Collateral warranties and the ability to adjudicate

In Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP [2024] UKSC 23 the Supreme Court reversed the Court of Appeal’s decision on whether collateral warranty claims brought by adjudication can be enforced.

This insight reviews the judgment, concerning whether an adjudicator’s award pursuant to a collateral warranty was enforceable, which turned on whether it was an “agreement for construction operations” under the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act).

What is the background of the case?

On 29 June 2015, Sapphire Building Services Ltd appointed August 2008 LLP (formerly Simply Construct (UK) LLP) (August) under a JCT Design and Build Contract 2011 to design and build a care home at Holders Hill Road (Property). August subsequently entered into a collateral warranty with the beneficiary Abbey Healthcare (Mill Hill) Ltd (Abbey) and the tenant of the Property (Abbey Collateral Warranty).

Abbey made claims against August in respect of fire safety defects at the Property via adjudication. August challenged the adjudicator’s jurisdiction on the basis that the Abbey Collateral Warranty was not a “construction contract” pursuant to the Construction Act, being a contract for the carrying out of construction operations as defined in s.104(1)(a) of the Construction Act; however, the adjudicator rejected this argument.

The adjudicator awarded Abbey £869,500 in damages, but August did not pay the award and Abbey issued proceedings in the Technology and Construction Court (TCC) to enforce the adjudicator’s decision by way of summary judgment.

The TCC refused Abbey’s summary judgment on the basis that the Abbey Collateral Warranty was not a construction contract as it was signed some years after completion of the works and, therefore, could not be an agreement for the carrying out of construction operations.

Abbey appealed to the Court of Appeal who followed Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC) and determined that the Abbey Collateral Warranty was a construction contract.

August subsequently appealed on this issue to the Supreme Court.

The decision

Until now, the controversial decision of Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC) remained the authority on the position that collateral warranties were construction contracts for the purpose of the Construction Act, meaning that parties were able to adjudicate under the statutory regime. The Supreme Court acknowledged that, following this decision, the industry appeared to broadly accept the result despite it being widely criticised.

However, the Abbey decision has now flipped this position on its head and provides much sought after clarity to those across the construction industry that collateral warranties should generally be excluded from the Construction Act.

Lord Hamblen stated:

“It is also in the interests of certainty that there is a dividing line which means that collateral warranties are generally outside the 1996 Act rather than everything being dependent on the wording of the particular collateral warranty in issue. That will assist those in the construction industry, and those advising them, to know where they stand. Moreover, if it is wished to have a right to adjudication that can always be provided for. Adjudication will, however, be voluntary rather than mandatory.”

This decision was based on the following conclusions from the Supreme Court’s analysis of items 1 and 2 above:

• A collateral warranty will be an agreement “for … the carrying out of construction operations” if it is an agreement by which the contractor undertakes a contractual obligation to the beneficiary to carry out construction operations which is separate and distinct from the contractor’s obligation to do so under the building contract.
• A collateral warranty where the contractor is merely warranting its performance of obligations owed to the employer under the building contract, will not be an agreement “for” the carrying out of construction operations.

Key takeaways

The decision effectively rules out most adjudication claims made pursuant to collateral warranties. The only obvious exception to this is where the beneficiary is exercising step-in rights in relation to the underlying contract, but that tends to be a right reserved to funders and not owners/ leaseholders.

The Supreme Court’s decision will no doubt be welcome to contractors, consultants and sub-contractors who are often contractually obliged to provide collateral warranties to a variety of beneficiaries, but worrisome to those beneficiaries seeking to rely on such collateral warranties as the ability to adjudicate under a collateral warranty will be near impossible, and bringing claims under litigation are likely to be more time consuming and expensive.

One option that remains available is to include a contractual right to adjudication in the collateral warranty. The judgment mentions that the “construction operations” test to use the statutory right to adjudication under s.104 would not be required.

Insights

There has been suggestion that collateral warranties could be amended to permit a contractual adjudication, whilst opinions are developing, our view is that this goes outside of the intention of adjudication and has downsides that make it undesirable.

Parkwood was a particularly controversial and much criticised decision, and its reversal is entirely sensible, but that decision certainly did not open the floodgates to adjudication of defects claims under collateral warranties which remained rare. It is of note that other jurisdictions with similar construction laws (some Australian states for example) see adjudication as a payment dispute remedy only, and not an area for defects.

Adjudication has not been a requirement for lenders or institutional investors and is not a point attaining airtime prior to Parkwood, which is reasonable justification to leave adjudication to its original intended purpose i.e. as a temporary cash flow remedy in the construction supply chain.

Contractual adjudication of defects claims presents issues:

• Contractual adjudication provisions need careful consideration as they do not have the statutory underpinning of the Scheme for Construction Contracts, so may be more at risk of challenge.
• Adjudication decisions are binding, but not automatically final, so either party could bring the claim again in litigation, negating any time and cost advantage.
• Litigation may be a more appropriate route for defects claims in terms of evidence, particularly for more complex claims. In respect of fire safety defects (as was the case in Abbey), Remediation Contribution Orders under the Building Safety Act in the First Tier Tribunal may be an alternative route but retaining some time and cost advantages.
• Collateral warranties with these provisions included are currently off-market, and could lead to more protracted negotiation, and the involvement of professional indemnity insurers where new clauses are introduced.

Given there has been rare active use of this right and beneficiaries retain a proven right of recourse for defect via litigation in introducing a new contract right to adjudicate the downsides outweigh very little benefit.

In reality, Abbey simply takes the position back to that before Parkwood and, in our view, collateral warranties should be treated in the same way, and left unchanged.