Supreme Court confirms that collateral warranties will not (generally) be "construction contracts"

9 minute read
10 July 2024

The Supreme Court has handed down judgment in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP).

The judgment brings welcome clarity to the question: is a collateral warranty a "construction contract" under Part II of the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act), so as to give rise to a right to statutory adjudication?

The Supreme Court unanimously held, amongst other things, that:

  • the collateral warranty in question was not a construction contract within the meaning of section 104(1) of the Construction Act – so the beneficiary had no right to statutory adjudication thereunder;
  • a collateral warranty will "not be an agreement “for” the carrying out of construction operations for the purposes of section 104(1)" (and hence a "construction contract") if it "merely promises to perform obligations owed to someone else under the building contract"; and
  • in light of this finding, "most collateral warranties will not be construction contracts".

This judgment overrules both the prior decision of the Court of Appeal in this case, and the earlier decision in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013].

We examine the background to the decision and the Supreme Court's reasoning in more detail below.



Background

  • The dispute arose out of alleged fire safety defects at a care home in London, which Simply Construct(UK) LLP ("Simply") was contracted to build in 2015-2016.
  • Abbey Healthcare (Mill Hill) Ltd ("Abbey") is the tenant and operator of the care home.
  • Simply had provided Abbey with a collateral warranty in 2020 (referred to in the judgment as the "Abbey Collateral Warranty") under which Simply warranted that it "has performed and will continue to perform diligently its obligations under the Contract."
  • Abbey commenced adjudication proceedings against Simply to recover the cost of remediating the defects.
  • Simply challenged the adjudicator's jurisdiction, on the basis that the collateral warranty granted to Abbey was not a “construction contract” as defined in section 104(1) of the Construction Act.
  • The adjudication proceeded with Simply reserving its rights on jurisdiction. The adjudicator reached a decision on liability in favour of Abbey and awarded damages plus interest.
  • In subsequent enforcement proceedings brought by Abbey in the Technology and Construction Court (TCC), Mr. Martin Bowdery KC found that the Abbey Collateral Warranty was not a construction contract within the meaning of s. 104(1). As a result, he held that the adjudicator lacked jurisdiction.
  • Abbey appealed the decision. The Court of Appeal allowed the appeal by a majority, holding that the Abbey Collateral Warranty was a "construction contract" within the meaning of s. 104(1).

Supreme Court decision

As noted above, the Supreme Court has now unanimously reversed the decision of the Court of Appeal, confirming that the Abbey Collateral Warranty was not a construction contract within the meaning of s. 104(1) of the Construction Act. In reaching its decision, the Court considered two issues:

  1. What is the meaning of an agreement “for… the carrying out of construction operations” in section 104(1) of the 1996 Act?

Section 108 of the Construction Act gives “a party to a construction contract…the right to refer a dispute arising under the contract for adjudication”. Section 104(1) defines a "construction contract" as an agreement for (amongst other things) the "carrying out of construction operations".

Accordingly, the issue to be determined was whether a collateral warranty was an agreement "for" the carrying out of construction operations.

The Supreme Court held that:

  • the main object or purpose of a collateral warranty is usually to afford a right of action to a third party in respect of defectively carried out construction works.  In the construction industry, collateral warranties are commonly provided by contractors to third parties such as funders, purchasers and tenants, giving them direct contractual rights should defects arise in the works. The practice arose following the House of Lords decision in Murphy v Brentwood District Council [1991] 1 AC 398, which restricted the rights of third parties to makes claims in tort for economic loss.
  • It is "difficult to see" how the object or purpose of a collateral warranty is the carrying out of such construction operations themselves. It is the building contract that gives rise to the carrying out of the construction operations, and not the "collateral" warranty: "[t]here is no promise to carry out any construction operation for the beneficiary; merely a promise to the beneficiary that the construction operations to be carried out for someone else under the building contract will be performed."
  • This distinction is supported by the fact that the beneficiary has no control over how the construction operations are performed, e.g. it cannot issue instructions as to how the work is carried out, has no entitlement to order variations or to suspend or terminate the works. Instead, the beneficiary simply "follows the fortunes" of the employer under the building contract.

In light of the above, the Supreme Court concluded that a collateral warranty will not amount to an agreement “for” the carrying out of construction operations "if it merely promises to perform obligations owed to someone else under the building contract." For it to do so, there would need 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."

  1. How should the Abbey Collateral Warranty be construed and, so construed, is it an agreement “for… the carrying out of construction operations”?

The Court of Appeal's interpretation of the wording of the Abbey Collateral Warranty had been critical to its decision. This provided that Simply “has performed and will continue to perform” its obligations under the Building Contract. Coulson J in the Court of Appeal considered that this was a "warranty of both past and future performance of the construction operations”.

The Supreme Court held that:

  • Whilst this is, at least potentially, a "warranty as to future performance", it is an "entirely derivative promise": the contractor is not promising anything that is not already promised under the building contract.
  • Collateral warranties have to be expressed in such terms because they need to cover all the contractor’s obligations under the building contract and may well be given while the works are still being carried out. They therefore need to be drafted in terms which cover past and future performance.
  • A "far more workable approach" is to distinguish between collateral warranties which merely replicate undertakings given in the building contract, and those which give rise to separate or distinct undertakings for the carrying out of construction operations.
  • Such an approach is "likely to mean that most collateral warranties will not be construction contracts". This is aligned with the intent of the Construction Act: the payment-related provisions of the Act are inapplicable to collateral warranties since the consideration is usually nominal. Further, one of the twin purposes of the Act (i.e. improvement of cash flow) is also not furthered by its application to collateral warranties.

Key takeaways

This decision provides welcome clarity to those in the construction industry and their advisers on where they stand in relation to disputes arising out of collateral warranties. The dividing line set out by the Supreme Court (i.e. that most collateral warranties will not be construction contracts, unless they give rise to separate or distinct undertakings for the carrying out of construction operations) offers a "workable" approach and much-needed certainty on whether disputes under a collateral warranty must be adjudicated.

As the Supreme Court observed, it is open to parties who wish to have the right to adjudicate under ancillary contracts such as collateral warranties to include drafting to provide for this, in conjunction with their legal team, in such agreements. However, following this decision, it is clear that adjudication under collateral warranties will be voluntary, and that they fall outside the scope of mandatory statutory adjudication under the Construction Act.


NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as, legal advice. You should not rely on, or take or fail to take any action based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. Gowling WLG professionals will be pleased to discuss resolutions to specific legal concerns you may have.