Adjudication and collateral warranties

September 16, 2024

In our latest article in the Alternative Dispute Resolution series published by Construction Law, Kirsti Olson considers the implications for ADR arising from a landmark Supreme Court decision.

In a standard construction package, it is common for the building contractor to have an obligation to procure collateral warranties in favour of key third parties (typically funders, owners and tenants). Collateral warranties give organisations, which may suffer loss in the future if the building is defective, a direct contractual right to make a claim against the person responsible.

One issue discussed after the Housing Grants, Construction & Regeneration Act 1996 Act (the Act) came into force was whether a collateral warranty could be a "construction contract" for the purposes of the Act and whether adjudication could therefore be used to resolve disputes.

In the case of Parkwood Leisure Limited v. Laing O'Rourke Wales and West Limited [2013] BLR 2665 (TCC), Akenhead J decided that a collateral warranty could be a construction contract. The contractor had undertaken that "it has carried out and shall carry out and complete the works in accordance with the contract…". The judge decided that the contractor was not simply warranting what had been done, but also its future performance.

The Supreme Court, in the case of Abbey Healthcare (Mill Hill) Limited v. Augusta 2008 LLP (formerly Simple Construct (UK) LLP) [2024] UKSC 23 , has reached a different view. A collateral warranty will not be an agreement for the carrying out of construction operations if all that it contains is a promise to perform obligations owed to someone else under a separate contract. To be a construction contract, a warranty would have to contain a separate or distinct obligation to carry out construction operations for the beneficiary. It is not a construction contract if it is merely derivative i.e. one that derives from and mirrors the obligations already set out in the building contract.

This decision puts the position back to what the industry thought it was, prior to Parkwood. Under section 104(1) of the Act, a construction contract is an agreement for the carrying out of construction operations. Construction operations are carried out under building contracts. Collateral warranties warrant performance under separate contracts but (except in limited circumstances) do not actually require construction operations to be performed.

The wider purpose behind the introduction of adjudication in the Act was to resolve disputes quickly, to keep cash flowing and maintain progress on site. Disputes under collateral warranties commonly concern defects that become apparent after completion. By that stage, cash flow and timely completion are no longer live issues.

The Abbey Healthcare decision may have some implications. Previous adjudication decisions under collateral warranties might be challenged as invalid, because it is now clear that there was no implied right to adjudicate. However, there may not be many cases in that category and the practicalities and costs of trying to sort this out (particularly if money has changed hands) may be prohibitive.

Sometimes when a decision of this significance is issued, drafters make a simple change to their contract forms and move on. The Supreme Court noted that parties may still contract into the adjudication regime. It seems unlikely, however, that this will be common practice. It is not in the best interests of contractors (or their insurers) to give a third party the right to adjudicate against it, at short notice, at any time in the 12 years after a building project has been completed.

This article was first published in Construction Law on 5th August 2024.