Neil Kelly

In a very significant decision for the construction sector issued, 9 July 2024, (Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP)), the Supreme Court found that a collateral warranty granted by a contractor to a tenant did not give the tenant a right to adjudicate a dispute with the contractor about defects in the contractor’s works under the Housing Grants, Construction and Regeneration Act 1996, as amended (‘the 1996 Act’). In doing so, the Supreme Court overturned the decision of the majority in the English Court of Appeal.

Background

Section 108 of the 1996 Act gives a statutory right to refer to adjudication any dispute which arises under a ‘construction contract’ as defined in section 104.

It is common practice in the construction industry for ‘collateral warranties’ to be granted to third parties, such as funders, purchasers and tenants. Collateral warranties give those parties express contractual rights against contractors (or others) should defects arise in work carried out by them.

In this case, a tenant, Abbey Healthcare (Mill Hill) Limited (‘Abbey’), claimed that there were fire safety defects in the property built by Simply Construct UK (‘Simply’).

Relying on a collateral warranty Simply had granted to Abbey, Abbey claimed about £5.5 million from Simply for alleged losses arising out of the defects and raised adjudication proceedings against Simply seeking payment of that sum.

Simply challenged the jurisdiction of the adjudicator on the basis that the collateral warranty wasn’t a ‘construction contract’ under the 1996 Act. The adjudicator rejected that argument and awarded Abbey about £900,000.

Simply refused to give effect to the adjudicator’s decision on the basis that Abbey had no right to refer the dispute to adjudication because of the collateral warranty. Simply claimed that, as a result, the adjudicator’s decision was invalid and unenforceable. Abbey sought to enforce the adjudicator’s award through the courts which Simply opposed on the same basis.

The issue

The central issue in the case was whether the collateral warranty granted by Simply to Abbey is a ‘construction contract’ within the meaning of section 104 of the 1996 Act which would give rise to a right to adjudicate and specifically whether it is an agreement ‘…for … the carrying out of construction operations…’ under section 104(1)(a) of the 1996 Act.

The Decision

On how section 104 should be interpreted, the Supreme Court held that the section required an assessment of ‘…whether the object or purpose of the agreement is the carrying out of construction operations’.

The court stated that the ‘main object or purpose’ of a collateral warranty is ‘to afford a right of action in respect of defectively carried out construction work, not the carrying out of such work’. Such a warranty does not give rise to the carrying out of construction operations themselves; it is the building contract which does so.

The court considered that a collateral warranty will not be an agreement ‘for… the carrying out of construction operations’ if it merely promises to perform obligations owed to someone else under the building contract. There needs to be a separate or distinct obligation to carry out construction operations for the beneficiary [under the collateral warranty]; not one that is merely derivative and reflective of obligations owed under the building contract.

Critical to the decision of the majority in the English Court of Appeal was their interpretation of the provisions of the collateral warranty under which Simply promised to Abbey that it ‘has performed and will continue to perform its obligations under the building contract’. The Supreme Court described that as ‘an entirely derivative promise. The contractor is not thereby promising anything that is not already promised to the employer under the Building Contract. It does not in itself give rise to any construction operation’.

The Supreme Court considered that ‘a far more principled and workable approach is for the dividing line to be between collateral warranties which merely replicate undertakings given in the building contract and those which give rise to separate or distinct undertakings for the carrying out of construction operations. That is a distinction which can be easily understood and applied.’

Taking account of the above, the Supreme Court held that the collateral warranty Simply had granted to Abbey was not an agreement ‘for … the carrying out of construction operations…’ as required by section 104. That being so, Abbey had no right to adjudicate under section 108.

Comment

This much-anticipated decision of the Supreme Court on collateral warranties is likely to come as a surprise to people right across the construction industry.

Many will be aware of the decision of Atkenhead J. (a distinguished construction lawyer) in the case of Parkwood Leisure Limited v Laing O’Rourke Wales and West Limited which, in 2013, decided that a collateral warranty could be a construction contract under the 1996 Act. That case is expressly overruled by the Supreme Court.

The Supreme Court’s decision is likely to affect most existing collateral warranties but, as the court points out, if parties want adjudication as a dispute resolution mechanism in the future, it can be expressly incorporated in the terms of the collateral warranty by agreement. Experience suggests that it is less likely to be agreed at a later stage, for example, after circumstances have arisen which are likely to develop into a dispute.

Neil Kelly is a partner at Morton Fraser MacRoberts