Supreme Court Rules "Most Collateral Warranties Are Not Construction Contracts" in Abbey Healthcare v Simply [2024] UKSC 23

This overturns the Court of Appeal’s decision from June 2022, thereby providing certainty on the definition of a construction contract and the subsequent availability of adjudication as a method to resolve disputes under collateral warranties.

Key takeaways The position in Parkwood and the Court of Appeal decision in Abbey has been reversed. As a starting premise, a collateral warranty will not be a construction contract under the Construction Act, unless it comprises a separate or distinct undertaking for the carrying out of construction obligations. Key determining factors in the decision were: When considering whether it was a contract “for… the carrying out of construction operations” – the Court considered the natural meaning of the word “for” denotes function and purpose, so construction work should be the object of a “construction contract”. The main object or purpose of a collateral warranty is to afford a right of action in respect of defectively carried out construction work, not the carrying out of such work. A principal purpose of the Construction Act (improvement of cashflows) is not served by including collateral warranties within its ambit, and therefore it was unlikely that it would extend. Third-party beneficiaries under collateral warranties may still elect to submit disputes to adjudication, but this must be achieved by clear drafting of construction obligations, or specifically providing for adjudication

Legal background – adjudication and collateral warranties

Adjudication

Adjudication is a private form of dispute resolution whereby a dispute, rather than being heard by a court judge, is referred to a trained independent adjudicator for determination. The adjudicator, who has 28 days from the provision of the referral document to reach a decision, will tend to be a construction specialist. The process results in a legally enforceable decision, which is binding on parties on an interim basis until final determination by arbitration, litigation or agreement.

An obvious advantage of adjudication as compared to litigation is its expediency which, in turn, keeps costs down and improves cash flow. A further advantage is that, regardless of the outcome, both parties bear their own costs meaning that the costs’ risk for the referring party is very different to that in litigation or arbitration.

Under s.108 of the Construction Act, there is a statutory right for disputes under a “construction contract” to be decided on an interim basis by adjudication even in the absence of express adjudication provisions. In turn, s.104(1) of the Construction Act defines a construction contract as an agreement “for… the carrying out of construction operations”.

Collateral Warranties

A collateral warranty is a contract under which a party involved in construction works warrants to a third-party beneficiary that it has fulfilled its obligations under the original building contract. This type of agreement is common in the industry.

Under the original building contract, an employer contracts with a contractor to carry out the works. There is a clear contractual relationship through which either the employer or contractor may bring a claim. However, the rule of privity of contract means that an interested third party (such as a tenant, or a funder) cannot enforce the terms of the contract as they are not a party to it.

In the absence of that contractual link, a third party would have to rely on a claim in negligence. This is far from desirable given that (i) a duty of care would need to be established and (ii) recovery in negligence is somewhat more limited thanks to the decision in Murphy v Brentwood.¹

For this reason, collateral warranties are used to bridge the gap and create a direct contractual link for the benefit of those parties that may otherwise have no recourse.

Can parties to a collateral warranty refer a dispute to adjudication?

Absent an express provision providing for recourse to adjudication, s.108 of the Construction Act, parties to a collateral warranty will only be able to refer a dispute to adjudication if the collateral warranty is considered a “construction contract” within the meaning of s.104(1).

Parkwood (2013)2

Eleven years ago, Akenhead J ruled in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd (“Parkwood”) that whether a given contract was a “construction contract” had to be determined by reference to the terms of the contract itself.³ This meant that a collateral warranty could be a construction contract in certain situations, with the determining factor being the express wording used in the collateral warranty.

Akenhead J stated that “a very strong pointer” in favour of the collateral warranty being a construction contract would be whether the relevant contractor is “undertaking to the beneficiary of the warranty to carry out such operations”, while “[a] pointer against may be that all the works are completed and that the contractor is simply warranting a past state of affairs as reaching a certain level, quality or standard”.⁴

To this end, it was found that the use of the words “warrants, acknowledges and undertakes” as opposed to “warrants” alone pointed towards the warranty being a construction contract. Akenhead J suggested that “these three verbs, whilst intended to be mutually complementary, have different meanings. A warranty often relates to a state of affairs (past or future); a warranty relating to a motor car will often be to the effect that it is fit for purpose. An acknowledgement usually seeks to confirm something. An undertaking often involves an obligation to do something”.⁵ As a result, he found that the collateral warranty in Parkwood, which contained this wording, was a contract for the carrying out of construction operations because it was not merely warranting or guaranteeing a past state of affairs but providing an undertaking that the contractor would actually carry out and complete the Work.

In light of this decision, parties negotiating collateral warranties could use careful drafting to either include or avoid an automatic right to adjudicate.

Nevertheless, the broader and more fundamental question remained: Are collateral warranties generally construction contracts? This question would be addressed head on in the Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP litigation.

Abbey v Simply (2021-2024)

Factual background

Simply Construct (UK) LLP (“Simply”) had entered into a JCT Design & Build Contract for the construction of a care home in London, pursuant to which Simply were obligated to provide collateral warranties to purchasers and tenants. Simply provided a collateral warranty in favour of its tenant, Abbey Healthcare (Mill Hill) Limited (“Abbey”) (the “Abbey Collateral Warranty”), some five years after the principal building contract was entered into. It is important to note at this juncture that the Abbey Collateral Warranty only used the word “warrants”.

As a result of fire safety defects and associated remedial works, Abbey commenced adjudication proceedings against Simply. The Adjudicator awarded Abbey £908,495.98. Simply refused to pay these costs, resulting in Abbey’s commencing enforcement proceedings before the TCC. Simply contended that the Abbey Collateral Warranty, which did not contain express adjudication provisions, was not a “construction contract” as defined in s.104 of the Construction Act and therefore could not be referred to adjudication by operation of s.108.

