Collateral warranties: right to adjudicate will depend on timing and wording

Collateral warranty contracts are frequently granted by contractors and consultants to third parties with a financial interest in works that are being or have been constructed. They establish contractual grounds for the third party to recover loss should the contractor or consultant not have complied with the terms of the underlying construction contract or professional appointment.

In a recent case, the High Court in London considered whether claims to recover losses under a collateral warranty could be referred to statutory adjudication where, as is often the case, the warranty had been granted after completion of the works.

The court ruled that a defects dispute on a collateral warranty could not be referred to adjudication under the 1996 Housing Grants, Construction and Regeneration Act (Construction Act) because of the wording of the warranty and, particularly, the timing of its execution.

Will you be able to adjudicate?

The Construction Act grants a right to adjudicate disputes arising under ‘construction contracts’ – defined as “agreements for the carrying out of construction operations”. Where the contract does not provide for adjudication in the form specified by the Act, the provisions of the Scheme for Construction Contracts will take effect as implied terms.

In a 2013 case, the court ruled that a collateral warranty could be a construction contract for the purposes of the adjudication provisions of the Act, depending on the wording and “relevant factual background” of that warranty. Mr Justice Akenhead considered two factors important: whether the party subject to the warranty gave an undertaking to carry out construction operations (which would point towards the warranty being a construction contract); and whether the works were complete (if they were, that points away from the warranty being a construction contract).

This new judgment builds on that foundation.

Abbey Healthcare was the occupational tenant and operator of a care home constructed by Simply Construct under a JCT building contract (JCT Design and Build Contract 2011 with amendments June 2015). In August 2018, almost two years after practical completion, defects were discovered in Simply’s works and the landowner, Toppan Holdings Ltd, employed another contractor to remedy the defects. In September 2020, four years after practical completion and after the defects had been remedied, Simply executed a collateral warranty in favour of Abbey in which it warranted that it “has performed and will continued to perform diligently its obligations under the building contract”.

In December 2020, Abbey raised adjudication proceedings. Simply objected on jurisdictional grounds that the collateral warranty was not a construction contract under the Construction Act. The adjudicator rejected that and awarded damages to Abbey for loss of trading profit. Simply resisted enforcement of the adjudication award and sought a stay of execution on the jurisdiction ground, among others.

Deputy High Court judge Martin Bowdery QC found that Simply’s jurisdictional objection was “valid and justified”. Under the Abbey collateral warranty, Simply warranted that it had and would continue to perform its obligations under the building contract but the wording did not “undertake” to carry out the works. As a matter of fact, there were no works still to do when the warranty was given. Especially against the factual background of the timing of completion of the works years before, and the remedying of the defects before the execution of the warranty, the judge could not see how, applying commercial common sense, the warranty could be construed as an agreement for the carrying out of construction operations. 

The judge laid out what is likely to be a useful rule of thumb:

• Where a contractor agrees to carry out uncompleted works in the future, that will be a very strong pointer that the collateral warranty is a construction contract and the parties will have a right to adjudicate.
• Where the works have already been completed and, as in this case, even latent defects have been remedied by other contractors, a construction contract is unlikely to arise and there will be no right to adjudicate.

The judgment provides support for the position expressed in previous cases that many collateral warranties will be construction contracts, but that depends on their wording and timing. On the facts of this case, this collateral warranty was not to be construed as a construction contract. It was instead a “warranty of a state of affairs past or future akin to a manufacturer’s warranty”.