Supreme Court confirms a collateral warranty is not a construction contract

Adam Chaffer, Associate & Mediator

There is a well-trodden path at the start of every construction dispute. That path starts with a pivotal question; “is my contract, a construction contract?”. Getting the right answer to this question is essential to the progression and ultimate resolution of the dispute.

If it can be said that the contract is a construction contract then the parties have the statutory right to rely on adjudication to determine any dispute at any time. If it is not a construction contract then the resolution of the dispute will be determined by arbitration or more likely through the courts which on balance is a more protracted and expensive route.

While this question is a preliminary question within often a much larger and complex dispute it often necessitates a significant investment of time, thought and energy to determining what the answer may be.

In this article, we consider the recently handed down Supreme Court decision in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP [2024] UKSC 23 which has confirmed the question of whether a collateral warranty is a construction contract for the purposes of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”).

Background
The dispute itself concerned a care home in London and works relating to the building’s fire safety system. The works were performed by Augusta 2008 LLP (“Augusta”), with the building’s tenant being Abbey Healthcare (Mill Hill) Limited (“Abbey”).

Augusta had provided Abbey with a collateral warranty which included wording to the effect that Augusta had, “performed and will continue to perform diligently its obligations under the [Building] Contract” (the “Augusta Warranty”)

The question which was posed to the Supreme Court was whether the Augusta Warranty, fell within the meaning of a construction contract under the Construction Act.

If it did fall within the meaning, then it would trigger the right for the parties to that contract to engage in adjudication. The Court of Appeal, in an earlier majority decision found that the Augusta Warranty was a construction contract. Augusta sought to appeal that decision to the Supreme Court.

The decision
Unanimously, the Supreme Court in the judgment of Lord Hamblen, held that a collateral warranty does not generally fall within the definition of a construction contract for the purposes of the Construction Act. It is likely that the outcome of this decision is going to have a significant impact on the enforcement of collateral warranties in the future.

A detailed look
A collateral warranty provides third parties contractual rights against contractors should defects arise in respect of the works carried out by them. They are an important mechanism in construction contracts because of the complex contractual framework which exists between Employer, Contractor and professional appointments and end user of the construction works.

The definition of a “construction contract” appears in section 104(1) of the Construction Act, and considering that definition for the purposes of a collateral warranty the Court held that as a generality, it is difficult to see how the object or purpose of a collateral warranty is the carrying out of construction operations. The main object or purpose of such a warranty is to afford a right of action in respect of defectively carried out construction work, not the carrying out of such work.

Placing that point into a practical context, what the Supreme Court found is that:

1. a collateral warranty is an agreement by which the contractor undertakes a contractual obligation to the beneficiary to carry out construction operations which is separate and distinct from the contractor’s obligation to do so under the building contract; and,
2. where a collateral warranty is merely warranting the performance of obligations owed by a contractor to an employer under the building contract, that type of warranty will not be an agreement “for” the carrying out of construction operations.

Applying this to the Augusta Warranty, as promisor, Augusta had provided a warranty that it had “performed and will continue to perform” its obligations under the building contract. Those words did not go beyond an obligation to perform what they intended to do under the contract and therefore they could not be said to be providing a warranty as to a construction operation and indeed at the time of the documents execution those obligations had been performed.

In broader terms, beyond just a contractual interpretation of that phrase, the Supreme Court observed that the payment provisions of collateral warranties; normally a consideration at a nominal value such as a pound, did not correspond with the payment provisions of sections 109 to 113 of the Construction Act.

Practical considerations
The decision of the Supreme Court is significant and is likely to have a far reaching effect on the construction sector.

The decision overrules the earlier case of Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] BLR 589 (TCC), in which Akenhead J held that the collateral warranty in that case was a construction contract under the Act and this is no longer seen as a reliable approach. From a practical perspective, the decision demonstrates that it is not niceties of the language used in collateral warranties, for example the use of the word “warrants” or “undertakes”, which would be likely to lead to fine distinctions being drawn and to disputes on the drafting and interpretation of collateral warranties. By overruling Parkwood, the Supreme Court has gone back to the approach taken prior to that decision.

This approach taken by the Supreme Court means that most collateral warranties will not likely be construction contracts. That rational is based on the interests of contractual certainty as there is a far more principled and workable approach is for the dividing line to be 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. That is a distinction which can be easily understood and applied.

The Supreme Court did observe, that there was nothing preventing the parties to a collateral warranty from expressly agreeing a contractual provision to allow them to adjudicate, however, such a mechanism would be voluntary rather than mandatory.

Next steps
As the Supreme Court decision demonstrates, determining whether a contract is a construction contract for the purposes of the Construction Act and the mandatory provisions that this would give rise to is a complex question. If you have a construction or engineering dispute and you are unsure whether it is a construction contract or not, then please contact Jan Rzedzian or Adam Chaffer in the Construction Team.