The Supreme Court has decided that most collateral warranties will not be construction contracts and unanimously allowed the appeal of the Court of Appeal decision in Abbey Healthcare (Mill Hill) Limited v Simply Construct (UK) LLP [2022].

Background

Under s.108 of the Housing Grants, Construction & Regeneration Act 1996 (Construction Act), parties to a construction contract have a right to refer disputes arising under those contracts to adjudication. Construction contracts are defined in s.104(1) and include ‘the carrying out of construction operations’.

n this case, Abbey was the beneficiary of a collateral warranty from Simply Construct (now Augusta 2008 LLP) and commenced an adjudication to resolve a dispute arising out of fire safety defects.

Abbey was awarded £908,495.98 in the adjudication that Simply Construct failed to pay. In the adjudication and the enforcement proceedings, Simply Construct argued that the adjudicator lacked jurisdiction as the collateral warranty was not a construction contract within the meaning of s.104(1) of the Construction Act and therefore there was no statutory right to refer the matter to adjudication.

At enforcement, the judge agreed with Simply Construct that the collateral warranty was not a construction contract within the meaning of s.104(1) of the Construction Act. 
As a result, there was no right to refer matters arising under the collateral warranty to adjudication and consequently the adjudicator lacked jurisdiction and the decision of the adjudicator was not enforced.

Key to that decision was that, whilst the collateral warranty in question referred to both the past state of affairs and future performance, it was executed four years after practical completion and months after the disputed remedial works had been completed by another contractor. The judge stated, “… where the works have already been completed, and as in this case even latent defects have been remedied by other contractors, a construction contract is unlikely to arise and there will be no right to adjudicate”.

Consequently, the judge at first instance held that whether a collateral warranty is a construction contract that is subject to adjudication will largely depend on when the collateral warranty was entered into. Shoosmiths’ analysis of that first instance decision can be read here.

Court of Appeal decision

In a majority judgment, the Court of Appeal reversed the first instance decision and held that the collateral warranty in question was a construction contract within the meaning of s.104(1) of the Construction Act.

The Court of Appeal decision held that, even where a collateral warranty is executed sometime after the works have been completed, this is irrelevant when deciding whether it was a construction contract for the purposes of the Construction Act. What matters is the wording of the collateral warranty and specifically whether this includes future performance. In this case, the warranty contained a promise as to the standard of work carried out in the future and these “future-facing” obligations had retrospective effect. This decision is discussed in Shoosmiths' analysis of the decision.

Supreme Court decision

In Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) [2024] UKSC 23, the Supreme Court held that whether a collateral warranty will be an agreement “for … the carrying out of construction operations” will depend on whether 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.

The Supreme Court held that where a contractor merely warrants the performance of obligations it owes to the employer under the building contract, this will not be an agreement for the carrying out of construction operations. As a result, most collateral warranties will not be construction contracts

The Supreme Court held that the main purpose of a collateral warranty is to create a right of action for the beneficiary (a tenant, purchaser or funder) against the contractor in respect of defectively carried out construction work. In contrast, it is the building contract that contains the obligations and entitlements arising from the agreement to perform construction operations.

So, for a collateral warranty to be a construction contract: “There needs to be 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”.

The Supreme Court then went onto consider whether the collateral warranty provided by Simply Construct was an agreement for the carrying out of construction operations.
Under the collateral warranty, Simply Construct warranted to Abbey that it "has performed and will continue to perform diligently its obligations under the Contract".

The Supreme Court held that these words did not give rise to any requirement to perform construction operations and were “an entirely derivative promise”. Essentially, the Supreme Court held that the contractor was not promising anything under that collateral warranty that it had not already promised the employer under the Building Contract.

The Supreme Court rejected the majority decision of the Court of Appeal and held there was a “dividing line” between collateral warranties replicating undertakings already given in the building contract and those that contain “separate or distinct” undertakings to carry out construction operations.

Collateral warranties and adjudication

The guidance from the Supreme Court will be of significant interest to the real estate industry.

Collateral warranties remain an important way of creating a contractual link between, for example, future owners, occupiers or funders that are not party to a building contract, but who have an interest in a project, and those responsible for constructing the building.

Despite the availability of third-party rights, the use of collateral warranties remains commonplace and these are frequently executed after the work to which they relate has been completed.

The decision of the Supreme Court means that for most collateral warranties, statutory adjudication will not be available in respect of a dispute which arises under the collateral warranty.

The Supreme Court acknowledged that it “is also in the interests of certainty that there is a dividing line, which means that collateral warranties are generally outside the 1996 Act rather than everything being dependent on the wording of the particular collateral warranty in issue. That will assist those in the construction industry, and those advising them, to know where they stand”.

As noted by the Supreme Court, it is always open to parties to agree that disputes arising under a collateral warranty can be resolved by adjudication, but there will not be a statutory right to refer disputes to adjudication under most collateral warranties.