Most collateral warranties not construction contracts

Stuart Pemble welcomes the Supreme Court’s decision that most collateral warranties are not construction contracts. Key points Most collateral warranties will not be construction contracts There is an argument as to whether warranties with step-in rights will be treated differently It is fair to say that Akenhead J’s landmark decision in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC); [2013] PLSCS 210 (www.egi.co.uk/legal/an-error-of-judgment), that collateral warranties could be construction contracts for the purposes of the Housing Grants, Construction and Regeneration Act 1996, was not without its critics (including me). I should therefore nail my colours firmly to the mast at the start of this note: I am delighted (an opinion shared by most, if not all, transactional construction lawyers) that the Supreme Court has taken a different approach in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) [2024] UKSC 23; [2024] PLSCS 127. Parkwood has been overturned and, with one exception, it is unlikely that collateral warranties will ever be construction contracts. The main practical effect of this is that a warranty beneficiary will not be able to bring a claim in adjudication against the party providing the warranty. When Abbey was considered by the Court of Appeal ([2022] EWCA Civ 823; www.egi.co.uk/legal/collateral-warranties-are-probably-contracts), part of the court’s reasoning was that it would be contrary to the purpose of the 1996 Act if an employer and contractor could take advantage of adjudication to resolve their dispute, but a warranty beneficiary and contractor would have to resolve their dispute (arising from the same facts) through lengthier and more expensive court or arbitral proceedings. It is worth noting that this point was not considered by the Supreme Court. The facts A was the leaseholder of a care home which had been built by S between 2015 and 2016. S gave a collateral warranty to A in October 2020, just over four years after practical completion. The warranty included a covenant that S “had performed and will continue to perform” its obligations under the building contract. There were some fire safety defects at the care home which required remedial work. Another contractor completed that work. A paid those costs and sought to recover them from S in an adjudication. A was awarded just under £910,000 in damages. When A applied to enforce that award, Martin Bowdery QC ([2021] EWHC 2110 (TCC)) held that the warranty was not a construction contract, because all of the construction operations necessary to make it so were complete at the time the warranty was granted. In the Court of Appeal, in addition to the point mentioned earlier, the majority (agreeing with Parkwood) held that a covenant in a collateral warranty that a contractor had carried out and would continue to carry out construction operations was a construction contract and the fact that the warranty was granted after the obligations to which it related were complete was irrelevant. The Supreme Court Lord Hamblen, giving the judgment of the court, took a different view: Generally, collateral warranties exist to create a cause of action in respect of defective construction work, rather than a separate obligation to carry out construction operations. In particular, a warranty which promises the beneficiary that the construction work in the underlying contract will be carried out derives from and mirrors the obligation to perform the underlying contract. That obligation is owed to a different party and the warranty beneficiary typically has no control over how those obligations will be performed. A clause where the warranty provider promises to continue to perform the obligations in the underlying contract does not make a difference to that analysis where that promise simply replicates the one(s) given in the underlying contract. Collateral warranties were not intended to fall within the scope of the 1996 Act. A number of provisions (including those around payment) are inapplicable to collateral warranties and the Act’s main purpose – the improvement of cash flow – is not helped by applying the Act to warranties. Practical effects As mentioned at the outset, the decision means the vast majority of collateral warranties will not be construction contracts. The exception is where the warranty contains a direct covenant to carry out construction operations which is separate to (and distinct from) the obligation under the underlying contract; in particular, where the warranty beneficiary can be said to have influence or control over how those obligations are carried out. There has been some discussion as to whether warranties which contain step-in rights (clauses allowing the beneficiary the option to replace the original employer client as a party to the underlying contract in certain circumstance) may be one such exception. One possible challenge to that analysis is that the right only takes effect when the warranty beneficiary chooses to exercise its option to step in. When it does, the underlying contract is effectively novated to it and it becomes a party (effectively replacing the original employer client). At that point, it becomes a party to the underlying contract, which is caught by the 1996 Act. Should it choose not to exercise the right to step in, then it is difficult to see that it has any control over the warranty provider. Indeed, it has chosen not to have that control. Does this mean that the warranty (with step-in rights) only becomes a construction contract at the moment the beneficiary steps in? And, if that is right, what benefit is there to the beneficiary which has just become a party to the underlying contract? I suspect there may be litigation on that point in the future. Stuart Pemble is a partner at Mills & Reeve Image © Scott Graham/Unsplash