On 21 June 2022, the Court of Appeal in a majority decision has decided that collateral warranties can be “construction contracts” for the purposes of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”). This judgment has provided some much needed certainty on the contractual status of a collateral warranty.

The important takeaway from the judgment is that all collateral warranties with forward facing obligations will now be a construction contract even if they are executed after the works or services are performed. If possible, collateral warranties should therefore be limited to warranties as to existing affairs.

In this article, Antony Smith, Andrew Croft and Kush Patel look at the importance of this case and what this judgment could mean for the industry, particularly for contractors, consultants and insurers whose risks may increase due to this judgment.

Background

This case concerns the design and construction of Aarandale Manor, a care home located in Mill Hill, London (the ‘Care Home’).

The Defendant, Simply, was engaged by Sapphire Building Services Limited (‘Sapphire’) under a building contract as design and build contractor in June 2015. These works were deemed complete in October 2016. Following completion, Sapphire novated all its rights and obligations under the building contract to Toppan Holdings Limited, (‘Toppan’) the freehold owner of the Care Home. The Care Home was let to Abbey, as tenant operator, under a long lease dated 12 August 2017.

A number of defects were then identified at the Care Home and were notified to Simply in January 2019. Another company was engaged to undertake the remedial works, and these were completed in February 2020.

The building contract obliged Simply to execute a collateral warranty in favour of the tenant upon notification. This right was exercised by Toppan in June 2020 but Simply never executed the warranty. Following specific performance proceedings, a collateral warranty was subsequently executed on 23 October 2020 (the ‘Abbey Collateral Warranty’). This was four years after practical completion of the original construction works, and 8 months after completion of the remedial works.

To recover their respective losses in relation to the disputed defects, Toppan and Abbey both brought adjudication proceedings, which ran in parallel. Abbey and Toppan were awarded separate sums in the adjudication proceedings: £1.047m to Toppan and £894k to Abbey (exclusive of the Adjudicator’s fees). Simply resisted enforcement of the decision on the grounds that the Adjudicator did not have jurisdiction to decide the dispute, as there was no contractual right to adjudicate and/or implied contractual right to adjudicate under the Abbey Collateral Warranty.

High Court decision

Abbey and Toppan made an application for summary judgment in the High Court to enforce the two adjudication awards. The High Court did not enforce the Abbey award on the grounds of jurisdiction. Their view was that the Abbey Collateral Warranty was not a construction contract for the purposes of the Housing Grants, Construction and Regeneration Act 1966 (the ‘Construction Act’).

The Judge placed particular emphasis on the timing of when the warranty was executed. Following the decision in Parkwood v Laing O’Rourke [2013], the Judge stated that because the collateral warranty was signed after the construction and remedial works had completed, it could not be considered a construction contract for the purposes of the Construction Act. Namely because a ‘construction contract’ is defined (amongst other things) as a contract for the ‘carrying out of construction operations’ (see S.104(1) of the Construction Act). There was, therefore, no contractual right for Abbey to adjudicate under the Construction Act.

Abbey appealed this decision and the question for the Court of Appeal was whether or not the Abbey Collateral Warranty was a construction contract for the purposes of the Construction Act, thereby entitling Abbey to adjudicate and enforce the Adjudicator’s decision.

Court of Appeal decision

The court had three questions to consider:

1. Can a collateral warranty ever be a construction contract for the purposes of the Construction Act?
2. If yes, did the terms of the Abbey Collateral Warranty make it a construction contract for the purposes of the Construction Act?
3. Did the date on which the Abbey Collateral Warranty was executed make any difference?

Issue 1: Can a collateral warranty ever be a construction contract for the purposes of the Construction Act?

LJ Coulson (providing the leading judgment) was clear that a collateral warranty can be a “construction contract”, albeit it will depend on the precise words used in the collateral warranty and the rights conferred.

A “construction contract” is defined in the Construction Act as including contracts “arranging for the carrying out of construction operations by others”. In deciding whether a collateral warranty satisfied this requirement, he considered the statutory definition in more detail.

In the court’s view, a “construction contract” could not be defined narrowly and a ‘strait-jacketed judicial interpretation should be avoided’. LJ Coulson noted that parliament deliberately left the definition wide. This would mean that there could be multiple construction contracts for one set of construction operations, i.e. that the agreement for the original construction works is not the only construction contract on a project. He supported this by noting that there is nothing in the Construction Act that prevents this interpretation.

