A collateral warranty is not a construction contract

As you may be aware, the landmark case of Parkwood v Laing O’Rourke [2013] EWHC 2665 (TCC) was the first ruling that stated a collateral warranty could constitute a ‘construction contract’.

Lawrence Isaac, Paralegal in our commercial real estate team explores what this means for the construction industry and how parties should navigate these changes moving forward.

What are the practical implications of the ruling?

You may have read the title of this piece with some apprehension, but hopefully the following can provide you with some reassurance:

Under s.104(1) of the Housing Grants, Construction & Regeneration Act 1996 (the Construction Act) parties to a construction contract have a right to refer disputes arising under those contracts to adjudication. Construction contracts are defined in s.104 and include ‘the carrying out of construction operations’.

The result of this ruling has seen parties enter lengthy contract negotiations for collateral warranties to minimise the risk of potential adjudication. As a result, there have been strong arguments against collateral warranties being considered a ‘construction contract’ as one may struggle to describe it as a ‘contract for the carrying out of construction operations’.

One may argue:

• if the building contract is terminated, the beneficiary of the warranty can no longer insist the works are completed (save for there being step in rights within the warranty); and
• the beneficiary of the warranty has no direct power to determine how the works are completed (again, save for step in rights within the warranty)

For the matters stated above, a conclusion can be drawn that collateral warranties are not a contract for the ‘carrying out construction operations’ and were never intended to act as a fast-track means of redress by third parties against a defaulting contractor.

What are the latest updates in collateral warranties and construction contracts?

There has now been a significant update in the ever-changing story. The recent case of Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23 (9 July 2024) saw the Supreme Court unanimously hold that a collateral warranty is not a construction contract for purposes of Section 104(1) of the Construction Act.

Lord Hamblen held that:

A collateral warranty is not a contract “for” the carrying out of construction operations under section 104(1) “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; not one which is merely derivative and reflective of obligations owed under the building contract”.

What does this mean going forward?

Most standard collateral warranties typically used within the construction industry will not constitute a ‘construction contract’ with the drafting used being the determining factor as to whether this is the case. In light of this, parties to a collateral warranty will no longer have a statutory right to adjudicate any dispute under it at any time.

The decision is a step forward to bring clarity to this topic and remove any uncertainty for parties that arose from the previous judgements. We suspect that this ruling will endorse the views already widely held within the construction industry.

However, for those who are disappointed by the ruling, it does not mean that parties will never have the right to refer a dispute to adjudication. Going forward, additional drafting will be required that expressly confers the right to refer a dispute to adjudication at any time. Or, if parties wish for the collateral warranty to be captured by the Construction Act, additional drafting will be required that provides a clear obligation to carry out construction operations for the beneficiary.

If you have any questions or concerns regarding this topic, please reach out to a member of our commerical real estate experts who can assist you further.