Not all Collateral Warranties are Construction Contracts

By Matthew Friedlander and Tanya Chadha

The contractual matrix of commercial construction projects commonly includes collateral warranties.  Collateral warranties typically grant a contractual cause of action to third parties (such as tenants or end-users) with an interest in the project who may not otherwise have a contract in place with parties that are designing, constructing or providing professional advice on the project.   For the beneficiary, a collateral warranty can therefore be invaluable.

Recently, for example, collateral warranties have proven to be extremely useful for long leaseholders and tenants in private residential developments where cladding and fire safety issues have been discovered.  Where such a warranty exists, leaseholders (as the beneficiaries) have been able in some cases to rely upon collateral warranties as a means of recovering losses, or compelling the original contractors or designers to rectify those fire safety defects in circumstances where the leaseholder was not involved in the original construction of the development.

In the context of construction projects, it is possible for a collateral warranty to be a “construction contract” for the purposes of the Housing Grants Construction and Regeneration Act 1996 (as amended) (the Construction Act). This principle was established in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd (2013) EWHC 2665 (TCC) (Parkwood). Whether a collateral warranty is a construction contract within the meaning of the Construction Act is important because if it is, the parties to that warranty have a statutory right to refer any dispute thereunder to adjudication.

However, there is a common misconception that all collateral warranties will be construction contracts for the purposes of the Construction Act.  The recent case of Toppan Holdings Ltd and another v Simply Construct (UK) LLP [2021] EWHC 2110 (TCC) (Toppan) demonstrates that the position it is not always straightforward.

The Position under Parkwood

In Parkwood, the court was asked to consider, amongst other things, whether a collateral warranty provided by Laing O’Rourke Wales and West Limited, in favour of Parkwood, was a construction contract for the purposes of the Construction Act, such that Parkwood could refer a dispute thereunder to adjudication.

Pursuant to section 104(1)(a) of the Construction Act, a “construction contract” is essentially an agreement for “the carrying out of construction operations”.  In Parkwood, Akenhead J made it clear that whether a collateral warranty is an agreement for “the carrying out of construction operations” depends on the wording of the warranty itself.

The warranty in Parkwood was held to be a construction contract for various reasons, including:

  1.  the underlying construction contract was a construction contract for the purposes of the Construction Act;
  2.  the warranty expressly related to the carrying out and completion of works;
  3.  the express wording of the warranty included the words “warrants, acknowledges and undertakes”.  These three words, whilst complimentary, have different meanings:

(a) the warranty concerned works already carried out;

(b) the undertaking concerned the completion of remaining works and the warranty went to works both already carried out and yet to be executed; and

(c) the warranty included an undertaking that the contractor would carry out and complete the works in accordance with the building contract.

All of the above firmly led to the conclusion that the collateral warranty was therefore for the “carrying out of construction operations” and, as such, a construction contract for the purposes of the Construction ActThat said, the judge made it very clear that not all collateral warranties will be construction contracts within the meaning of the Construction Act and that “one needs primarily to determine in the light of the wording and of the relevant factual background each such warranty to see whether, properly construed, it is such a construction contract for the carrying out of construction operations”.

That is exactly the task that the court undertook in Toppan.  

The Position under Toppan

The defendant, Simply, carried out works to a care home owned by Toppan (the first claimant) and operated by Abbey (the second claimant). Practical completion was in October 2016. In January 2019, Simply was notified of defects, which were subsequently rectified by another company. During 2020, the parties executed a collateral warranty whereby Simply warranted to Abbey that it had performed its obligations under the underlying building contract.

A dispute arose between Abbey and Simply which was referred to adjudication. The adjudicator awarded £908,000 in favour of Abbey. Simply resisted enforcement on the basis that adjudicator lacked jurisdiction because the collateral warranty was not a construction contract and therefore the dispute was not capable of being referred to adjudication.

The judge found in favour of Simply and held that the collateral warranty was not a construction contract. The two principal factors in the Court’s decision were as follows:

  1. The wording of the warranty did not refer to any acknowledgement or undertaking with regard to the works, as was the case in Parkwood.
  2. Perhaps most importantly, the timing of the warranty indicated that Simply was only warranting a state of affairs (much like a manufacturer warranty). The judge emphasised the words of Akenhead J in Parkwood: “A pointer against [the warranty being a construction contract] may be that all the works were completed and that the contractor is simply warrantying a past state of affairs as reaching a certain level, quality or standard.”

There was no evidence that Abbey or Simply contemplated the possibility of any further construction operations being carried out as a result of any breach of the underlying building contract. The works had been completed years before the warranty had been entered into and even latent defects had been remedied by that time.

Abbey therefore found itself in the unfortunate position whereby it succeeded in adjudication, only to have the decision declared unenforceable as the warranty was not a construction contract for the purposes of the Construction Act.

Conclusions

Parties to a collateral warranty must therefore review the terms of the warranty and carefully consider whether the warranty is an agreement for the “carrying out of construction operations”, such that it is a construction contract for the purposes of the Construction Act.  If the works are ongoing or if further works are contemplated pursuant to the underlying building contract, that may indicate that the warranty is a construction contract. However, where there is any doubt, a referring party to an adjudication will have to accept the risk of incurring the costs of an adjudication in circumstances where the adjudicator’s decision may not be enforceable.   Following Toppan, a well-versed responding party may well reserve its position regarding the jurisdiction of the adjudicator and challenge the enforcement of the decision on that basis. As well as the frustration of having an unenforceable adjudication decision, the referring party could also find itself out of pocket for the costs of the adjudication in addition to being liable for the responding party’s costs of the enforcement proceedings.  If the dispute is unavoidable, and there is doubt as to the status of the warranty, parties may want to consider whether court proceedings may be a better option for resolution of the dispute.

Whilst Toppan therefore raises strategical considerations as to the best forum for resolving disputes, it is important to remember that whether a warranty is, or is not, a construction contract, will not deprive or otherwise affect the beneficiary of the contractual remedy. The beneficiary of the warranty can still pursue an action for breach of contract via proceedings in the Court.  It is simply the case that the warranty will not fall under the auspices of the Construction Act and a statutory right to adjudicate will not exist.