Liam McKay, a solicitor in Anderson Strathern’s contentious construction team, tells Project Scotland why a recent Supreme Court decision on collateral warranties has major implications for the construction sector
A recent decision by the UK Supreme Court should provide the construction industry with some welcome certainty around the enforcement of collateral warranties. The judgment has major implications for dispute resolution in the construction sector and could impact anyone from employers and funders to contractors and end users.
In the case in question (Abbey Healthcare (Mill Hill) Ltd -v- Augusta 2008 LLP (formerly Simply Construct (UK) LLP) – which we’ll call Abbey v Simply), Simply was engaged by Sapphire Building Services Ltd to design and build a care home. The project was governed by the terms and conditions of a JCT Design and Build Contract 2011 with bespoke amendments. These obliged Simply to ‘carry out and complete the Works in a proper and workmanlike manner’ and fix any defects within the contractual rectification period.
After Abbey Healthcare became the ultimate tenant of that care home, fire safety defects were discovered. But because Abbey was not a party to the original contract, Simply had no contractual obligations towards Abbey, only to Sapphire. This meant Abbey couldn’t sue Simply for breach of contract.
However, what Abbey did have was a collateral warranty, granted in their favour by Simply. So, Abbey referred a dispute to adjudication, hoping for a speedy interim resolution to the losses it had incurred fixing the defects, relying upon this collateral warranty.
Adjudication is normally only available in disputes arising from a construction contract. This is defined as a contract ‘for the carrying out of construction operations’ (per the Construction Act 1996). Was this collateral warranty really a ‘construction contract’?
Simply argued that it was not, challenging the adjudicator’s jurisdiction. The adjudicator rejected this challenge and found in favour of Abbey. Proceedings were then raised to enforce the adjudicator’s decision. The courts had to determine whether a collateral warranty can be a contract ‘for the carrying out of construction operations’. If the answer was ‘yes’, then a collateral warranty could be enforced through adjudication in terms of the Construction Act 1996.
The Court of Appeal agreed that the collateral warranty was a construction contract. However, in a significant and unanimous ruling, the Supreme Court has now reversed the Court of Appeal’s decision, finding that, in general, a collateral warranty will not be an agreement for the carrying out of construction operations.
That is because the purpose of a collateral warranty is to warrant the work already performed by the contractor under the original building contract. The collateral warranty granted to Abbey warranted that Simply ‘has performed and will continue to perform diligently its obligations under the Contract.’ The Supreme Court characterised this language as being derivative: it merely referred to the original obligations. The warranty did not create any new obligations in favour of Abbey. It was simply a promise to honour the obligations already existing within the original employer-contractor agreement.
What does this mean for the construction sector in the future?
The Supreme Court’s decision means that, in general, a dispute arising from a collateral warranty cannot be referred to adjudication. A collateral warranty will only be considered a construction contract if it imposes ‘original and distinct obligations’ upon the contractor to carry out construction obligations for the third party.
However, the Supreme Court did not say that a collateral warranty can never be a construction contract. The court’s decision hints at ways in which a collateral warranty could be drafted so that it could arguably amount to a contract for the carrying out of construction operations. This involves ensuring that the terms of the collateral warranty are drafted in a manner that gives the beneficiary the right to regulate and control the construction operations warranted. For example, by ensuring that the beneficiary is entitled to:
1) Instruct how the works are to be carried out
2) Instruct variations to the works
3) Suspend the works
4) Terminate the works
Alternatively, an easier option may be to include an express term within a collateral warranty stating that any disputes can be referred to adjudication. Adjudication would therefore becme a voluntary agreement, rather than a right as per the Construction Act 1996. Parties may find it easier to agree on this kind of provision, rather than trying to draft a collateral warranty so that the option to adjudicate is a statutory right.
Ultimately, unless contractors and third parties proactively consider whether a collateral warranty should be drafted differently, or decide to agree to an express term to refer any disputes to adjudication, then the option to adjudicate will not be available. The third party will instead need to pursue any claims through the courts.
