Supreme Court Rules on Whether Collateral Warranty is a Construction Contract

The Supreme Court has now handed down judgment in the case of Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (link to judgment below), addressing the question of whether a collateral warranty can be considered a "construction contract" under the Housing Grants, Construction and Regeneration Act 1996 ("the 1996 Act").

The case involved a dispute between Abbey Healthcare (Mill Hill) Ltd ("Abbey") and Augusta 2008 LLP ("Simply Construct") regarding alleged fire safety defects in a care home construction project. The key issue was whether the collateral warranty given by Simply Construct to Abbey was a ‘construction contract’, thereby giving rise to a right to refer a dispute to adjudication.

Facts

The appellant, Augusta 2008 LLP (formerly Simply Construct (UK) LLP), was engaged by Sophia Building Services Ltd to design and build a care home. The respondent, Abbey Healthcare, was the tenant of the property. Simply provided Abbey with a collateral warranty warranting, amongst other things, that Simply “has performed and will continue to perform diligently its obligations under the [Building] Contract”.

Arguments

Simply argued that the collateral warranty was not a construction contract within the meaning of the 1996 Act. Essentially, it contended that the warranty merely promised to perform obligations owed to the employer under the building contract and did not give rise to separate or distinct obligations to carry out construction operations for Abbey. On the other hand, Abbey argued (essentially) that the collateral warranty constituted a construction contract as it contained promises regarding the ongoing and future performance of construction operations.

Decision

The Supreme Court allowed the appeal and held that the collateral warranty was not a construction contract under the 1996 Act.

The court concluded that for a collateral warranty to be considered a construction contract, it must give rise to separate or distinct obligations to carry out construction operations for the beneficiary. Merely promising to perform obligations owed to the employer under the building contract does not meet this requirement.

The court reasoned that the purpose or object of a collateral warranty is not the carrying out of construction operations but rather to provide a right of action in case of defectively carried out construction work. The court emphasised that a collateral warranty does not give the beneficiary control over the construction operations and does not involve any separate or distinct obligation to carry out such operations. The court also highlighted the practical difficulties and lack of certainty that would arise if all collateral warranties were considered construction contracts.

The court’s decision was based on the interpretation of section 104(1) of the 1996 Act but also the contractual interpretation of the warranty’s terms. The court critiqued the Court of Appeal’s reliance on the warranty clause, indicating continued performance of the building contract, stressing the need for distinct obligations for a warranty to fall within section 104(1).

This decision will be important for the construction community, as the only other previously reported decision on this issue was?Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd?[2013] BLR 589 (TCC).? The Supreme Court overruled that judgment and reverted back to the position pre-Parkwood.

Commentary

While it is widely considered that the decision brings helpful clarity to the law, there has already been significant debate among commentators concerning the decision.

Firstly, some commentators have expressed concern in relation to the court's interpretation of section 104(1) of the 1996 Act. These commentators say that the majority of the court took a too narrow view of the provision, stating that a collateral warranty must give rise to separate or distinct obligations to carry out construction operations for the beneficiary to be considered a construction contract. These commentators have argued that this interpretation fails to consider the broader purpose and intent of the legislation, which is to provide an effective dispute resolution system and improve cash flow in the construction industry. By narrowly defining what constitutes a construction contract, the court (they argue) limits the scope of the 1996 Act and undermines its objectives. The court’s decision has been seen as limiting the rights of third parties with an interest in construction works. Adjudication is a quick and cost-effective method of resolving disputes in the construction industry. By denying this right to beneficiaries of collateral warranties, some consider that the court may have inadvertently increased the time and cost of dispute resolution for these parties.

By contrast, other commentators argue that the court's interpretation of section 104(1) of the 1996 Act is in line with the plain and ordinary meaning of the provision. They say that the court correctly emphasised that for an agreement to be considered a construction contract, it must have the purpose or object of carrying out construction operations. By requiring a separate and distinct obligation to carry out construction operations for the beneficiary, the court ensures that the 1996 Act is applied to agreements that directly involve construction activities. The Act was enacted to improve cash flow in the construction industry and streamline dispute resolution processes. By limiting the scope of the Act to agreements that involve the actual carrying out of construction operations, the court ensures that the Act's provisions, such as interim payments and adjudication, are applied to the core activities of construction projects. These commentators argue that this promotes the Act's objectives and provides a clear framework for resolving construction disputes.

Some commentators also argue that the court's reasoning that a collateral warranty does not involve the carrying out of construction operations is flawed. While it is true that the beneficiary does not have control over the construction operations, these commentators argue that the warranty still provides a promise of ongoing and future performance of those operations. Their argument is, that the fact that the beneficiary ‘follows the fortunes’ of the employer under the building contract does not necessarily negate the existence of a separate obligation to carry out construction operations for the beneficiary. As a result, some commentators consider that the court's distinction between derivative and separate obligations is artificial and does not align with the practical realities of construction projects.

Some commentators also argue that the decision also creates uncertainty and inconsistency in the interpretation of collateral warranties. While the decision has been given a wide press as laying down a general principle of law, the court's reliance on the wording of specific clauses in the Abbey Warranty to determine its status as a construction contract opens the door for disputes and litigation over the drafting and interpretation of such warranties by distinguishing particular terms. Some commentators say that this potentially undermines the purpose of collateral warranties, which is to provide assurance and protection to third parties involved in construction projects.

By contrast, other commentators argue that the court's decision also provides certainty and avoids potential confusion in the interpretation of collateral warranties. By distinguishing between collateral warranties that merely replicate obligations under the building contract and those that give rise to separate obligations to carry out construction operations, they say that the court establishes a clear dividing line. This clarity benefits parties in the construction industry, as they can now understand the status of collateral warranties and their rights and obligations under the 1996 Act.

Additionally, some commentators have suggested that the court's decision to overrule the previous case of Parkwood Leisure Ltd v Laing O'Rourke Wales and West Ltd is questionable. Parkwood established that a collateral warranty could be considered a construction contract under the 1996 Act, and some commentators maintain that its reasoning was sound. These commentators argue that, in overturning this precedent, the court creates inconsistency and uncertainty in the law, leaving parties in the construction industry unsure of the status of collateral warranties and their rights and obligations. However, such comments do perhaps ignore the obvious point that the Supreme Court’s decision sets an authoritative precedent for such matters.

Other commentators argue that the court's decision to overrule the previous case of Parkwood Leisure Ltd v Laing O'Rourke Wales and West Ltd is justified. They argue that Parkwood's interpretation of collateral warranties as construction contracts was met with surprise and criticism within the construction industry at the time. The Supreme Court's decision to now overturn Parkwood (it is said) restores certainty and consistency in the law, ensuring that collateral warranties are not automatically considered construction contracts unless they meet the specific criteria set out by the court.

Conclusion

The Supreme Court has helpfully clarified that a collateral warranty will not automatically be considered a construction contract under the 1996 Act. The court has established that, for a collateral warranty to be classified as a construction contract, it must give rise to separate or distinct obligations to carry out construction operations for the beneficiary.

This landmark decision has potentially significant implications for the construction law community. It provides some clarity that the beneficiary of the collateral warranty may be unlikely to have a statutory right to refer a claim to adjudication.

A link to the judgment can be found here:

?https://www.supremecourt.uk/cases/docs/uksc-2022-0124-judgment.pdf