Offsite manufacturing carries risks as well as benefits. What should you be watching out for?
Offsite manufacture is taking centre stage in discussions about the future of the construction industry, and the residential sector in particular. Those project managing developments and/or administering building contracts need to be aware of six issues in particular with offsite manufacture?
Current contracts Most construction contracts are drafted with traditional construction practices in mind. Existing provisions for payment for goods and materials stored elsewhere can be extended to cover elements of offsite manufacture but significant offsite manufacture may require a different contractual arrangement.
Ownership Ownership of items should transfer to the client when it pays for them and the contractor/manufacturer should be required to provide evidence that it is able to pass ownership to the client when it is paid. This may not be possible if the contractor/manufacturer is seeking payments for incomplete items; and trying to offset the risk of not owning the incomplete item by transferring ownership in the constituent parts may be of limited effect both legally and practically. For example, do those parts have any value for a client if a replacement contractor/manufacturer cannot use them? A practical alternative is to restructure payment/manufacturing timetables so that the client has less cash exposed for a shorter time.
Risk and insurance Risk in goods/materials generally passes at the same time as ownership and, as ownership tends to transfer on payment, risk may pass to a client when it has no control over the items or where they are stored. This can be resolved by the storage party taking the risk of damage or loss with appropriate insurances.
Storage and access Items should be stored separately and clearly marked to identify that they are the client’s and have been allocated to a particular project. A member of the client’s team should be given rights to inspect storage arrangements and, provided they are the client’s, remove materials if needed.
As ownership tends to transfer on payment, risk may pass to a client when it has no control over the items or where they are stored
Insolvency This is an ever present risk. Carrying out thorough due diligence and understanding the supply chain is still the best way of grasping this risk. Annual accounts may be out of date so requesting copies of management accounts and/or carrying out other financial checks may be more useful ways of establishing the financial stability of a proposed contractor/manufacturer.
If the offsite manufacturer or the storer of items becomes insolvent goods may be treated by the insolvency practitioner as the manufacturer/storage party’s assets rather than the client’s. Even if the insolvency practitioner is persuaded that the items are the client’s, the project may be delayed if they are not released when they should be. At the most extreme the insolvency practitioner may ‘deal’ with the items, leaving the developer to bring a claim for damages for the tort of conversion and an urgent need to find an alternative manufacturer.
These risks can be minimised with clarity about ownership and storage requirements and a robust inspection regime referred to above. If the right steps are taken a developer should be able to recover items even if a contractor/manufacturer becomes insolvent.
Financial protection While a bond cannot compensate for the lost time and programme implications of having to find an alternative manufacturer, it can provide an element of financial protection. Such bonds are generally on-demand and allow the client to make a call if finished items are not delivered on time.
As well as considerable benefits offsite manufacturing brings risks. However, with careful planning and structuring it is possible to mitigate them.
Angus Dawson is a partner at Macfarlanes LLP
In plain English: Bonds
When dealing with offsite manufacture one way of mitigating an employer’s risk where it has paid the contractor a deposit or paid for goods that have yet to be delivered to site is an advance payment bond. In return for a premium a bank, insurance company or specialist bondsman will, on receipt of a demand, pay the employer the amount demanded up to the agreed value of the bond (usually the value of the items or the amount of the advance payment). This provides protection if the contractor goes bust or fails the deliver the items to site. As long as a request is in the required format and any conditions in the underlying contract have been complied with a demand under this type of bond (known as an ‘on demand’ bond) can generally only be challenged on the grounds of fraud. An advance payment or ‘on demand’ bond should not be confused with a guarantee/performance bond which provides security against any breach of the terms of the building contract by the contractor but requires proof of breach of the contractor’s obligations under the building contract.