In the wake of the recession of the early 1990s and the construction insolvencies that followed, the UK parliament enacted Part II of the Housing Grants, Construction & Regeneration Act 1996 (the Construction Act). At the heart of the new legislation was a recognised need to improve payment practices and cash flow in the construction sector. The Construction Act sought to achieve this via the introduction of the following:
These three key entitlements apply automatically to ‘construction contracts’, as defined in the Construction Act. In other words, whether or not a particular agreement falls within the ‘construction contract’ definition can have huge implications for an individual party’s rights and remedies under that agreement.
One category of agreement in particular has generated significant debate and commentary over the years as to whether it constitutes a ‘construction contract’. We are of course referring to collateral warranties – instruments provided in favour of an interested third party beneficiary, such as a funder or incoming commercial tenant, under which the construction provider warrants to the third party beneficiary that it has complied and shall continue to comply with the terms of its principal contract with the ultimate client.
The question of whether such a warranty constitutes a ‘construction contract’ is significant from the beneficiary’s perspective, as the answer will likely dictate whether it can launch a fast-track adjudication for a defect claim or whether it will instead need to bring a far more lengthy and costly claim through the courts.
The 2013 first instance decision of Parkwood Leisure v Laing O’Rourke ruled that a typical collateral warranty is a construction contract. The Parkwood ruling was the understood industry position until the question arose again in the case of Abbey Healthcare v Simply Construct.
Simply Construct was engaged to design and build a care home in London. The works were completed in 2016 and Abbey Healthcare took a commercial lease of the care home shortly afterwards. Abbey Healthcare was not the employer under the building contract but received a collateral warranty under which Simply Construct warranted that it “[had] performed and [would] continue to perform diligently its obligations under the Building Contract.”
In 2018, fire safety defects were discovered in the care home. The necessary remedial works were carried out in 2019 by a third party contractor.
Abbey commenced adjudication proceedings against Simply Construct to recover its losses relating to the defects. The adjudicator ruled that Simply Construct was liable for Abbey’s losses arising from those defects. Simply Construct did not pay the amounts awarded, arguing that the collateral warranty was not a ‘construction contract’ within the meaning of the Construction Act and therefore the adjudicator did not have jurisdiction to award such sums.
The first instance judge in the Technology and Construction Court disagreed with the position taken in Parkwood and accepted Simply Construct’s argument that the collateral warranty was not a ‘construction contract’. Abbey appealed that decision and the Court of Appeal agreed with their claims, reverting back to the Parkwood position. You can read our article on the Court of Appeal decision here.
Simply Construct then took the matter all the way to the Supreme Court, who unanimously ruled that the Court of Appeal and Parkwood decisions were wrong. We now have absolute clarity from the highest Court in the land that a typical collateral warranty is not a construction contract and therefore does not attract an automatic, statutory right to adjudicate.
The Supreme Court ruled that, in order for the ‘construction contract’ definition to be engaged, the provider’s undertaking to carry out construction operations must be for the direct benefit of the counterparty to that contract, for example as is the case with the ultimate employer under a main building contract. A promise given to a third party in a collateral warranty about the performance of those obligations is insufficient and does not fall within the statutory definition.
It followed that Abbey’s collateral warranty did not attract a right to adjudicate, as it merely repeated obligations owed by Simply Construct to the employer under the building contract, and did not create a separate or distinct obligation to carry out the care home works.
The court also pointed to the overriding purpose of the Construction Act (namely improvement of cash flow) and noted that such purpose is not furthered by interpreting the ‘construction contract’ definition as being applicable to collateral warranties. Unless step-in rights are exercised, the beneficiary under a collateral warranty has no construction related payment obligations.
It is important to note that this decision does not impact the validity of a typical collateral warranty. It only affects the application of the Construction Act to that warranty and the corresponding statutory right to adjudicate. Collateral warranties remain a tried, tested and valuable tool for providing security on a whole host of projects and associated contractual structures.
Moving forward, however, beneficiaries must be mindful that a claim under such an instrument will (subject to the next paragraph below) need to be brought in the courts rather than via a much speedier adjudication process.
It is also worth noting that the Supreme Court ruling only prevents warranty beneficiaries from claiming an implied, statutory right to adjudicate. It is still perfectly possible to include an express, contractual right to adjudicate within the written terms of the warranty itself. We expect to see a sharp increase in beneficiaries seeking to include such express written terms in light of the Abbey Healthcare case. Whether the contractor, sub-contractor and consultant markets accept such a move remains to be seen.
For further information, please contact the construction and infrastructure team.
