing the rule of law to be applied to projects using prefabrication can pose a challenge for those drafting construction agreements. On one hand, traditional construction projects are governed by common law, with state-specific statutes addressing issues such as delay damages and forum selection clauses. Manufactured goods, on the other hand, are governed by the Uniform Commercial Code (UCC). Here, concepts such as “perfect tender,” unique warranties, and a shorter statute of limitations apply. Blending these concepts throughout project-related contracts can result in unintended consequences for drafters — emphasizing the importance of distinguishing the applicable law.

Prefabrication can easily be viewed as a manufacturing of goods calling for the application of the UCC. However, the concepts of the UCC often do not work well with construction. For example, the “perfect tender” rule allows a purchaser to either reject the whole or accept the whole, or accept a specific unit and reject the remainder if the goods fail to strictly conform to the contract. Typically, the standard in construction is substantial compliance, a common law concept. Arguably, the logic should follow that construction “goods” are indeed complex and as such, minor “punch-list” items should not allow a constructor to reject the “whole.” Instead, the prefabricator should be required to bring the unit into conformance with the project requirements on-site. Thus, in consideration of this distinction, the UCC’s concept of “perfect tender” simply does not work for construction.

The Risk of Loss of Prefabricated Materials in Transit

Risk of loss in transit is another factor that should be considered in drafting a construction agreement. While nuanced, the UCC apportions the risk of loss to the manufacturer until delivery. Common law, however, assigns the risk of loss to the buyer during transport. In this instance, the common law is less than ideal for the prefabrication process. Logically, it makes sense for the prefabricator to remain responsible until the prefabricated units are delivered to the site. If the prefabricator is also the installer, it should remain responsible until acceptance of the installation. That is because the final, installed unit is the true subject of the construction agreement. Thus, in drafting your construction agreement, coordinating insurance coverage for losses based on this apportioned responsibility is critical.   

The Warranty Coverage of Prefabricated Materials

The warranty section of a construction agreement typically receives a lot of attention in negotiations, and for good cause. However, the following consideration may ease the angst of negotiating this provision. In terms of the UCC, an implied warranty of merchantability is standard. A warranty of fitness for a particular purpose can also be available. These warranties, respectively, provide that the components: (i) will be fit for the ordinary purpose for which the components are used; and (ii) are fit for a particular purpose if the seller has knowledge of the purchaser’s particular purpose and the purchaser is relying on the seller to furnish goods for that particular purpose. The common law rule, on the other hand, provides that the warranty is as expressed in the agreement — a construction industry standard.

Adopting the UCC warranties for the prefabricated units, but not the whole build, makes little sense. Again, the true subject of a construction agreement is the final construction. With that in mind, your drafting should expressly disclaim UCC warranties in most circumstances.

Jurisdictional Conflicts

Lastly, the nature of prefabrication in and of itself provokes jurisdictional conflicts with regard to a number of construction-related issues. Specifically, if the worksite and prefabrication site are in different states, a potential conflict between the two states’ laws may exist.

For instance, different industry standards and state plans for the Occupational Safety and Health Administration (OSHA) may apply if the build site and prefabrication site are located in different jurisdictions. Labor-related jurisdictional issues may conflict with local collective bargaining agreements. Licensing requirements in the project build state may also be different than the licensing requirements in the prefabrication state. There is no catch-all form to address these issues. Rather, drafters must be cognizant of these requirements when advising clients.

For further consideration, there is currently only one industry form for prefabrication — the Consensus Docs 753, which addresses many of the UCC issues outlined in this publication. However, there are other issues a drafter must address. Drafters must know the building codes used in each jurisdiction as there is no modular construction building code. Most states use the International Building Code (IBC) as their base model code, but the IBC is written assuming stick-build construction. And while the International Code Council and the Modular Building Institute have both recently published standards for off-site construction, few states have amended building codes to address prefabrication. Most states rely on the IBC, thus inspections of prefabricated units at an offsite facility fall under the jurisdiction of a state’s modular building program. Currently, thirty-six states have modular building programs, and local authorities govern in the other states. Ultimately, the law that governs a manufacturing facility will also govern the inspections of the facility.

In conclusion, there are many issues that can arise when preparing a construction agreement employing prefabrication. While disclaiming many UCC provisions can help, there are numerous other issues that must be addressed. Drafters should pay particular attention to standards of performance, warranties, and risk of loss. These are some of the major concepts where the UCC differs drastically from common law. Drafters must also analyze numerous state law issues such as OSHA, labor-related issues, and state licensing requirements to avoid potential conflict.

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