Collateral warranties: can you adjudicate?

Collateral warranties: can you adjudicate?

New Year resolution construction webinar series session 1: improve sustainability

In the recent case of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP [2022] the Court of Appeal considered whether a collateral warranty was a construction contract for the purposes of HGCRA. and therefore, whether the beneficiary was able to bring a claim via adjudication, rather than through the courts.

Also, Orchard Plaza Management Company Ltd v Balfour Beatty Regional Construction Ltd [2022] highlights the importance of collateral warranties and a beneficiary’s ability to claim damages via a collateral warranty.

Why is this important?

Collateral warranties are widely used on construction projects to give parties who have an interest in the project, but who are not a party to a particular contract, the right to rely on provisions of the contract and bring claims against the original contractor, consultants and/or sub-contractors in the event of a breach of contract. This gives parties such as funders, purchasers or tenants rights against contractors and/or consultants in the event of a problem. This can be particularly important if the original developer is no longer available to meet a claim. Collateral Warranties also allow a main Employer to bring a claim against a sub-contractor despite the employer not being a party to the sub-contract.

Under the Housing Grants, Construction and Regeneration Act 1996 (HGCRA), parties to a "construction contract" are able to refer disputes to adjudication at any time.

Adjudication is often a quicker and cheaper way of resolving disputes compared to court proceedings. It therefore means that a beneficiary to the collateral warranty would potentially be able to bring and resolve a claim much quicker and more economically if the collateral warranty is considered a "construction contract" for the purposes of HGCRA.

What is a "construction contract"?

The HCGRA sets out a definition of what will be termed to be a "construction contract" at s.104 to 106. In essence, a "construction contract" is one which involves "construction operations" (as defined at s.105(1) of HGCRA). There has long been a question as to whether a collateral warranty is a contract for construction operations, or whether it is purely a form of warranty or guarantee, which would not fall within the definition of a "construction contract" under HGCRA.

If a collateral warranty is not a "construction contract", then the beneficiary would have no right to refer any disputes to adjudication under HGCRA.

The case – Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP [2022]

In this case, the Court of Appeal overturned an earlier TCC decision in Toppan Holdings Ltd and Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP. You can see our analysis of the earlier case in our video blog here. Briefly, the TCC had held (among other things) that a collateral warranty will not be a "construction contract" if the works have been completed at the time the parties enter into the collateral warranty. In that case, the relevant works had been completed some years before the collateral warranty was signed by the parties. The court considered that the party providing the warranty was simply warranting it had carried out the past works to the quality expected under the original contract. Therefore, the collateral warranty was not a construction contract and the beneficiary had no right to adjudicate.

In the appeal, the Court of Appeal has now stated that the collateral warranty was a contract “for the carrying out of construction operations” in accordance with the statutory definition. In coming to this decision, the court gave the following guidance:

  1. The phrase in s104(1) HGCRA "an agreement for the carrying out of construction operations" can be interpreted broadly. It includes agreements “related to” construction operations.
  2. A warranty does not need detailed payment provisions to be a "construction contract", a nominal payment provision (such as £1 as is standard) would comply with s109 HGCRA.
  3. If a warranty contains future obligations as well a retrospective effect (i.e. the warrantor is warranting that past works meet a certain standard and any future works will meet that same standard) it is likely to be a construction contract. This is because it is not limited to a past or fixed situation and is therefore different to a product guarantee.
  4. The date the warranty is entered into, subject to the above principles, is irrelevant.

This last point is particularly important, as collateral warranties are often signed some time after the works have been completed (for example, when a tenant enters into a tenancy of a completed building). If the date the warranty was entered into was relevant it could mean that a collateral warranty entered into after the date of practical completion of the project would not be a construction contract. But the same collateral warranty entered into the day before practical completion could be. The Court of Appeal has now clarified that the timing of the warranty is not the determinative factor.

Recovering damages under a collateral warranty in practice

As discussed above, collateral warranties are a key way in which a beneficiary can seek to recover losses incurred due to defective design or workmanship.

The recent TCC case of Orchard Plaza Management Company Ltd v Balfour Beatty Regional Construction Ltd [2022] highlights the importance of collateral warranties and a beneficiary’s ability to claim damages.

In this case a claim was brought against a contractor by the management company of an apartment block for defective cladding and fire safety defects. The management company brought this claim under a collateral warranty which had been assigned to it from the funder of the development. Despite the collateral warranty being originally granted to a funder (who would therefore be unlikely to incur costs of repair given their position in the project structure) the court held that it was within the contractor’s reasonable contemplation that an assignee of its benefit would incur repair costs if the works were defective. The court also held it was a serious possibility that a funder would incur repair costs as its losses were not only limited to diminution in value.

This case highlights the potential scope for the recoverability of damages under a collateral warranty.

Key points to take away

  • Firstly, a collateral warranty can be a “construction contract” under the HGCRA so long as there is wording which includes a warranty that both past and future works will meet a certain standard.
  • Secondly, collateral warranties are a vital way parties obtaining an interest in a recently built property can get security for the costs of remedying defects.
  • Finally, it now appears that parties to a collateral warranty will have the right to adjudicate disputes arising under the collateral warranty, as long as the form of warranty meets the requirements noted by the Court of Appeal in the recent judgement. However, if the parties wish to ensure that adjudication will be available, it may be sensible to consider whether to include an adjudication clause into the form of warranty…and avoid any argument.

Stevens & Bolton regularly advises on issues regarding collateral warranties and it is common for the importance of these documents to be overlooked. Given that it is now clear that collateral warranties can be “construction contracts” and give rise to the statutory right to adjudicate disputes, beneficiaries potentially have a much quicker and cheaper way of pursuing a claim under a collateral warranty.

Contact our experts for further advice

Search our site