The UK Supreme Court has issued a decision concerning whether collateral warranties are construction contracts under the Construction Act.

This will be of interest to all contracting parties and contract negotiators in the UK construction industry.

Back in August 2022, we commented on the English Court of Appeal’s decision in this case (see here). We asked: “Can you adjudicate on a collateral warranty?”

Our answer on the back of that case was: “Possibly – it just got a lot easier”. Almost two years later, the UK Supreme Court has unanimously said: “Probably not”. Below we explore why and the practical effects.

Facts

The case is Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP). The facts and timeline are as follows:

• 2015 – a design-and-build contractor (Simply) enters into a building contract (a JCT D&B 2011) for a north London care home. The building contract requires Simply to give a collateral warranty to a tenant when required. The contract contains a draft form of collateral warranty.
• 2016 – practical completion is certified.
• 2017 – the building contract was novated to another employer, who then enters into a lease as landlord with a tenant (Abbey).
• 2018 / 2019 – the landlord discovers fire safety defects, which it says prevent a sale of the property. The landlord instructs Simply to remedy the defects. Simply does not do so and the landlord engages a third party instead.
• September 2020 – simply produces a collateral warranty in favour of the tenant (Abbey) (the “Abbey Collateral Warranty”). Under the Abbey Collateral Warranty, Simply “warrants” that it “has performed, and will continue to perform diligently” its obligations under the building contract. It also said that Simply “has exercised and will continue to exercise” reasonable skill and care in the contractor-designed parts of the works.
• December 2020 – the tenant starts a statutory adjudication under the Abbey Collateral Warranty; something it could only do if the Abbey Collateral Warranty was a “construction contract” under the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act).

UKSC decision

The decision dealt with two issues – statutory interpretation and contractual interpretation – to confirm whether the Abbey Collateral Warranty amounted to a construction contract.

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 parties disagreed about the meaning of the word “for”.

The Supreme Court’s answer? A collateral warranty will be 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. Such a warranty does not give rise to the carrying out of construction operations – only the building contract does that. The warranty derives from and mirrors the obligations already undertaken under the building contract.

Contractual interpretation

The Supreme Court then asked whether the Abbey Collateral Warranty was a “construction contract”.

The court’s answer was “no”. Simply’s 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 also rejected the Court of Appeal’s reliance on the specific language used in the Abbey Collateral Warranty. In the Supreme Court’s view, that approach would mean that whether a collateral warranty was a construction contract “will always depend on the niceties of the language used” and lead to fine distinctions and disputes in relation to the drafting and interpretation of collateral warranties. Instead, the Supreme Court said that a far more principled and workable approach is for the dividing line to be between collateral warranties which (1) merely replicate undertakings in the building contract and those which (2) give rise to separate or distinct undertakings for the carrying out of construction operations.

Practical effects

This decision has importance to the UK construction industry. Although the Supreme Court’s decision is an appeal from the English courts, the case is also likely to be persuasive in Scotland, as the relevant legislation is the same in both countries. The wording in the Abbey Collateral Warranty is commonly seen in collateral warranties, which play an important part of the contractual matrix of construction projects.

For contracting parties

Our previous blog mentioned a potential future of disputes about attempts to adjudicate disputes under collateral warranties. The Supreme Court seems to have prevented that future.

This decision significantly reduces the chance that a collateral warranty of the type commonly used in the industry will be a “construction contract” under the Construction Act. As the Supreme Court pointed out, the mandatory payment provisions for construction contracts (ss 109–113) are usually inapplicable to collateral warranties anyway, where improving cashflow is not an issue. More importantly, however, collateral warranties which are not construction contracts will not confer a statutory right to adjudicate under s 108 of the Construction Act. In that case, if a dispute arises between the beneficiary of a collateral warranty and the contractor, and the collateral warranty does not give the parties an express contractual right to adjudicate, the beneficiary will not be able to adjudicate and will need to use other methods to resolve the dispute.

The ability to adjudicate allows parties to run dispute proceedings in a quick and cost-effective manner. This can be particularly useful in cases of construction defects arising some time after construction. Where beneficiaries of collateral warranties do not have that ability, they will face the more cost and time-intensive options of court or arbitration.

For contract negotiators

The Supreme Court recognised that its decision was likely to mean that most collateral warranties will not be construction contracts. Therefore, if parties to a collateral warranty wish to have the right to adjudicate, they need to use express words. The court said that its ruling “allows parties to contract into the adjudication regime where this is seen as desirable but not to be fixed with an inability to contract out”.

Time will tell whether beneficiaries will insist upon express adjudication clauses in collateral warranties and whether this will become market standard. In every case, parties should consider whether they wish to have adjudication as an option under a collateral warranty and if so, ensure that the necessary wording is in place.

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

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