Collateral Warranties – To be or not to be a construction contract? That is the Question…

Often, simple questions can cause the most confusion. This is illustrated by the Supreme Court judgment of Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) that considers the question: is a collateral warranty a construction contract?

This question is important as, if a collateral warranty is found to be a construction contract,  the beneficiary has certain rights under the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”) including the right to adjudicate. The process of adjudication is often a quicker and cheaper way to resolve disputes than litigation or arbitration. 

This case offers clarity for all parties in the construction supply chain, as well as beneficiaries such as purchasers, tenants and funders, with regards to transactions which involve collateral warranties. 

Collateral Warranties Explained

Briefly, a collateral warranty is a promise by the contractor, subcontractor or a professional consultant (the warrantor) to carry out its obligations under a building contract or professional appointment for the benefit of a third party who has an interest in the construction project such as a purchaser, funder or tenant (a beneficiary).

Facts

For the background and procedural history of this dispute, please refer to our previous article which commented on the Court of Appeal decision.

On 21 December 2022, Simply Construct were granted permission by the Supreme Court to appeal the Court of Appeal judgement. The central issue was whether the collateral warranty was a construction contract within the meaning of s.104(1) of the Construction Contract so as to give rise to a right to adjudication, and specifically whether it was an agreement "for... the carrying out of construction operations" under s.104(1)(a) of the Construction Act.

Decision

The Supreme Court unanimously granted the appeal from Simply Construct and held that a collateral warranty is not generally a "construction contract" for the purposes of section 104(1) of the Construction Act, so parties do not have a statutory right to adjudicate any dispute under it "at any time".

In doing so, the Supreme Court allowed an appeal against the majority ruling of the Court of Appeal and also overturned the earlier decision of Parkwood v Laing O'Rourke [2013], the first court judgment which found that a collateral warranty could constitute a "construction contract".

Giving the leading judgment, Lord Hamblen held that:

• A collateral warranty is not a contract "for" the carrying out of construction operations under section 104(1) of the Construction Act "if it merely promises to perform obligations owed to someone else under the building contract. There needs to be a separate or distinct obligation to carry out construction operations for the beneficiary; not one which is merely derivative and reflective of obligations owed under the building contract"
• The specific collateral warranty between the parties in this case was not a construction contract because it was "an entirely derivative promise" and the contractor had not promised anything that was not already promised to the employer under the building contract.

 Has clarity been achieved?

Following Parkwood and the Court of Appeal decision in this case, there was a clear unease around the issue of whether collateral warranties are construction contracts. This has now been clarified by the Supreme Court and the position has arguably been reset as Parliament intended prior to the Parkwood case and the Court of Appeal’s decision.

In practice, although it remains possible for a document referred to as a collateral warranty to be a construction contract under the Construction Act, those that are most typically in circulation on construction projects are unlikely to be considered as construction contracts under the Construction Act.

For a collateral warranty to comprise a “construction contract”, the judgment suggests that there is a “dividing line… between collateral warranties which merely replicate undertakings given in any building contract and those which give rise to separate or distinct undertakings for the carrying out of construction operations. That is a distinction that can be easily understood and applied”.

Consequently, in the absence of specific drafting, funders, purchasers and tenants will now be unlikely to have the right to issue statutory adjudication proceedings for breaches of obligations under collateral warranties. This is often a far more cost effective and timely way of resolving construction disputes, but no longer available to beneficiaries under a collateral warranty with the likely route being a breach of contract claim in court. Court claims are inevitably longer, more complex and expensive.

From a policy perspective, it is odd that the decision comes at a time when residential buildings have been blighted by serious health and safety defects. The fact that it could now take longer to implement and pay for those remedial works appears counter-intuitive in the current climate. More specifically:

• The responsible parties for building safety defects (particularly fire safety) are often designers and subcontractors, who will have given collateral warranties
• Adjudication is no longer a simple route to recovery against one party under a collateral warranty, necessitating court actions, with the risk of multi-party proceedings. The Design & Build Contractor will always be responsible, in addition to any designer or subcontractor. Accordingly, a claimant may decide to sue multiple parties as a belt and braces approach or additional defendants may be brought into the court proceedings.

Whereas adjudication can be viewed as “rough justice”, it is a lot quicker and cheaper (and can be used strategically) when compared to having a judge preside over certain matters.

Comment

Against this background, historical collateral warranties could  be amended and “new” warranties drafted to confer an express, contractual right to adjudicate with a process similar to statutory adjudication.

It will be interesting to see if there is a general acceptance that collateral “warranties were not intended to fall within the scope of the 1996 Act” or whether drafting will be used to get around the judgment.