The Emerging Trend of Modular Construction
Stites & Harbison Client Alert, August 14, 2018
An emerging trend in cost-conscious and sustainable construction is modular construction. With traditional stick-build construction, all work is performed sequentially and on-site, and adjustments to design and construction can be made along the way. In modular construction, building units or “modules” are produced in a controlled factory environment and later delivered to the project site for incorporation into a larger building. Unlike more commonly recognized prefabricated systems, such as kitchen or bathroom “pods” often used in hotel and multi-family housing developments, modular construction involves the construction of full rooms or units. Modules are produced according to architect specifications, and structural and mechanical inspections may be performed in the factory setting prior to site delivery. State and local building codes still apply to modular construction, and many states have adopted legislation specific to modular construction and other prefabricated work.
Prefabricated modules are typically transported to the project site on a flatbed truck and then lifted and placed into the final structure by a crane. When modular construction is employed on a project, the amount of onsite and offsite construction varies depending on the project’s scope. A collection of modules may form a self-supporting structure on their own, in any number of configurations, or modules may be placed into an independent structure or structural framework. Because modules are complete upon arrival to their intended project site, the nature of modular construction demands a careful and thorough design stage to ensure modules will be properly fitted and aligned within the larger structure.
Although modular construction is prevalent internationally, modular construction is only recently gaining popularity in the United States. Modular construction’s newfound popularity is attributable to rising affordable housing needs in large cities and a demand for sustainable building. In May of this year, New York City issued its first request for proposal (“RFP”) seeking developer pitches for the advancement of affordable housing using modular construction methods, and San Francisco is considering a similar initiative. These plans follow the initiation of modular housing developments in other cities facing housing crises such as Denver, Colorado and Los Angeles, California. According to the Modular Building Institute, modular construction is expected to rise to 5% of all new commercial construction in North America by 2021.
Modular construction has many potential benefits. Off-site construction in a controlled environment, as well as large-scale, repetitive production of a product, theoretically allows for a better quality-controlled product and reduced labor costs. Further, off-site construction of modules allows simultaneous on-site work, saving time and easing scheduling and coordination burdens. For example, in early 2015, a Chinese construction company erected a 57-story skyscraper in approximately 19 working days (three floors per day) using modular design. Together, these benefits may result in cost savings, greener projects, and safer job sites. However, the unique nature of the modular construction process presents a number of novel issues concerning risk allocation.
Risk Allocation and Insurance
Transferred risk is an inherent benefit of modular construction. Modular construction transfers unpredictable on-site risks to controlled offsite facilities. In so doing, traditional risks born by contractors are often shifted to other parties. This allows contractors to limit need for expansive general liability policies. In turn, insurers and underwriters are forced to lower inflated premiums. To better understand this arrangement, let’s take a closer look at commercial general liability policies (“CGL”).
Commercial General Liability Policies. CGL policies are ubiquitous in the construction industry. They are designed to protect the insured or insureds against third-party claims and lawsuits for bodily injury or property damage arising out of business operations. CGL coverage is most often purchased by contractors to protect against job site accidents and losses.
CGL coverage can be quite complex in the construction context. This has to do with the number of parties involved on a project and the inherent risk sharing that occurs. In fact, there is still debate over what is covered under a contractor’s CGL policy. Insurers often include policy endorsements that specifically exclude CGL coverage for claims arising from factors “under the control of the insured.” This leads to questions involving defective work and a contractor’s “control” over work performed by its subcontractors. In fact, the Supreme Court of Ohio is currently reviewing whether insurers (via a CGL policy) are required to cover damages sustained by construction companies as a result of their subcontractor’s allegedly defective work.
Modular construction aides contractors by limiting their need for complex CGL coverage. This occurs through shifting on-site, contractor borne risks to off-site manufacturing facilities. The bulk of a modular build occurs in a controlled, safe, off-site manufacturing facility. After the modules are manufactured, they are shipped to the project site where they are offloaded and installed. It is not until delivery, that a contractor’s on-site risk level reaches its peak. Even then, the liability window is limited as the contractor is merely installing the modules and not required to engage in a drawn out build process. As a result, modular construction significantly limits the scope of contractor borne on-site liability. In doing so, modular build can protect against complex CGL coverage, resulting in lower premiums and less headaches for contractors.
Absorption of Traditional Risk and Creation of New Risk. One of modular construction’s most exciting benefits is transferred risk. Traditional stick-build construction requires significant risk for a contractor. Much of this risk manifests in the contractor’s inability to control the infinite number of moving parts on the job site. Modular construction absorbs much of this on-site risk, capturing it in a controlled manufacturing environment. It also creates new risks, such as complex crane operations (installation) and large load transportation from manufacturing facility to job site. Indeed, transporting modules from a manufacturing facility to the job site is one of the riskiest elements of modular construction. Large modules are often transported over long distances resulting in significant risk of loss and/or delay. As a result, insurers should recognize the need for multifunctional risk assessment approaches using elements of transportation and logistics when writing modular construction policies.
Product vs. Work . The product vs. work determination is a key consideration in modular construction. Modular construction inherently involves both goods and services. This triggers legal analysis using the UCC and the common law. In the event of a claim, a determination as to whether a module constitutes a “product” or “work” must be made.
Traditionally, courts have used the “predominant purpose test” to examine mixed contracts for goods and services. Under this test, mixed contracts are subject to the UCC if the sale of goods aspect predominates, and subject to the common law if the service aspect predominates. In modular construction, the question is: was the loss precipitated by a failure/deficiency of the manufactured product or by the installation/construction operations? In most cases, installation/construction operations are to blame, thus triggering the common law.
Insurers and contractors must be sure to clearly define work vs. product in their contracts when engaging in modular construction.
Modular construction is here to stay. It is not likely to overrun stick-built construction, but its suitability for certain projects is undeniable. To that end, insurers, construction professionals, and risk analysts should engage in collaborative discussions to address issues and create policies for the modular construction industry.