Third party rights — is a collateral warranty a construction contract?

Despite legislative changes across the UK — including in Scotland which my colleague Sarah Stuart covered in a blog post back in 2018 — that give third parties contractual rights in certain circumstances, the reality is that collateral warranty agreements are still the preferred industry option.

And that’s perhaps surprising because, despite their heavy use, collateral warranties remain relatively untried and tested when it comes to the courts.

Legal debate

Among the many debates lawyers have had for years is whether a collateral warranty is a construction contract under the Housing Grants, Construction and Regeneration Act 1996.

With that legislation having been effective since 1998, you’d be forgiven for asking "so what if it is?"

Surely after all this time — and the many, many collateral warranties put in place meantime — that’s academic?

In many cases, that may be correct, but a Court of Appeal decision in England and Wales should give pause for thought, particularly for those granting collateral warranties — who now may be at a higher risk of exposure to claims and adjudication — as well as insurers.

Abbey Healthcare Limited (Mill Hill) Ltd v Simply Construct (UK) LLP

Abbey Healthcare was a new-build care home tenant. Simply Construct was the main project contractor. The terms of that contract included the requirement to provide a collateral warranty in favour of Abbey, as tenant, which created the contractual link between the two.

A dispute arose because of fire-safety defects and required remedial works.

Abbey referred that dispute to adjudication, and secured an award of just over £900,000 against Simply.

Adjudication is a form of dispute resolution that all construction contracts under the 1996 act must provide for. If that doesn’t happen, the legislation effectively writes in those provisions.

Conversely, collateral warranties in standard industry terms don’t have provisions allowing for statutory adjudication.

When it came to Abbey taking action to enforce the adjudicator’s award and recover payment, Simply resisted.

Simply’s argument was the collateral warranty wasn’t a construction contract as defined under the 1996 act, so Abbey had no right to take the dispute to adjudication and Abbey’s recourse was to pursue a claim through the civil courts (a more time consuming and costly process).

At first instance, the Technology and Construction Court (TCC) judge favoured Simply’s argument. Reflected in his decision was the application of reasoning set out in a 2013 TCC judgement in Parkwood Leisure Limited v Laing O’Rourke to the effect that a collateral warranty may simply be that “a past state of affairs has reached a certain level, quality or standard…” rather than being an agreement for “the carrying out of construction operations” which is required under the 1996 act for it to be a construction contract and therefore allowing for statutory adjudication.

As is often the way in construction projects, Simply didn’t provide the collateral warranty in favour of Abbey until months after practical completion of the works (and then only because of proceedings being raised to force them to do so).

The court’s view was that this was a retrospective collateral warranty and was unlikely to ever constitute a construction contract. At the time it was executed, the TCC judge’s view was it was a warranty of a state of affairs past or future, similar to a manufacturer’s product warranty.

Court of Appeal

However, in this recent judgement, the England and Wales Court of Appeal disagreed.

Fundamentally it says all collateral warranties with future obligations could be a construction contract — therefore offering statutory access to adjudication — even if they are executed after the project's completion.

The Court of Appeal considered the statutory intent behind the 1996 act and took the view parliament had intended the definition of a construction contract be construed widely.

The Court of Appeal also noted the act’s central aim to improve the payment regime and dispute resolution mechanisms in the construction industry.

The fact the underlying dispute and defective work was the same between Simply and Abbey as it was between Simply and its employer, Toppan, influenced the judgement too.

There was no doubt at all that the agreement between Toppan and Simply was a construction contract.

Therefore, to argue adjudication could resolve only one of these was counterintuitive to the act’s aim, in the court’s view.

As such, the court concluded a collateral warranty can be a construction contract, but the warranty’s factual background must be considered.

The court also analysed the warranty’s wording and took the view it was for both past and future construction operations, but was not limited to the standard to be achieved, nor a past or fixed situation. It went further than merely recognising Simply had obligations to Toppan under the building contract, placing separately actionable obligations on Simply.

It followed, then, that as the collateral warranty contained future-facing obligations and was retrospective in effect, the date of execution was irrelevant. In practical terms, this may be the most notable part of the Court of Appeal’s decision.

What now?

While this applies to England and Wales, it wouldn’t be a surprise if courts in Scotland take a similar view.

For many years, beneficiaries’ requirements, including from funders, as well as the insurance market — backing contractors’ obligations — have driven trends dictating warranties’ terms.

It’s likely then, because of those trends and this decision , we’ll see new provisions creeping into Scottish collateral warranties.

The result

The good news for beneficiaries is they now have a quick and cost-effective dispute resolution mechanism through adjudication. Will that encourage more active challenges and claims? Will that lead to other “standard” provisions within collateral warranties being scrutinised more closely?

Time will tell.

On the other hand, those granting warranties are now more exposed to adjudication and potential claims.

How will those providing insurance view that? Will that mean more cost to those granting warranties? Will it be possible to pass that cost on? Will any court looking at consultant-granted collateral warranties in the future regard those as different to those contractors have granted? Are there ways to mitigate exposure?

Looks like Sarah and I have much to debate for a while yet on this topic. If you’d like to join that debate, or have us review your rights and obligations, please get in touch.

And you can read more legal insights in our news and views page.