When is a collateral warranty a construction contract? When can a beneficiary be adjudicating under a collateral warranty?
What will the Supreme Court decide in Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP?
Recent case law has approved the practice of Adjudicating under a Collateral Warranty. A collateral warranty is capable of being a construction contract. That was the finding of the Court of Appeal in the case of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP when it overturned the TCC decision of the Deputy High Court Judge (Stuart-Smith LJ dissenting). We await the Supreme Court decision with interest (and hope that the Supreme Court overturns the Court of Appeal decision).
In the meantime, there are certain drafting changes that contractors should seek to make to collateral warranties to exclude the reach of the Housing Grants, Construction and Regeneration Act 1996 (the “Constriction Act”).
Background to Adjudication
I undertook my first Adjudication over 20 years ago whilst employed as a junior in-house solicitor at the UK main contractor, Jarvis plc.
The entitlement to Adjudicate was a compulsory term written into the majority of non-residential construction contracts by the Constriction Act, a piece of legislation implementing Sir Michael Latham’s recommendations in his paper “Constructing the Team”. Latham was primarily concerned about cashflow. Cashflow is the very lifeblood of the construction industry (Denning LJ noted in Modern Engineering (Bristol) Ltd v Gilbert-Ash (Northern) Ltd (1973) 71 LGR 162).
Prior to the Construction Act, Statutory adjudication for construction contracts did not apply. Some contracts provided for contractual adjudication, but there was no right implied into construction contracts where the contract did not expressly confer such a right. Prior to the Construction Act, the primary forum for dispute resolution was arbitration. The courts only had jurisdiction where there was no effective arbitration clause. Litigation in the courts is not only expensive, but also slow. It is not be uncommon for a trial to be delayed for at least 12 months from commencement of the claim. Although arbitration was quicker and arguably preferable because the arbiter was a construction professional, it was not uncommon for the arbitration clause to stipulate that an arbitration could not be commenced prior to the project being concluded; indeed, I only recently saw such a clause.
The Construction Act was therefore welcomed by the construction industry and has become the dispute mechanism of choice within the construction industry. Although adjudication is only temporarily binding until the dispute is finally determined [by arbitration or court proceedings], in the vast majority of cases the parties accept the adjudicator’s decision and do not seek to revisit the adjudicators’ determination.
The Referring Party benefits by having his entitlements determined swiftly, but I suggest at the expense of the “no cost” rules. However, there are many jurisdictions where costs are not recoverable in litigation. Unlike litigation, costs in adjudication can be reliably estimated. Where disbursements are likely to be high, such as expert fees in defect disputes or delay analysis, then the benefit of adjudicating in terms of speed has to be considered in the context of a potentially large cost liability that in most circumstances will not be capable of being recovered.
The vast majority of decisions from adjudicators are enforceable. Because of the temporary nature of adjudication, where a receiving party may not be able to repay to the paying party that which it received pursuant to the adjudicator’s decision, the paying party may seek a stay of the adjudicator’s decision pending the dispute being finally determined. But where the financial health of a party to an adjudication has not deteriorated since the contract was entered into, then a stay is unlikely to be awarded. As was suggested by the Judge in the case of WRB (Northern Ireland) v Henry Construction Projects Limited 2023, a party must lie in the bed that it makes for itself.
The right to Adjudicate derived from statute and required construction contracts to provide for Adjudication as a means to determine disputes. There was no right of adjudicating under a collateral warranty. Collateral Warranties were not initially considered to be construction contracts.
The Case Law and other Authorities suggesting that a Collateral Warranty is a Construction Contract
The concept of adjudicating pursuant to a collateral warranty is relatively new.
In Parkwood Leisure v Laing O’Rourke [2013] EWHC 2665 (TCC), [2013] All ER (D) 221 (Aug), the TCC for the first time considered a collateral warranty was capable of being a construction contract. There was a right of adjudicating under a collateral warranty. Many considered the decision of the Judge surprising.
In giving his decision, Akenhead J made it clear that not all collateral warranties would be a construction contract. It would depend on the words of the warranty and the relevant factual background. Mr Justice Akenhead doubted the fact that a warranty was entered into after the works had commenced would on its own disapply the effects of the Construction Act, i.e., the collateral warranty could still be a construction contract.
After the Parkwood case we saw many collateral warranties drafted by developers containing an express adjudication provision conferring the right to adjudicate upon a beneficiary. The beneficiaries wanted to preserve the right of adjudicating under a collateral warranty. The developers’ lawyers would cite Parkwood as authority for such a provision. We would argue that if the developer was so certain that Parkwood was good law, they did not need an express right to adjudicate. Invariably the developer would back down. Where the developer produced the form of collateral warranty, robust negotiation was required in order for the developer to concede drafting to dis-apply the consequences of Parkwood. The majority of collateral warranties were executed with wording that preceded Parkwood on the basis that contractors were willing to take the risk that Parkwood introduced.
But of course, a contractor does not choose to get into bed with the beneficiary of a collateral warranty. The beneficiary of a collateral warranty is most likely to bring a defects claim against the contractor several years after practical completion. As above, the disbursements associated with disputed defect claims may be considerable and it is unclear why or indeed how adjudication is suitable to such claims.
