Collateral warranties are not construction contracts.

The Supreme Court has handed down an important decision which effectively restated that Section 104(1) of the Housing Grants, Construction & Regeneration Act 1996 (HGCRA 1996) does not generally apply to collateral warranties. Collateral warranties give third parties contractual rights against contractors should defects arise in respect of the works carried out by them and are very common in the construction industry. 

Background:

In June 2015, Augusta 2008 LLP (formerly Simply Construct (UK) LLP) was engaged by Sapphire Building Services Ltd to build a care home under an amended JCT Design and Build 2011 contract which set out, among other things, detailed provisions in respect of warranties including rights in favour of purchasers and tenants. In October 2016, the works were completed. 

In August 2017, Toppan granted a 21-year lease to Abbey Healthcare (Mill Hill) Ltd which ran the care home. In August 2018, alleged fire safety defects at the property were detected and Toppan asked Simply to rectify them. Simply did not comply.

A key term of the collateral warranty, which became central to this case, provided that Simply "has performed and will continue to perform diligently its obligations under the contract" and that it "has exercised and will continue to exercise" reasonable skill, care and diligence in carrying out and completing the works. Following Simply's failure to remedy the defects, Abbey and the freeholder brought adjudication proceedings against Simply.

In December 2020, Abbey commenced adjudication proceedings against Simply for the cost of remediation works and Simply contested on jurisdiction grounds. The High Court dismissed Abbey’s claim. The Court of Appeal (CoA) however reversed the decision and Simply appealed to the Supreme Court.  

Decision: 

The Supreme Court decided unanimously that the collateral warranty was not a construction contract for the purpose of the Housing Grants, Construction & Regeneration Act 1996 (HGCRA 1996). 
The Supreme Court noted that a collateral warranty will not be a construction contract if it merely promises to perform obligations owed to someone else under the building contract. To be an agreement for the carrying out of construction operations “this obligation needs to be separate and distinct from the contractor's obligations under the building contract and not one which is merely derivative and reflective of the same”.

The Supreme Court disagreed with the CoA and found that the clause ‘has performed and will continue to perform' its obligations under the building contract’ is an ‘entirely derivative promise’ as nothing was promised beyond what was found in the building contract. 

Implications:

This judgement was much anticipated by the construction industry. This decision also overrules the ruling in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] and reinstates the traditional view which is that most collateral warranties will not be regarded as construction contracts. However, the Supreme Court has not ruled out the possibility that some collateral warranties may in effect constitute construction contracts. 

This decision makes a clear distinction between the status of collateral warranties which copy existing obligations of a contractor under a building contract, and those which include separate and distinct obligations owed to the beneficiary under the warranty. 

Following this decision, specific contractual adjudication provisions will need to be added to a collateral warranty otherwise, any construction disputes will need to be adjudicated through the courts.

For those drafting collateral warranties, they should ensure that the obligations owed by the contractor do not go further than those provided under any building contract to avoid the implication of the statutory right to adjudicate.