Marc Hanson is a partner and WWilliam Chung a mmanaging partner of law firm Mishcon De Reya
As companies grapple with the implications of the new form of innovation in the form of artificial intelligence, one technological advance that doesn’t seem to have lived up to its initial promise is modular construction.
“Developers need to understand and anticipate their funder’s concerns about modular construction“
Recent negative headlines following the closure of dangerous modular schools and concerns raised by the National Fire Chiefs Council and the Association of British Insurers about the fire safety of modular buildings have affected confidence in modular construction. However, it is the financial difficulties of some modular contractors that have had the biggest impact in dissuading developers and financiers from undertaking modular projects.
Lose confidence
It was only in 2016 that modular construction was heralded as one of the solutions to Farmer Review’s stark diagnosis of the industry’s need to “modernize or die”. But in the past 18 months, the UK has seen a number of high-profile offsite construction specialists go out of business. Caledonian Modular and Urban Splash House fell into administration in 2022. Meanwhile, Ilke Homes was the latest UK modular housebuilder to fall by the wayside when it collapsed in June this year.
In addition, the announcement in May by Legal & General, possibly the patient capital of modular construction, that it was halting production at its modular home factory near Leeds was seen as a lack of confidence in the sector.
So what can be done to revive the financial confidence of developers and financiers in modular construction?
Modular construction certainly comes with inherent risks and challenges; the most obvious being the implications of the insolvency of the main contractor before a project is completed when the majority of the project has been pre-fabricated off-site. The consequences of this “doomsday” scenario must be sufficiently mitigated by developers legally and contractually from the outset to make modular construction a palatable option for financiers and investors.
The valuation process provided for in the construction contract should, at a minimum, require the delivery of certificates of acceptance to prove the transfer and ownership of title to the developer once the modular elements produced and stored have been paid for out of place
However, matters become more complex when considering the cash flow concerns of a modular contractor, such as their need for upfront payment to purchase goods and materials and begin prefabrication at the factory.
Advance payments or off-site material bonds are likely to be prohibitive or simply unattainable given the current limits of contractor bonding capacity.
There is no ready-made solution, but creative approaches to explore from the start of the project include an enhanced retention scheme where a percentage of the sums requested in respect of goods and materials is withheld until meet agreed milestones, such as passing a totality inspection. modules assembled in the factory or delivery of the modules on site. It is also worth considering additional preconditions to the valuation procedure, such as ‘not exceeding’ the figures of an approved cash flow forecast (which the funder’s follow-up survey will have oversight of).
The developer’s right to periodically inspect modules at the factory at key stages of the pre-fabrication process is included in the contract to prevent defects found in delivered modules from being repeated in modules yet to be manufactured and delivered to site. If an enhanced retention regime is adopted, the release of any additional retained sums should be triggered by the contractor’s satisfactory compliance with the required testing, commissioning and installation requirements demonstrated in the inspection process .
The contract must ensure that, once paid for, the goods and materials and subsequently assembled modules are stored in a place controlled by the developer or, failing that, are set aside and clearly marked as the property of the developer. promoter In an insolvency scenario, this should help the developer claim the assets it legally owns. Once the prefabricated modules are ready for delivery, the contractual provisions must define the obligations to insure the modules against loss and damage during the loading, unloading and transportation of the modules from the factory to the job site.
Copyright issues should be dealt with in a more nuanced way in modular construction. It is understandable that a modular contractor would want to retain pre-existing intellectual property (IP) rights in the stock design given the initial investment and research and development that went into creating the design and software to develop the its own prefabrication process.
However, the developer’s copyright license to use the modular elements shall survive the termination of the contract (if the modular contractor becomes insolvent) and shall include any project-specific IP developed from the modular process for the developer to use – them for all purposes in connection with this project and this property/site. If this is not provided for, a developer could leave a building that any potential replacement contractor is unwilling or unable to complete.
Reassuring investors
Developers need to understand and anticipate their funders’ concerns about modular construction and ensure they are addressed in the underlying contract. While contractors’ reliance on a sustained portfolio of business to translate their significant upfront costs into profit cannot be ignored, it is important that they appreciate financiers’ low appetite for a mutual risk-sharing approach, especially given the significant sums needed to buy modulars. items that may be in a factory for some time before being assembled on site. This is more pronounced when there is institutional investment, which brings an even higher degree of scrutiny and financial responsibility.
A healthy balance needs to be struck for modular construction to be a long-term success. Developers must demonstrate to their funders that insolvency risks have been properly identified and eliminated to the extent contractually possible.
Funders need to focus less on this doomsday scenario and instead embrace the undeniable benefits that adopting modular construction can bring in terms of potential time and cost savings and the positive impact in sustainability and the environment.
Given today’s economic challenges of rising material and labor costs and strained supply chains, carefully considered modular construction procurement can still deliver tangible benefits to contractors, developers and their funders .
