What are offsite’s contractual implications?

Growing adoption of offsite manufacturing could change the traditional model of construction. But what are the legal implications of this shift in focus – away from onsite labour and subcontractors and towards production of products and components?

The majority of construction contracts are drafted with “traditional” construction practices in mind, where the building is mostly constructed on site. Existing payment provisions for goods and products stored off site can be extended to cover offsite manufactured elements – but if a significant proportion of the building’s components are being made in a factory, then different contractual arrangement may be required.   Options could include procuring infrastructure works, the building core and centralised M&E elements as a building contract, with the offsite elements procured as a supply or supply-and-installation contract.

Who owns the offsite items?

There is a question over “ownership of items” which have been manufactured off site, for example bathroom pods. Ownership should transfer to the client when it pays the contractor, which should, wherever possible, provide the client with a vesting certificate confirming this.

This should be relatively easy when payment is for finished items. However, it will be more difficult to “vest” component parts which have yet to be assembled, such as tiles and furniture in the bathroom pod. Also, vesting of component parts which have yet to be assembled may be of limited value to the client if a replacement contractor or manufacturer would be unlikely to use those components.

Structuring advance or deposit payments can mitigate these risks. For instance, the client could make an interim payment for five complete bathroom pods, with ownership transferring to the developer on payment, instead of a partial payment for 10 incomplete pods, where ownership may not pass until several weeks later, which would leave the client without security for the payment it has made until the items are finished.

Risk generally passes along with ownership and, as ownership generally transfers on payment, risk may pass to a client when it has no control over the quality of the items.

In instances where the client may have paid in full for offsite-manufactured components, which are stored by the supplier prior to installation on site, the vesting certificate should make it clear that the subcontractor agrees to store the panels safely, be responsible for any damage and put in place appropriate insurances.

Additionally, these components should be stored separately and clearly marked to identify that they are the client’s property and allocated to a particular project. The client’s team should be given rights to inspect the items and, provided ownership has passed to the client, remove items if needed.

Protecting against insolvency

Insolvency risk should also be considered where offsite specialists are part of a project’s supply chain. Carrying out thorough due diligence, including requesting management accounts and carrying out other financial checks, remains the best way of understanding and deciding how to tackle insolvency risk.

If an offsite manufacturing firm becomes insolvent, components may be treated by the insolvency practitioner as that company’s assets rather than the client’s – and may not be released even if intended for the client’s project.

This risk can be minimised with clarity about ownership and storage requirements in the contract and a robust inspection regime. This should allow the client to recover the components if a supplier of offsite-manufactured products becomes insolvent.

In such situations, although replacing an insolvent supplier has lost-time and programme implications, having a bond can provide an element of financial protection. Such bonds are generally available on demand and can be used by the client if offsite-manufactured components are not delivered when required or when the supplier becomes insolvent.

As offsite manufacturing is likely to take an increasingly prominent role in the industry, it is important to understand the legal and practical implications of procuring projects this way. Clients need to give careful consideration to contractual relationships to ensure they are properly protected.

Angus Dawson is a partner at Macfarlanes.

This article was originally published on 27 April 2018 in Construction Manager magazine. The original can be accessed via the Construction Manager magazine website (click here).