Supreme Court ruling on collateral warranties and construction contracts
Relying on Collateral Warranties as “construction contracts” to launch an adjudication is now riskier than ever. The Supreme Court decides that most Collateral Warranties will not be “construction contracts” for statutory adjudication. Katherine Sibley, partner and head of construction law, provides clarity on whether a collateral warranty qualifies as a construction contract under the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”).
On July 9 2024, the Supreme Court delivered its judgment in the case of Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) [2024] UKSC 23. This landmark ruling concluded that the collateral warranty in question was not a construction contract, and most collateral warranties generally will not be considered as such meaning that the beneficiary of a warranty will generally not have the right to refer a dispute under a collateral warranty to adjudication.
Background of the dispute
The dispute involved alleged fire safety defects at a North London care home built by the appellant, Simply Construct. The respondent, Abbey Healthcare Ltd (“Abbey”), was the tenant and operator of the care home.
Simply Construct had granted Abbey a collateral warranty (the “Abbey Collateral Warranty”) pursuant to which Simply Construct warranted that it “has performed and will continue to perform diligently its obligations under the Contract.”
The court at first (Mr Martin Bowdrey QC) instance held the Abbey Collateral Warranty was not a construction contract meaning that Abbey had no entitlement to adjudicate the dispute.
Issue on appeal
The appeal centred on whether the Abbey Collateral Warranty was a construction contract within the meaning of the Construction Act, thereby entitling Abbey to adjudicate the dispute. The Court of Appeal, by a majority (with Peter Jackson and Coulson LJJ in favour and Stuart-Smith LJ dissenting), found it was a construction contract giving Abbey the right to refer the dispute to adjudication. Simply Construct appealed to the Supreme Court.
Supreme Court judgment
In a unanimous decision, the Supreme Court ruled in favour of Simply Construct deciding that the Abbey Collateral Warranty was not a construction contract for the purposes of the Construction Act. Lord Hamblen, delivering the judgment with the agreement of Lord Briggs, Lady Rose, Lord Richards, and Lady Simler, clarified the definition of a “construction contract” under section 104(1) of the Construction Act:
- A construction contract is “an agreement for the carrying out of construction operations”.
- A JCT contract, for example, creates primary obligations between a contractor and an employer and so fits four square within the definition.
- In contrast, the purpose of a collateral warranty is usually to create a contractual nexus between a beneficiary and a party who owes obligations to someone else under a separate contract. A practical example is a Purchaser receiving a warranty from a Main Contractor who is employed by the Purchaser’s Seller.
- The Supreme Court described obligations under such a collateral warranty as being “derivative obligations”, i.e. a mere right to enforce obligations under a separate contract.
- The Supreme court recognised that there will be collateral warranties which do create primary obligations, and which are, on the facts, construction contracts.
- Each case must be considered on its merits, but the position in principle will be that collateral warranties are not generally intended to be construction contracts in their own right.
In this case, the Abbey Collateral Warranty was held not to be a construction contract. Simply Construct’s assurance that it “has performed and will continue to perform” its obligations under the Building Contract did not constitute a new promise to perform construction operations but was derivative of the original building contract.
Significance of the decision
This ruling is significant, overturning the precedent set in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] BLR 589 (TCC), where Akenhead J had deemed the collateral warranty in that case a construction contract under the Construction Act. The Supreme Court determined that the decision in Parkwood was not satisfactorily distinguishable and should be overruled, emphasizing that such determinations should not hinge on the specific language used, which could lead to minor distinctions and drafting disputes.
Clarification and certainty
The Supreme Court’s decision provides clarity and certainty, as Lord Hamblen noted:
- General Exclusion from the Construction Act: Most collateral warranties are unlikely to be construction contracts meaning that the parties to the collateral warranty have no entitlement to refer a dispute under the warranty to adjudication.
- Intended Scope of the Construction Act: Collateral warranties generally were not intended to fall within the scope of the Construction Act, as the payment provisions of the Construction Act do not apply to them and the Construction Act’s purpose of improving cash flow is not furthered by applying it to these warranties.
- Clear Distinction: Certainty is best served by generally excluding collateral warranties from the Construction Act rather than depending on specific wording.
- Understandable Distinction: A clear distinction should be made between collateral warranties that replicate obligations in the building contract and those that create separate or distinct obligations for construction operations. This distinction is straightforward and practical.
Voluntary adjudication rights
Parties desiring adjudication rights can, of course, explicitly provide for them, ensuring that adjudication of disputes under collateral warranties remains voluntary rather than mandatory. In short, express wording will ensure that the right to adjudicate is available to the parties to the collateral warranty.
What does this mean in practice?
Almost all participants in the construction industry are impacted by collateral warranties in one guise or another. Contractors, subcontractors and consultants give them and Employers, end users, purchasers, tenants and funders will be on the receiving end.
The first issue for any beneficiary (especially funders where the collateral warranty forms part of the security package) will be to review to what extent they are likely actually to have recourse to a collateral warranty to enforce the rights conferred by it. If they do frame their risk management to include having collateral warranties which have real teeth, then they will want to revisit their required terms to ensure that primary rights are granted rather than the normal “derivative” rights. This is, clearly, especially relevant where statutory adjudication is a preferred forum for dispute resolution.
Warrantors are going to have a different and opposite perspective. As well as wanting generally to limit their exposure, they will want to review their PI policies and take steps to mitigate/ minimise their exposure to claims arising under collateral warranties.
These claims do occur in the event of contractor insolvency and so design subcontractors and consultants need to be alert to closing off that additional avenue of risk. In the same way as they reacted to Net Contribution clauses, PI insurers may well develop policy exclusions in relation to loss resulting from a voluntary assumption of risk.
Clauses giving beneficiaries primary rights under a collateral warranty rather than ensuring that the rights are derivative (thus mitigating the risk of adjudication) could result in loss/ limitation of cover.
For both beneficiaries and warrantors, the precise wording of the duty of care provisions and the actual warranty of performance are going to be coming under considerable scrutiny.