By Ross Taylor, partner, dispute resolution, Gillespie Macandrew
A construction contract is an agreement ‘for’ the carrying out, arranging ‘for’ the carrying out or providing labour ‘for’ the carrying out of construction operations. So says Section 104 of the Housing Grants, Construction and Regeneration Act 1996, as amended.
Section 104 also states that if an agreement relates to construction operations and other matters, the Act applies only so far as that agreement relates to ‘construction operations’ (as defined by Section 105).
In July 2024, the UK Supreme Court held that in general, a collateral warranty is not a construction contract (Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP [2024] UKSC 23).
Lord Hamblen concluded the Supreme Court’s decision:
“(1) A collateral warranty will be an agreement “for… the carrying out of construction operations” if it is an agreement by which the contractor undertakes 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.
(2) A collateral warranty where the contractor is merely warranting its performance of obligations owed to the employer under the building contract will not be an agreement ‘for’ the carrying out of construction operations.”
Lord Hamblen’s remarks were made in the context that the principal contract before the court was a building contract. There is no logical reason why the decision of the court, and the foregoing categorisation, should not apply equally to warranties given by other parties in the construction project, such as the design team.
Let us call the first category of warranty a ‘hybrid collateral warranty’. It relates to additional construction operations; and gives a warranty of the work already done under the principal contract. Because of the former, it will fall within section 104 (5) of the Act. That means that the statutory right to adjudication will be implied into the warranty by the Act. However, the implied right will extend only to the additional construction operations. A hybrid collateral warranty will not result in the parties having a right to adjudication in respect of the work carried out under the principal contract.
The inclusion of step-in rights in a collateral warranty will not make it a hybrid collateral warranty. Step-in rights allow the beneficiary to step into the shoes of the employer under the building contract. The construction operations are provided for in the building contract, not the warranty, and continue to be so after step-in. The warranty at issue in Abbey included step-in rights and was held by the court not to be a hybrid collateral warranty.
Similarly, in the Abbey warranty, the contractor warranted that it ‘has performed and will continue to perform diligently its obligations under the [building contract]’. Over-ruling the majority decision of the Court of Appeal, the Supreme Court said that encompassing future performance into the warranty does not make it a hybrid collateral warranty.
A collateral warranty can do no more than allow the beneficiary to (in the words of Lord Hamblen) ‘follow the fortunes’ of the employer under the principal contract.
As was noted in C Spencer Limited v M W High Tech Projects Limited [2020] EWCA Civ 331:
“The twin purposes of [the Act] was to improve cashflow in the construction industry, and to streamline its dispute resolution process. The former aim was achieved through mandatory provisions relating to interim payments, payment notices and the like, and the latter through a new, compulsory scheme for construction adjudication.”
Perhaps except for a nominal sum to meet a requirement for consideration (that is not a requirement of Scots law of contract), a collateral warranty does not include any obligations for payment, at intervals or otherwise. The Act adds no benefit to the provider of a collateral warranty in respect of improving cashflow. That was one reason why the Supreme Court considered that collateral warranties are not construction contracts.
Whether or not a collateral warranty is a hybrid collateral warranty is relevant only to determining if the beneficiary has the benefit of a statutory right to adjudication, absent of express provision in the warranty.
In respect of this second benefit, the Supreme Court decided it was better to allow parties to choose to include this process in the collateral warranty than to force adjudication upon them by implication under the Act.
To take that view, the Supreme Court required to overrule the 2013 decision of Mr Justice Akenhead in 2013, that a collateral warranty was a construction contract (Parkwood Leisure Limited v Laing O’Rourke Wales and West Limited [2013] EWHC 2665 (TCC). In the Court of Appeal, Lord Justice Coulson had placed considerable reliance on that decision, in his reasoning that a collateral warranty was a construction contract. The Supreme Court concluded from interpretation of the Act, that the legislature had not intended to go so far.
Mr Justice Aitkenhead’s decision caused discontent in the construction industry. Although the industry has embraced adjudication, it has not liked the extension of that process to subsequent purchasers and tenants, as the beneficiaries to collateral warranties. This is because it has been feared that beneficiaries might use adjudication to push through favourable decisions in latent defects claims, long after project completion. As the number of such beneficiaries is no doubt greater that the single employer in the construction project, risk to the contractor, sub-contractor and project team was greatly increased, and along with it their insurance costs.
In practice, it is difficult to envisage a scenario in which a hybrid collateral warranty would exist. Surely if the beneficiary wished the provider of the warranty to undertake additional construction operations, the parties would contract for that separately.
There are also difficulties for the beneficiary insisting upon such a warranty. The obligation of the provider of a warranty to do so is contained in the principal contract. The additional construction operation in favour of the beneficiary would require to be anticipated and provided for in in the principal contract. And that is something that the employer under the principal contract would have no interest in.
The main contract could provide for the contractor to enter into a collateral warranty on terms ‘to be agreed between the contractor and the beneficiary’, in which case additional ‘construction operations’ could be included. Whilst hypothetically possible, this is unlikely to be palatable for the contractor or its insurer, as they will look for certainty in what they are to provide. They will not want to take on the risk of failure to provide a collateral warranty in terms of the contract, if terms cannot be agreed.
If there is no obvious benefit to a hybrid collateral warranty, why then did the Supreme Court contemplate its possibility? Perhaps the answer is a simple one. Before matters came before it, the analysis of whether a collateral warranty was a construction contract had focused on whether it provided for any future construction operations.
The Supreme Court rejected that analysis. It preferred the analysis put to it on behalf of Augusta, which proposed that the determining factor for whether the Act applied to a collateral warranty was whether it was a hybrid collateral warranty – it included additional construction operations at the instruction of the beneficiary, which were not already included in the building contract.
That analysis was persuasive. It gave the Supreme Court a vehicle of justification to hold that a collateral warranty is not a construction contract and to overrule the past contrary decisions. The concept of a hybrid collateral warranty leaves open, the theoretical door to a collateral warranty being (in part) a construction contract. In fact, can there really be a hybrid collateral warranty? Perhaps the construction sector can rest easy, for the answer is surely ‘no’ or at least, not in practice.
