UK Supreme Court provides clarification as to whether collateral warranties are 'construction contracts'

In the recent judgment in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP), the Supreme Court has confirmed that a collateral warranty is not a "construction contract" within the meaning of the Housing Grants, Construction and Regeneration Act 1996, unless it contains a separate obligation to carry out construction operations.

The court clarified that merely promising to perform the obligations due under a building contract does not make a collateral warranty a "construction contract". This decision reverses the previous decision of the Court of Appeal and provides certainty that most collateral warranties will not fall within the scope of the Act.

The most significant consequence of this determination is that disputes concerning collateral warranties cannot be referred to adjudication unless expressly provided for.

Facts

Simply had been engaged as building contractor for the construction of a care home in London under a building contract. Abbey had taken a lease of the property. Simply provided a collateral warranty to Abbey which stated that Simply "has performed and will continue to perform diligently its obligations under the Contract".

After fire safety defects were discovered at the property, Abbey brought a claim against Simply for the cost of remedial works. Abbey referred the dispute to adjudication, with the adjudicator finding that Simply was liable for the cost of those works. Abbey issued proceedings to enforce the adjudicator's decision by way of summary judgment.

Simply contended that the appointed adjudicator lacked jurisdiction to make a ruling, as the collateral warranty was not a "construction contract" under the Act. As such, the right to refer a dispute under a construction contract which is conferred by the Act had not arisen.

Though the Technology and Construction Court held in the first instance that the collateral warranty was not a "construction contract", the majority of the Court of Appeal reached the opposite conclusion, deciding that a collateral warranty could be a "construction contract", depending on its precise wording.

Two questions raised

The Supreme Court unanimously allowed Simply's appeal, overturning the decision of the Court of Appeal. The court observed that the appeal raised two questions:

• Statutory interpretation: what is the meaning of an agreement “for… the carrying out of construction operations” in section 104(1) of the Act?
• Contractual interpretation: how should the collateral warranty be construed and, so construed, is it an agreement “for… the carrying out of construction operations”?

Statutory interpretation

On the first question, the court found that in order for an agreement to be considered "for…the carrying out of construction operations", it is necessary for the agreement to give rise to the carrying out of construction operations. A collateral warranty that merely promises to the beneficiary that the construction operations undertaken under the building contract will be performed, does not satisfy this criteria.

The court considered that there needs to exist a separate obligation to carry out construction operations, not one which is merely reflective or derivative of the obligations under the building contract. It emphasised this distinction by identifying that a beneficiary under a collateral warranty has no control over how the building operations under a building contract are carried out.

Contractual interpretation

The court then considered the question of contractual interpretation and determined that the collateral warranty that Simply was relying on did not give rise in itself to any construction operations. The fact that the collateral warranty was drafted in terms so as to cover future performance was irrelevant; Simply did not promise anything under the collateral warranty that was not already promised under the building contract.

The promise to carry out works was a derivative promise. The collateral warranty was therefore not an agreement “for… the carrying out of construction operations” and did not constitute a "construction contract" under the Act.

Osborne Clarke comment

The decision in Abbey Healthcare is a welcome clarification as to whether collateral warranties fall within the Act. It has removed the uncertainty that arose from the earlier judgment in Parkwood v Laing O'Rourke (2013), which first stated that a collateral warranty could constitute a "construction contract".

The court reasoned that there was good evidence that it was never intended for collateral warranties to fall within the scope of the Act. One example of this is that, as a result of the nominal consideration usually provided by the beneficiary, many payment provisions of the Act are rendered inapplicable to collateral warranties.

The court also emphasised the importance of certainty in interpreting collateral warranties; placing collateral warranties largely outside the operation of the Act would prevent fine distinctions being drawn around drafting and interpretation.

In principle, a collateral warranty could still be considered a "construction contract" for the purposes of the Act if the warranty contained a separate and distinct obligation on the beneficiary to carry out construction operations. However, a typical collateral warranty where the contractor is warranting its performance of the obligations owed to the employer under the building contract will not be an agreement “for…the carrying out of construction operations". As such, unless it is expressly provided for, parties to such a collateral warranty will not have a right to refer a dispute arising from it to adjudication.

This Insight was written with the assistance of Madeleine Begg, Trainee Solicitor