Having determined that “construction contract” is not a narrow definition, the court considered whether a collateral warranty could be a construction contract. In doing so, they placed emphasis on the ‘wording’ of the warranty. In short, they stated that if a collateral warranty is just a fixed promise/guarantee to a past state of affairs, then it is unlikely to be a construction contract. However, if the warranty is that the “contractor was carrying out and would continue to carry out construction operations”, then this could be considered a contract “for the carrying out of construction operations” (i.e. a construction contract). This is because it is a promise (at least in part) which regulates the ongoing carrying out of construction operations.

LJ Coulson also covered the other requirements of a construction contract – namely payment. This is not the focus of this article or the judgment, but in short, a collateral warranty is likely to satisfy the payment requirements under the Construction Act where it includes a nominal payment arrangement.

In determining collateral warranties can be construction contracts, parties to a collateral warranty will have a statutory right to adjudicate. The Construction Act will imply a right to adjudicate where a construction contract is silent on this.

Issue 2: Did the terms of the Abbey Collateral Warranty make it a construction contract for the purposes of the Construction Act?

Applying the analysis above to the terms of the Abbey Collateral Warranty, the court held that the Abbey Collateral Warranty was a construction contract. In particular, LJ Coulson looked at the wording of the warranty pursuant to which Simply warranted “that, not only have they carried out the construction operations in accordance with the building contract, but they will continue to do so to carry out the construction operations in the future”.

As the warranty was not to a fixed or past state of affairs, and was promising future performance, this could be deemed a construction contract.

For Abbey this meant that they were entitled to bring the original adjudication proceedings and that the Adjudicator had jurisdiction. Whilst their contract did not include an express right to adjudicate, by virtue of the Abbey Collateral Warranty being deemed a construction contract, this was implied by the Construction Act.

Issue 3: Did the date on which the Abbey Collateral Warranty was executed make any difference?

One of the key considerations for the High Court in the previous judgment was the timing of the warranty. The Judge’s view was (following the line of thinking in the Parkwood case) that because it was executed after the works were complete and the remedial works were complete, the warranty was a warranty as to the state of affairs. It was not a construction contract.

The Court of Appeal disagreed with this and in short held that the timing of the warranty is immaterial. What is important is what is warranted. If part of the warranty is in relation to future performance, then the warranty may still be considered a construction contract, even if it is executed many years after the works are complete.

The overall judgment was that the appeal from Abbey Healthcare was allowed. The Court has also refused permission to appeal to the Supreme Court.

Key takeaways – what does this judgment mean for the industry?

The judgment brings some long-awaited clarity and certainty that collateral warranties can be deemed construction contracts for the purposes of the Construction Act and where they are, a statutory right to adjudicate will apply.

This decision will have a wide-ranging effect for the industry, and it may open the gates for a number of different contracts being deemed “construction contracts” (e.g., funding agreements or third-party rights schedules).

For contractors and consultants this could create real difficulties, particularly where the collateral warranty is executed post completion of the works and/or services. Provided the collateral warranty in question satisfies the “construction contract” requirements, beneficiaries will be entitled to adjudicate regardless of when the warranty was executed. The key concern is that disputes under a collateral warranty can be complex given the multiple parties involved and may not be appropriate for resolution by adjudication.

We expect to see far more scrutiny over the wording of collateral warranties following this judgment. Whereas previously the key point in determining whether the right to adjudicate applied was thought to be when the collateral warranty was entered into, the primary focus will now be on what the contractor or consultant is warranting. Is it a warranty on a fixed/past state of affairs, akin to a product guarantee, or is it a warranty to a past state of affairs and future performance, in which case it is likely to be deemed a construction contract. Insurers will also be considering the impact of this judgment on the coverage provided, as the potential number of claims may increase as a result of this decision.

For the beneficiaries of the industry (landlords, tenants, funders etc.) this will be a welcome relief. There is now certainty over whether they have a right to adjudicate, particularly given the current climate and the issues regarding fire safety. This is particularly important for those beneficiaries who cannot afford the time and expense associated with traditional litigation.

Adjudication was designed to be a cost and time saving process, and LJ Coulson made the point that it would be nonsensical in circumstances where two parties have the same underlying dispute, for one of them to be entitled to adjudicate and the other only to litigate. In his view, this would fundamentally go against the purpose of adjudication. This decision it would seem follows through on that and is looking to make adjudication equally accessible to both the original client and the intended beneficiaries.

This article originally appeared at the Beale & Co website.