UK Update: Collateral Warranties: Don’t Overlook the Right to Adjudicate

Can you adjudicate under a collateral warranty? Possibly – it just got a lot easier.

In any construction dispute, the first question to ask is, “Do I have a construction contract?” Why? The answer determines whether you have a right to adjudicate the dispute.

If the contract is not a “construction contract” (as defined in legislation), then the adjudicator has no jurisdiction to hear the dispute, and any purported decision by them will be unenforceable.

The Housing Grants, Construction and Regeneration Act 1996, commonly called “the Construction Act”, defines a “construction contract” as including an agreement “for … the carrying out of construction operations”. Does a collateral warranty fall within this definition? This was the point considered by the English Court of Appeal in the case of Abbey Healthcare v Simply Construct.

The facts

• 2015 – a D&B contractor enters into a building contract for a North London care home. The contractor is required to grant a collateral warranty to the tenant of the care home.
• 2016 – Practical Completion.
• 2018/19 – the landlord discovers fire safety defects, which, says the landlord (as novated employer), prevents a sale of the property. The landlord instructs the contractor to remedy the defects. The contractor does not do so, and the landlord engages a third party instead.
• September/October 2020 – the contractor produces a collateral warranty in favour of the tenant. Under the collateral warranty, the contractor warrants that it “has performed and will continue to perform diligently its obligations under the [Building] Contract”.
• December 2020 – the tenant starts an adjudication under the collateral warranty.

During the adjudication, the contractor argued that the warranty was not a “construction contract” within the meaning of the Construction Act, and that the adjudicator therefore had no jurisdiction. The adjudicator rejected this and awarded the tenant about £900,000. The contractor refused to pay up.

The tenant therefore had to raise a court action to enforce the adjudicator’s award. The contractor continued to maintain its position that the collateral warranty was not a “construction contract” and that the adjudicator therefore lacked jurisdiction. It was common ground that the relevant operations were “construction operations” within the meaning of the Construction Act. The controversial question was whether the warranty was a contract “for the carrying out” of those operations.  As will be obvious from the timeline above, the warranty was granted years after the construction works were completed.

Court of Appeal agrees with tenant

By a majority of two to one, the English Court of Appeal decided that the collateral warranty was a “construction contract”. As a result, they enforced the adjudicator’s decision.

What mattered was whether, under the warranty, the contractor accepted a primary obligation directly to the beneficiary for the carrying out of construction operations. If there is such a primary obligation, then the collateral warranty is a contract “for” construction operations in accordance with the Construction Act and the statutory right to adjudicate applies. If no such direct obligation is included, then the opposite conclusion is reached.

In the collateral warranty considered by the court, the contractor warranted that the contractor “has performed and will continue to perform diligently its obligations under the Contract”. Unlike many collateral warranties that are often encountered, there was no specific “undertaking” (as opposed to a warranty) on the part of the contractor to so perform. Can a provision bearing to be a warranty constitute a primary obligation owed to the beneficiary “for” construction operations?

Lord Justice Stuart-Smith, providing his dissenting judgment, accepted that the use of the verb “warrant” did “not preclude the possibility that the overall effect of the clause or agreement is to give rise to direct obligations”. However, in his view, that was not the case in the collateral warranty considered. His conclusion was that, in warranting its performance under the building contract, the contractor was “merely warranting its performance of obligations owed to someone else”. In such circumstances, the collateral warranty cannot be considered to be a contract “for” construction operations.

That was not a view shared by either Lord Justice Coulson or Lord Justice Jackson, who both accepted that “a warranty that the contractor was carrying out and would continue to carry out construction operations (to a specified standard) may well be ‘a contract for the carrying out of construction operations’”. Coulson LJ’s construction of the relevant provision of the collateral warranty was as follows:

“Simply Construct were warranting that, not only have they carried out the construction operations in accordance with the building contract, but they will continue so to carry out the construction operations in the future.”

Jackson LJ provides greater clarity on the majority approach when he states:

“… Simply Construct warrants to Abbey that it has performed and will continue to perform diligently its obligation to [the employer] to carry out the construction works. Is that a promise to Abbey, or merely a promise to compensate Abbey if there is a default under the Contract? In my view it is the former….  Although the scope of the obligation is set with reference to the main contract, the promise to carry out the works arises under the [collateral warranty] itself and is a promise made directly to Abbey.”

On the facts of this case, the majority of judges decided that this collateral warranty contained obligations owed directly to Abbey for the performance of construction operations. Consequently, the collateral warranty was a construction contract, the adjudicator had jurisdiction, and the adjudicator’s award could be enforced.

What does this mean in practice?

Until now, drafters have commonly drawn a distinction between collateral warranties which refer only to “warrants”, and those which refer to “warrants, acknowledges and undertakes”, on the basis that it is the words “acknowledges and undertakes” that result in the collateral warranty being a construction contract. Clearly, this decision clarifies that such a simplistic approach is not appropriate and that each collateral warranty needs to be considered on its own terms.

If the intention is to draft with a view to ensuring that the collateral warranty falls within the parameters of a construction contract, the retention of language incorporating “undertakings” in respect of future performance will be appropriate. However, if the parties do not want the collateral warranty to be a construction contract to which the statutory right to adjudicate applies, the mere avoidance of such language and reliance on references to “warrants” may not suffice to achieve such an objective.

The judgement of Jackson LJ, in particular, identifies differences in warranty wording which might appear to be minor, but which may have very significant consequences in terms of determining whether or not a collateral warranty is or is not a construction contract. One thing is clear – there is no wording that is a guaranteed or tried-and-tested formula for avoiding the application of the statutory right to adjudicate.

While there are no such guarantees, we can anticipate that many within the industry may attempt to come up with such a formula. The insurers of contractors and professional consultants may, in particular, have an interest to seek to avoid the reference of disputes under a collateral warranty to adjudication.

A future with disputes arising from such attempts may be awaiting us.

That is in the future. The more pressing requirement, for those in possession of a collateral warranty, may be to take legal advice on whether adjudication is an option that can be/should be pursued.

By Burness Paull LLP, Scotland, a Transatlantic Law International Affiliated Firm.  

For further information or for any assistance please contact ukscotland@transatlanticlaw.com

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