Is a collateral warranty a construction contract?

On 9 July 2024, the Supreme Court unanimously confirmed in the case of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP [2024] UKSC 23 that collateral warranties are not ‘construction contracts’ for the purposes of section 104(1) of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”). Section 104(1) of the Construction Act defines a construction contract as an agreement for “the carrying out of construction operations”. 

In doing do, the Supreme Court overruled the earlier decision in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] BLR 589 (TCC).

This authoritative judgment has provided clarity on this issue and has practical implications for any parties who may seek to rely on rights provided under collateral warranties in the future. 

Background

The dispute between the parties related to alleged fire safety defects at a care home in North London. Abbey Healthcare (Mill Hill) Ltd, as the tenant, was provided with a collateral warranty by the contractor, Simply Construct (UK) LLP (Abbey Collateral Warranty). The Abbey Collateral Warranty contained a provision that the contractor “has performed and will continue to perform diligently its obligations under the [Building] Contract”.

At first instance, the Technology and Construction Court judge held that the Abbey Collateral Warranty should be construed against the background that, at the time of its execution, works had been completed some four years earlier, remedial works to the address some fire safety defects had been completed eight months previously, and neither Abbey nor Simply contemplated the possibility of any further construction operations being carried out. The judge concluded that the Abbey Collateral Warranty was not a construction contract for the carrying out of construction operations but rather a warranty as to events which had occurred in the past, and on that basis the Abbey Collateral Warranty was not subject to the Construction Act.

In the Court of Appeal, all members of the Court agreed that in principle a collateral warranty can be a construction contract. However there was disagreement as to whether the Abbey Collateral Warranty was such a contract. The majority of the Court of Appeal concluded that if, properly construed, the collateral warranty was a construction contract then the timing of when it was entered into could not be determinative. This was first, because of its retrospective effect and secondly, because it would be an uncertain outcome if the answer depended on whether or not the warranty was executed before or after practical completion of the building works. There was no appeal from the Court of Appeal on the timing issue. 

Judgment

On 9 July 2024, Lord Hamblen handed down judgment on behalf of the Supreme Court and set out the standing of collateral warranties in the context of the definition of construction contracts under the Construction Act. The key points of the judgment are:

1. For a collateral warranty to be considered a construction contract, there needs to be “a separate or distinct obligation to carry out construction operations”, not just an obligation to perform the services / works already agreed as part of the building contract;
2. Merely warranting the performance of obligations under the building contract is not sufficient to say a collateral warranty is a construction contract for the purposes of the Construction Act.

In considering the Parkwood judgment, Lord Hamblen considered that provisions in a collateral warranty to the effect of a promise of future performance of obligations e.g. “has performed and will continue to perform”, is merely a derivative promise from the contractor’s primary obligation already contained in the building contract and as such cannot be construed as an agreement for construction operations.

Lord Hamblen also explained that the scope of the Construction Act was never intended to extend to collateral warranties in the first place, as the underlying principles behind the Construction Act was to ease the burden on construction companies’ cash flows by making payment provisions in construction contracts more regulated – save in circumstances of “step-in” (where the beneficiary may take over, for instance, in an insolvency situation), the parties to a collateral warranty are not concerned with payment for the works or services being warranted.

Analysis and considerations

The result of this judgment means that the majority of collateral warranties will not be a construction contract under the Construction Act, unless they contain clear and separate undertakings in relation to construction operations which are not already contained in the underlying agreement which the warranty is collateral to.

The main practical takeaway of the revised position is that parties to collateral warranties can no longer rely on the statutory right to adjudicate under the Construction Act, unless it is expressly drafted into the collateral warranty. Going forwards parties who want to voluntarily agree adjudication provisions will need to ensure these are set out and drafted into their collateral warranties. This is where the decision has drawn some criticism, as some commentators have suggested reducing the scope of the Construction and removing the parties’ automatic right to adjudicate under collateral warranties actually undermines the spirit of the Construction Act. Adjudication is a quick alternative method of dispute resolution so construction parties can avoid being tied up in potentially years of litigation and ensure their business cash flow is not heavily impacted; it seems somewhat contradictory that this will not be available to contractors / consultants / sub-contractors and third party warranty beneficiaries. The counter argument to that is that, the nature of disputes brought by way of a collateral warranty are unlikely to be arguments around payment and cash flow, and will most likely relate to defective works which perhaps warrants the more in depth analysis which comes with litigation.   

Nonetheless, the judgment provides much needed clarity on the status of collateral warranties and removes the need to consider the specific drafting contained therein; no longer will disputes around language such as “has performed and will continue to perform” and the distinction between “warrants” and “undertakes” play a role in determining whether a collateral warranty is, in fact, a construction contract.