Most collateral warranties not ‘construction contracts’, says UK Supreme Court

The court decided this point conclusively in a unanimous judgment issued on Tuesday morning, which means that collateral warranties will not normally give rise to a right to adjudicate under the Construction Act. A collateral warranty where the contractor is merely warranting its performance of obligations owed to the employer under the building contract will not be an agreement “for” the carrying out of construction operations, according to the court.

Collateral warranties are granted by contractors and consultants to third parties with an interest in works that are being or have been constructed. They establish a contractual basis for the third party to recover loss should the contractor or consultant not have complied with the terms of the underlying construction contract or professional appointment.

What constitutes a construction contract for the purposes of the Construction Act is an important question as the Act grants a statutory right to adjudicate disputes arising under ‘construction contracts’ – defined as “agreements for the carrying out of construction operations”.

The question was considered by the Supreme Court in the context of a dispute between a care home operator, Abbey Healthcare (Abbey), and a building contractor, Simply Construct – now, Augusta 2008 (Simply).

In this case, Abbey was the occupational tenant and operator of a care home constructed by Simply. In August 2018, almost two years after practical completion, defects were discovered in Simply’s works. The landowner, Toppan Holdings, employed another contractor to remedy the defects. In September 2020, four years after practical completion and after the defects had been remedied, Simply executed a collateral warranty in favour of Abbey in which it warranted that it “has performed and will continued to perform diligently its obligations under the building contract”.

In December 2020, Abbey commenced an adjudication against Simply under the Construction Act. Simply objected on jurisdictional grounds that the collateral warranty was not a construction contract under the Act. The adjudicator rejected that argument and awarded damages to Abbey. Simply resisted enforcement of the adjudication’s decision. Abbey pursued enforcement before the High Court, which ruled in Simply’s favour, but the Court of Appeal reversed that decision, determining in 2022 that the collateral warranty issued in this case did constitute a construction contract for the purposes of the Construction Act. The matter was further appealed to the Supreme Court by Simply.

In its ruling, the Supreme Court considered what is meant by the legislation’s wording ‘agreements for the carrying out of construction operations’. It considered that, to determine whether a contract is a construction contract for the purposes of the Act, an assessment needs to be made as to “whether the object or purpose of the agreement is the carrying out of construction operations”. It added that, in general, it is “difficult to see” how most collateral warranties can be characterised in that way.

In his leading judgment for the court, Lord Hamblen said: “Whether or not the carrying out of construction operations has to be the main object or purpose of the agreement, it must surely be necessary for the agreement to give rise to the carrying out of such operations. A collateral warranty that merely promises to the beneficiary that the construction operations undertaken under the building contract will be performed does not do so.”

“In such a case, it is the building contract that gives rise to the carrying out of the construction operations; not the ‘collateral’ warranty. Any obligation undertaken to the beneficiary to carry out construction operations derives from and mirrors the obligations already undertaken under the building contract. Everything is referable to the building contract and replicates duties owed thereunder,” he added.

Lord Hamblen said, however, that if a collateral warranty provides a “separate or distinct obligation to carry out construction operations for the beneficiary; not one which is merely derivative and reflective of obligations owed under the building contract”, then it is possible for it to constitute a construction contract, for the purposes of the Construction Act, giving rise to the statutory right to adjudication.

In this case, the Supreme Court determined that the collateral warranty executed on behalf of Abbey did not meet the ‘construction contract’ criteria.

Construction expert Andrew Batty said: “In short, the Supreme Court has said that the majority in the Court of Appeal were wrong. A standard type of collateral warranty is not a construction contract for the purposes of the Act. The Supreme Court did not say a collateral warranty could never be a construction contract. However, it would need it to be drafted to create a separate or distinct obligation to carry out construction operations for the beneficiary of the collateral warranty. This gives clarity to the industry.”

While the court considered it appropriate that a “dividing line” be set “between collateral warranties which merely replicate undertakings given in the building contract and those which give rise to separate or distinct undertakings for the carrying out of construction operations”, it confirmed that “most collateral warranties will not be construction contracts”.

The court added that it is “in the interests of certainty” for such a dividing line to operate, rather than for everything to be “dependent on the wording of the particular collateral warranty in issue”.

Lord Hamblen said: “That will assist those in the construction industry, and those advising them, to know where they stand. Moreover, if it is wished to have a right to adjudication that can always be provided for. Adjudication will, however, be voluntary rather than mandatory.”

In the 2013 Parkwood decision that has now been overruled, the High Court determined that a collateral warranty could be a construction contract for the purposes of the Construction Act, depending on the wording and “relevant factual background” of that warranty.