Legal Q&A: Collateral warranties are not construction contracts
Ryan McCuaig, Associate, CMS Cameron McKenna Nabarro Olswang
ON 9 July 2024, the UK Supreme Court issued its judgment in Abbey Healthcare (Mill Hill) Ltd v August 2008 LLP (formerly Simply Construct (UK) LLP) – a decision with far-reaching consequences for those in the construction industry engaged in projects which require the provision of collateral warranties. The case concerned a claim by Abbey, a tenant, to recover losses from Simply, a contractor, in respect of fire safety defects at a care home. Abbey sought and was awarded damages by an adjudicator in respect of these defects.
The decision of the adjudicator was challenged by Simply Construct firstly in the High Court which found in its favour, before that decision was overturned by the Court of Appeal, resulting in the matter coming before the Supreme Court.
In brief terms, the Supreme Court found that a collateral warranty which replicates undertakings given in the main building contract (as is typically the case) will not itself be a construction contract – within the meaning of the Housing Grants Construction and Regeneration Act 1996 – and will not therefore benefit from the statutory right to resolve disputes via adjudication. Before exploring potential implications of the judgment, we should examine the relevant concepts.
What is a collateral warranty?
Simply put, a collateral warranty is a contractual document which is used to create a contractual relationship between a party who benefits from a project (such as an owner, funder, tenant or purchaser) with a party who had a role in designing or constructing the project (such as the contractor, designers and key subcontractors). A typical example would be a property developer who contracts with a main contractor for design and construction of a project obtaining collateral warranties from those who were sub-contracted to work on the project by the main contractor.
The creation of this contractual relationship provides a route for the beneficiary of the warranty to pursue the party who gives the collateral warranty in the event that defects are later discovered which can be attributed some fault of that party.
What is a construction contract?
The construction act defines a construction contract at section 104 as an agreement for (a) the carrying out of construction operations; (b) arranging for the carrying out of construction operations by others, whether under subcontract or otherwise; or (c) the providing of labour, or the labour of others, for the carrying out of construction operations. This includes an agreement to do architectural, design, surveying, or to provide advice on building, engineering, decoration or landscaping work.
Construction operations is widely defined at section 105 of the act and includes construction, alteration, repair, maintenance, extension, demolition or dismantling of buildings and various other structures.
Adjudication
The most widely used dispute resolution method in the construction industry is the statutory right to adjudication under a construction contract. That form of dispute resolution process was established to preserve cashflow during the course of a project – providing relatively quick, binding (at least unless or until challenged in court) decisions on disputes between parties. In an industry run on increasingly fine margins, the maintenance of cashflow is a primary concern hence the ‘pay now, argue later’ approach taken in adjudication.
Adjudication is designed to provide a decision within a relatively short period of time and to be navigated by parties without legal representation – although, in practice, parties often engage lawyers and experts to assist with pursuing or defending adjudications.
Implications of Abbey Healthcare
The Supreme Court found that the collateral warranty provided to Abbey did not fall within the statutory definition of a construction contract because it was not a contract for the carrying out of construction operations. Rather, the collateral warranty merely promised the beneficiary that the construction operations carried out under the building contract would be performed.
This decision will impact a large number of collateral warranties, with the assumption now being that most collateral warranties do not fall within the construction act.It was held that in such cases, it is the building contract which gives rise to the carrying out of construction operations, not the collateral warranty. Therefore, unless the collateral warranty included separate and distinct obligations to carry out construction operations, it will not be considered a construction contract under the act, and will not be subject to the statutory adjudication regime.
This decision will impact a large number of collateral warranties, with the assumption now being that most collateral warranties do not fall within the construction act meaning any disputes arising in relation to them will not be able to be adjudicated. Additionally, many adjudications which were ongoing at the point of the decision being issued will have had to be abandoned.
There will also be an impact on the negotiation of future collateral warranties and it is anticipated that beneficiaries will press for the right to adjudicate to be written into future collateral warranties as a contractual right in order to maintain the ability to adjudicate disputes. Naturally, that may be unacceptable to those granting collateral warranties. It remains to be seen, in the absence of statutory adjudication, where the market will land and whether a new industry standard contractual regime will arise.
Ryan McCuaig, Associate, CMS Cameron
McKenna Nabarro Olswang
