Judgment determines when warranty amounts to construction contract

Collateral warranties are commonly used in the construction industry to provide assurances to third parties that act as the beneficiaries, allowing them to recover losses in the event that a contractor or consultant has breached the terms of the underlying contract.

In the case of Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP [2024], the key issue was whether a collateral warranty provided by the defendant, in its previous guise as Simply Construct (UK) LLP, qualified as a construction contract under section 104(1) of the Housing Grants, Construction and Regeneration Act 1996.

In 2018, defects – including fire safety defects – were discovered in the works. Simply was notified, and was asked to rectify the defects, but failed to do so. In September 2019, an alternative contractor was employed to carry out remedial works, which were practically complete by February 2020.

In October 2020, following a request by Toppan and the issue of proceedings for specific performance being issued, Simply executed a collateral warranty in favour of Abbey, stating it 'has performed and will continue to perform diligently its obligations under the building contract'.

On 11 December 2020 Abbey, and the property's freeholder Toppan, separately referred disputes with Simply about alleged defects at the property to statutory adjudication under the 1996 Act, and both were successful. The adjudicator in each instance found for Toppan and Abbey on liability, and awarded damages separately to both.

The judge dismissed Abbey's application for summary judgment on the grounds that its collateral warranty was not a 'construction contract' within the meaning of section 104(1) of the 1996 Act, and the adjudicator had therefore lacked jurisdiction.

In reaching his decision, the judge noted that the Abbey collateral warranty was entered into some four years after practical completion of the original works, and eight months after the remedial works by another contractor of the fire safety defects had reached practical completion.

The judge found that 'where the works have already been completed, and as in this case even latent defects have been remedied by other contractors, a construction contract is unlikely to arise and there will be no right to adjudicate'.

Abbey appealed and the Court of Appeal reversed the High Court's decision in July 2022, ruling that the warranty did indeed amount to a construction contract, under the 1996 Act.

The Court of Appeal found that a collateral warranty can be a 'construction contract' as defined in section 104(1) of the Act, but that it depends on the wording of the collateral warranty in question. In the present case, the contractor warranted that it had performed and would continue to perform its obligation to carry out the contract works.

Simply in turn appealed this ruling to the Supreme Court, to answer the question of whether or not the Abbey collateral warranty was a construction contract in the meaning of section 104(1).

The Supreme Court concluded that the main purpose of the warranty was not actually to carry out construction operations, but rather to provide a right of recourse for any defective work.

It disagreed with the Court of Appeal's ruling that clause 4.1(a) of the warranty, in which Simply stated it 'has performed and will continue to perform', created a direct obligation to carry out construction work.

In his ruling, Lord Justice Hamblen clarified that the term 'warrants' was merely a promise, and any duties referred to in the clause reflected existing obligations under the building contract.

He concluded that, if the Court of Appeal's approach were correct, determining whether a collateral warranty is a construction contract would depend on its specific wording – as opposed to the nature of the agreements – an outcome he considered undesirable.

The purpose of a collateral warranty is usually to afford a right of action between parties in the supply chain, closing the gap between those who otherwise have no contractual link – for example, employers and subcontractors – in respect of construction works that have been carried out defectively.

It is not typically for the carrying out of the construction operations themselves, which are usually covered by the building contract.

A collateral warranty promises the beneficiary that the construction operations undertaken in the building contract will be performed, deriving from the promise to perform obligations owed to someone else under the building contract.

The Supreme Court found that these are two distinct obligations, and that only the latter is for the 'carrying out of construction operations', so far as the purposes of the right to adjudicate under the 1996 Act are concerned.

Typically, the warranty does not provide the beneficiary with any control over how those operations are performed, although this will depend on the wording. Accordingly, a collateral warranty will not usually be an agreement to carry out construction operations if it merely promises to perform obligations that are owed to another party under the building contract.

In any contract the wording is key: it is not the case that a collateral warranty cannot be an agreement to undertake works, just that this isn't usually so.

The Supreme Court judgment found that the collateral warranty needs to contain a separate or distinct obligation to carry out construction operations for the beneficiary, if it is to serve as a 'construction contract' for the purposes of section 104 of the 1996 Act, rather than one that merely reflects obligations already owed under the building contract.

In Abbey, the wording of the collateral warranty was found to be a derivative promise since it derived from the promise to perform obligations owed to someone else under the building contract, as the contractor was not agreeing to do anything that was not already promised under the original building contract.

The wording 'has performed and will continue to perform' in the collateral warranty was held not to be enough to cover past and future performance. The Supreme Court decided that such 'few words' could not bear the significance placed on them by the Court of Appeal.

The Supreme Court said: 'A collateral warranty has to be expressed in such terms because it needs to cover all the contractor's obligations under the building contract and it may well be given while the works are still being carried out. It therefore needs to be drafted in terms [that] cover past and future performance.'

It follows that adjudication will not generally be available for parties to typical collateral warranties as a means of resolving disputes, unless there is further statutory intervention, or the parties explicitly include terms giving rise to such a right.

The decision of the Supreme Court means that rather than the niceties of the language used in a particular collateral warranty being the determining factor of whether or not it is a construction contract, the dividing line is now between firstly, collateral warranties that replicate undertakings in the building contract, and secondly, those which give rise to separate undertakings for the carrying out of construction operations.

This should provide greater clarity in the industry, as we expect typical collateral warranties would fall outside the 1996 Act.