We were not aware of any substantive cases that followed Parkwood until the case of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP. As above, the TCC was of the opinion that the collateral warranty in this case was not capable of being a construction contract, the main thrust for such thinking was that the collateral warranty had been executed several years after practical completion. By reaching such a conclusion we consider it possible the deputy High Court judge was trying to distinguish the Abbey case from Parkwood; to find a reason not to follow the Parkwood case which many construction dispute lawyers had considered an unfortunate development.
There was however compelling authority in support of Parkwood within the text of Coulson on Construction Adjudication (4th edn), para 2.21 where it was said.
“Although at paragraph 28 of his judgment, the judge noted that it did not follow from his conclusion that all collateral warranties given in connection with all construction developments would be construction contracts under the 1996 Act, it is safe to assume that, on this analysis, because the provision noted above is commonly found in such warranties, they will be so regarded. From a broader perspective, if the underlying contract was a construction contract, it makes commercial common sense for any parasitic warranties to be treated in the same way.”
Should beneficiaries be seeking to permit adjudicating under a collateral warranty ? It had been said in editorial comments of the Construction Law Review reporting on the Abbey case under the case title Toppan Holdings Ltd and another v Simply Construct (UK) LLP [2021] EWHC 2110 (TCC) that the
“commercial common sense referred to in the final sentence above is not immediately apparent Collateral warranties are given for the benefit of entities other than the direct employer (eg a funder or a landlord) often with the primary intention that they will be used after the works are completed. It is not immediately apparent why it makes commercial sense for those distinct contracts to be subject to the same dispute resolution rules as the main building contract unless doing so permits multiple disputes raising the same matters to be conjoined – something that is not possible with statutory adjudication.
In any event, if as here we are dealing with statutory implication of a term, commercial common sense ought to come second to legislative intent, and the primary purpose of adjudication was to preserve cash flow within the construction industry by enabling contractors to recover unpaid sums in a short timescale. It is unclear that this justification extends to enabling the beneficiaries of collateral warranties to sue for defective work. Such actions are commonly brought several years after completion of the project and are at face value unrelated to cash flow within the industry”.
We agreed with the editor. However, as above, the Court of Appeal overturned the first instance decision of Abbey and therefore the views of the editor as above were not approved of.
As matters stand, the law is clear. In most cases collateral warranties will be considered to be construction contracts and that means a beneficiary of a collateral warranty can, some years on, use the adjudication procedure to recover damages should the building suffer from defects. How frequently this may transpire is yet unclear. Arguably, Abbey would have been better served by proving its case for defects in the court rather than adjudication. In my opinion it was somewhat predictable that such an important question would at the very least find its way into the Court of Appeal and the expense of this could have been avoided by using litigation (which will be necessary if Abbey is overturned by the Supreme Court).
We suggest until the Supreme Court decides on the case Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP, it would be unwise for a beneficiary of a collateral warranty to use the Adjudication route to recover damages for defects.
We understand the Supreme Court will examine the scope of section 104 of the Construction Act and whether collateral warranties fall within the Act. Our view, as a representative of contractors and subcontractors, is that collateral warranties most certainly should not fall within s 104 of the Construction Act and the development of the law in such a direction is unfair and unwise. If the Supreme Court upholds the decision of the Court of Appeal, we anticipate representatives of the Construction industry to lobby government for a change in the law.
Removing Collateral Warranties / Contracting out of the Housing Grants, Construction and Regeneration Act 1996
A party cannot usually contract out of the Construction Act. However, before signing construction contracts and agreeing to give collateral warranties, it is possible to amend the terms of collateral warranties provided by the developer so as to limit the risks of the collateral warranty being considered a construction contract for the purposes of the Construction Act.
Collateral warranties do create considerable additional liability for construction contractors. They should not simply be agreed to without legal advice.
Contractors may consider that the terms of the collateral warranty are not important, or that commercial need for work means terms of the warranty must be agreed to. There are numerous amendments that can be made to collateral warranties so to limit or mitigate risk. Different contractors accept different risk profiles. Some contractors may not be concerned about the concept of Adjudicating under a Collateral Warranty. Design subcontractors frequently need to secure the consent of their insurance advisers before agreeing to collateral warranties and therefore main contractors should not assume that subcontractor warranty can be obtained. Where the main contractor has agreed to provide a collateral warranty from a subcontractor and fails to do so, the main contract that is in breach of contract and liable for damages.
We have experience of reviewing and drafting amendments to collateral warranties. We can suggest amendments in an attempt to ensure the collateral warranty is not considered a construction contract. We can seek to prevent the beneficiary Adjudicating under a collateral Warrant. In view of the current state of the law consequent to the Court of Appeal decision of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP, we consider it important that contractors do consider what risk they are prepared to take under collateral warranties and secure the necessary amendments to reflect the desired risk profile.
Matthew Dillon, LLB, Solicitor, MCIArb
MJD Solicitors
31 July 2023
This article is for information purposes, does not constitute legal advice and should not be relied upon. For terms and conditions of this article please read here
