Collateral Warranties: Plus ça change..?

The UK Supreme Court decision in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) gave some very clear and easy to apply guidance on whether a typical collateral warranty would be considered to be a “construction contract” in terms of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”) or not.

One significant implication of that distinction being whether the parties to a collateral warranty would have a statutory right to take any dispute arising under it to adjudication.

This article summarises the outcome of the Abbey Healthcare case and our observations on whether the case has had an impact on market practice since the Supreme Court decision was handed down.

UK Supreme Court decision

The Supreme Court decision (analysed in more detail in our earlier Blog – UK Supreme Court rules most collateral warranties are not construction contracts | Burness Paull ) dealt with two issues – statutory interpretation and contractual interpretation – to confirm whether a collateral warranty granted by Abbey (the “Abbey Collateral Warranty”) amounted to a construction contract and, therefore, whether the parties to that collateral warranty had a statutory right to take any dispute under it to adjudication.

1) Statutory interpretation

The Construction Act applies to “construction contracts”. It provides that a construction contract includes “a contract for … the carrying out of construction operations” (s 104(1)(a)).

The Supreme Court concluded that a collateral warranty is an agreement “for” the carrying out of construction operations if, under it, the contractor has an obligation to carry out construction operations which are “separate and distinct” from the contractor’s obligation to do so under the building contract.

If, however, the contractor only warrants the performance of obligations under the building contract, that is not an agreement “for” the carrying out of construction operations.

As the Supreme Court noted, s.104(1) of the Construction Act requires an assessment of whether the purpose of the agreement in question is the carrying out of construction operations. It is difficult, the court said, to see how that is the purpose of a collateral warranty, which is typically to afford a right of action for defective construction works, not the carrying out of construction operations themselves. The warranty does not give rise to the carrying out of construction operations.

2) Contractual interpretation

The Supreme Court then asked whether the Abbey Collateral Warranty, on an analysis of its specific terms, was a “construction contract”.

The court’s answer was “no”. Simply’s (now Augusta) promise to Abbey that Simply “has performed and will continue to perform” was an entirely derivative promise. In other words, it was not a “separate and distinct” obligation from Simply’s obligation to the employer under the building contract. Simply’s promise to Abbey did not promise anything new. It was merely warranting performance of its obligations already owed to the employer under the building contract.

The Supreme Court indicated that there was a clear dividing line between collateral warranties which (1) merely replicate undertakings in the building contract (which were not “construction contracts”) and those which (2) give rise to separate or distinct undertakings for the carrying out of construction operations (which could be “construction contracts”).

Impact on market practice

As a  firm, we have been giving a lot of thought to the extent to which this decision will impact on the advice that we give clients on the drafting of collateral warranties – both in terms of (i) whether the precise wording will meet the “construction contract” test or not and (ii) whether to include an express contractual right to adjudicate which avoids the need to rely on the “construction contract” test being met (which was not common practice).

A few months on from the decision of the Supreme Court, we have seen little movement in terms of market practice on this issue – with the consequence that adjudication will in many cases not be an option under typical collateral warranties.

That may be due, in part, to the following factors:

the employer under the relevant building contract or appointment agreement that sets the form of collateral warranty not being directly impacted by this issue (other than in the narrow case of post-novation collateral warranties in favour of the employer); and

the employer not being concerned that the inability of a purchaser, tenant or funder to adjudicate under a collateral warranty granted in their favour will be a deal breaker for a sale or lease deal or an impediment to obtaining funding.

If you would like to discuss any of the points above, please feel free to contact our construction team.

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