New construction law update: What is a Collateral Warranty?

By Jonathan Herd

In what could be described as the most significant construction judgement of the year, the Court of Appeal ruled that a Collateral Warranty can be deemed a construction contract under section 104(1) of the Construction Act 1996 (“the 1996 Act”).

The new judgement has provided much-needed clarity around Collateral Warranties and will broaden the scope for parties to refer disputes to adjudication under S.108 of the 1996 Act.

What is a Collateral Warranty?

Put simply, a Collateral Warranty is a contract under which a party involved in the works warrants to a third-party beneficiary that it has fulfilled its obligations under its underlying contract.

Recent updates to Collateral Warranties

The case in question covers the design and construction of a new care home in Mill Hill, London.

Simply Construct was engaged by Sapphire Building Services Limited under a building contract to build and design a new care home in 2015.

Once completed, all the rights and obligations of the buildings were transferred by novation agreement to Toppan Holdings Limited. The new care home was then let to Abbey as tenant operator under a long lease. Included within the D&B contract was an obligation on Simply Construct to provide Toppan Holdings Limited (and any future tenant) with Collateral Warranties on notification.

Years later, a number of defects were identified within the build and a separate company was instructed to make the repairs, which were completed in February 2020.

Following the completion of the works, Toppan asked Simply Construct for a Collateral Warranty in favour of Abbey, but Simply Construct argued that the Abbey Collateral Warranty was not a construction contract.

This was recently rejected by the adjudicator, who awarded Abbey over £900,000.

Ultimately, however, Simply Construct refused to pay this amount, leading Abbey to start enforcement proceedings. The question of jurisdiction under the Collateral Warranty was to be considered again during Abbey’s enforcement proceedings.

What does this decision mean?

On appeal from the High Court, the Court of Appeal were asked to consider whether a Collateral Warranty can ever be a construction contract.

Lord Coulson considered the issue in detail and emphasised the importance of the express words contained within the Collateral Warranty when determining whether it is a construction contract. Critically, wording which is an ongoing promise for the future, rather than past or redundant warranties, may be considered a construction contract.

Simply Construct (UK) LLP warranted to “perform and continue to perform diligently its obligations under the contract”, which was considered an agreement for the carrying out of construction operations by Toulson thereby falling within the definition laid out by S.104(1)(b) of the 1996 Act.

Interestingly, Toulson rejected the argument that a Collateral Warranty required detailed payment provisions to be considered a contract  and Toulson did not consider the absence of “acknowledges and undertakes” from the Collateral Warranty made any difference.

The Court of Appeal in Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP held by a majority on 21 June 2022 that Collateral Warranties could, depending on their precise wording, be construed as construction contracts for the purposes of S.104(1) of the 1996 Act.

What now?

Adjudication is a popular and cost-effective dispute resolution process for parties with defective or delayed buildings but, prior to the judgement, the jurisdictional scope of Collateral Warranties and whether they can be considered construction contracts for the purposes of the 1996 Act was unclear. Consequently, parties relying on Collateral Warranties had narrower, more expensive, avenues to recourse.

The judgement will have a great impact on the industry as a whole, possibly broadening the scope for Collateral Warranties to be adjudicated by aggrieved parties by activating their right to refer Collateral Warranty disputes to adjudication under S.108 of the 1996 Act.

On the other hand, the judgement also acts as a stiff reminder to parties providing Collateral Warranties to take care when warranting to perform future obligations because the precise wording of the Collateral Warranty is key.

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If you think this latest decision could affect you, or have any questions about the case, get in contact with Jonathan at jonathan.herd@primaslaw.co.uk.