A collateral warranty is not – generally – a construction contract

Background

In the recent Supreme Court decision in the case of Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP, the Supreme Court overturned a Court of Appeal decision, and decided that a typical collateral warranty is not a construction contract, as defined by Section 104 (1) of the Housing Grants Construction and Regeneration Act 1996 (Construction Act 1996).

In so doing, the Supreme Court overruled a line of cases since 2013 which had held that a collateral warranty would, depending upon its wording, generally, be a construction contract.

Why does this matter?

As many of you will know, collateral warranties are typically granted by contractors, sub-contractors and consultants to other parties on construction projects. These are typically purchasers or tenants or funders of building projects, so as to give those parties (“beneficiaries”) rights to make claims against the party granting the warranty (“donors”), and rights to step in and take over the contract. This would happen if the donor, for example the main contractor, becomes insolvent or to bring a claim should defects emerge in the building.

Whilst not common, in our experience it has tended to be claims relating to defects which have emerged after completion, so called ‘latent defects’, where beneficiaries of warranties have typically wanted to claim that a collateral warranty is a construction contract so as to give them the right to bring a claim via adjudication in respect of the defects.

As you will no doubt know, adjudication is a fast-track form of dispute resolution brought in by the Construction Act 1996 in which a decision can be granted by an adjudicator within as little as 28 days from the date of referral to the adjudicator.

In some cases, it has proven valuable for a beneficiary to be able to bring an adjudication claim under a collateral warranty.  Indeed, we have experienced a number of such claims, particularly from operators of leisure centres and other facilities where, in order to bring matters to a head where say the main contractor might be reluctant to rectify historic defects, they have chosen to commence adjudication.  Indeed the very first case on this was brought by such an operator, Parkwood, against Laing O’Rourke in respect of a swimming pool.

Notwithstanding the attractiveness of that to such beneficiaries, most commentators thought Parkwood and subsequent decisions were wrongly decided. This is because generally a collateral warranty is not a contract for the carrying out of construction operations, but more in the form of a warranty to confirm that the building contract works had been carried out or would be carried out in accordance with the contract.

When the matter reached the Supreme Court in Abbey Healthcare, Lord Hamblen, giving the leading judgment held that the collateral warranty was not a contract for the carrying out of construction operations “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”.

Whilst in theory it remains possible for a document labelled as a collateral warranty to constitute a construction contract, without any bespoke amendments, following this judgment most collateral warranties typically used in the construction industry will not amount to construction contracts and therefore there will be no statutory right to adjudicate.

Should collateral warranties be amended to include a right to adjudicate?

It remains to be seen if the market practice changes so that collateral warranties are amended to include a bespoke clause giving a right to adjudicate.  This would be a contractual right to adjudicate – as opposed to implied statutory right to adjudicate – and it is certainly not unheard of to include such contractual rights where there would not be a statutory right to adjudicate. For example, in JCT Minor Works Contracts for works for residential occupiers. We frequently recommend that supply-only contracts include a right to adjudicate to give the benefit of adjudication in the event of disputes arising with customers.

In the more typical collateral warranty situation, there are pros and cons.  From the beneficiary’s perspective it probably is advantageous to include a right to adjudicate as this can be a useful additional tool in bringing in a recalcitrant donor to the table if they refuse to rectify defects.  If this does not prompt a resolution then the adjudication process itself can produce a relatively rapid result and, subject to the wording of the adjudication clause, can still give either party a right to have the decision reviewed by the courts. This is the case with most adjudication provisions anyway, normally subject to the obligation to comply with the adjudicator’s decision first.

However, from the donor’s perspective, for example a main contractor or a sub-contractor or consultant, a right to adjudicate in a collateral warranty is less attractive as whilst there needs to be a pre-existing dispute, potentially claims relating to historic defects could be brought relatively rapidly.

Furthermore, as generally you cannot bring in other parties to an adjudication, it could cause issues where another party is partly to blame, and the donor may end up having to pay the full amount immediately and later seek a contribution from another party who may be partly responsible.

In other words, it really depends on whether you are a beneficiary or a donor of a warranty, but certainly it would be worth checking collateral warranties you are asked to sign in the future as to whether they do now incorporate a bespoke adjudication clause and to seek advice accordingly.