TCC decision (2021)⁶

The TCC judge, Bowdery QC, refused to enforce the adjudication decision made against Simply on the grounds that the Abbey Collateral Warranty was not a “construction contract” within the meaning of s.104(1) of the Construction Act and therefore the adjudicator had lacked jurisdiction. Specifically, Bowdery QC deemed it significant that the Abbey Collateral Warranty had been executed four years after construction works under the principal building contract had been completed, and a number of months after rectification of the defective works had taken place. Resultantly, he considered that, at the time of execution, the Abbey Collateral Warranty was akin to a warranty as to a state of affairs, both past and future, rather than a contract “for…the carrying out of construction operations” under s.104(1).

This decision suggested that there were instances, tempered by the drafting or time of the collateral warranty, in which a collateral warranty could avoid the Parkwood decision.

Court of Appeal decision (2022)⁷

The Court of Appeal, however, granted an appeal against the TCC decision and found, following Parkwood, that a collateral warranty could be a “construction contract” within the meaning of s.104(1) of the Construction Act. In particular, he found that the Abbey Collateral Warranty itself was a construction contract.

In his judgement, Coulson LJ, wanting to confer the benefit of adjudication onto more parties, determined that s.104(1) of the Construction Act should be construed broadly considering that it was a statutory purpose of the Construction Act to enable parties to two different construction contracts to refer disputes involving the same or similar underlying factual issues to the same adjudicator. Parliament, he believed, deliberately left the definition of “construction contract” wide such that there could be multiple construction contracts for one set of arrangements.

He also considered that s.104(5), which is concerned with hybrid contracts and uses the wider phrase “relates to construction operations”, informs a broad meaning of “construction contract” generally. However, this view was not shared by all of the Court of Appeal judges.

The Court of Appeal disagreed with the TCC finding that the timing of the execution of the Abbey Collateral Warranty was material or determinative of the question of whether it was in fact a “construction contract”. All three judges agreed that a collateral warranty is capable of having retrospective effect, meaning the date of the Abbey Collateral Warranty’s execution was irrelevant.

According to the Court, the wording of a collateral warranty itself would determine whether it was, in fact, a construction contract:

• if a collateral warranty is just a fixed promise/guarantee to a past state of affairs, then it is unlikely to be a “construction contract”; whereas
• if a collateral warranty provides that the “contractor was carrying out and would continue to carry out construction operations”, then this could be considered a contract “for the carrying out of construction operations” (i.e. a “construction contract”).⁸ The rationale is that the warranty in this instance is a promise (at least in part) which regulates the ongoing carrying out of construction operations.

It was determined by the majority that the Abbey Collateral Warranty itself contained a warranty of future performance of the construction operations such that “not only have [Simply] carried out the construction operations in accordance with the building contract, but they will continue to do so to carry out the construction operations in the future”.⁹ As the warranty was not to a fixed or past state of affairs, but was promising future performance, the Court of Appeal held that the Abbey Collateral Warranty was a “construction contract”.

Given that the Abbey Collateral Warranty only used the word “warrants”, this stopped practitioners from distinguishing or avoiding Parkwood with drafting alone. It appeared as though the position was clear and immovable: Collateral warranties were construction contracts which necessarily attracted the statutory right of adjudication.

Like Parkwood, this decision was met with mixed reviews. Indeed, the Court’s decision itself was not unanimous, with Stuart-Smith LJ disagreeing that the Abbey Collateral Warranty was a construction contract. It came as little surprise that there was a further appeal.

Supreme Court decision (2024)¹⁰

In a landmark decision made on 9 July 2024, the Supreme Court unanimously allowed the appeal against the majority decision of the Court of Appeal and expressly overruled Parkwood, deciding that “most collateral warranties will not be construction contracts”,¹¹ including the Abbey Collateral Warranty itself.

Reasoning

Central to the Supreme Court’s decision was the word “for” in the s.104(1) definition of a construction contract. Lord Hamblen reasoned, “a collateral warranty will not be an agreement “for” the carrying out of construction operations for the purposes of section 104(1) if it merely promises to perform obligations owed to someone else under the building contract. There needs to be a separate or distinct obligation to carry out construction operations for the beneficiary; not one which is merely derivative and reflective of obligations owed under the building contract”.¹²

It was wrong, the Court found, to equate contracts “for” construction operations as contracts “in respect of” construction operations.

Lord Hamblen suggested that the natural meaning of the word “for” denotes function and purpose. As such, the key question would be “whether the object or purpose of the agreement is the carrying out of construction operations”.¹³ With respect to collateral warranties, he commented that, “[a]s a generality, it is difficult to see how the object or purpose of a collateral warranty is the carrying out of construction operations. The main object or purpose of such a warranty is to afford a right of action in respect of defectively carried out construction work, not the carrying out of such work”.¹⁴ In short, a contract “for” construction operations “must…give rise to the carrying out of such operations”.¹⁵ A mere promise that construction operations will be done is not sufficient.

Consequently, the Supreme Court found that the Abbey Collateral Warranty could only be interpreted as a “promise to carry out the works” which amounted to an “entirely derivative promise”.¹⁶ Nothing was promised in the Abbey Collateral Warranty that was not already promised under the original building contract. There was no separate construction obligation, and so the Abbey Collateral Warranty was not a construction contract.

Moreover, the Supreme Court considered that collateral warranties were never intended to fall within the scope of the Construction Act. One of the key statutory purposes of the Construction Act was to improve cashflows in the industry; however, none of the payment provisions are applicable to collateral warranties (as consideration is usually only nominal). Consequently this purpose was not furthered by applying the Construction Act to collateral warranties.

Implications of the Supreme Court’s decision

The Supreme Court’s decision in Abbey v Simply is naturally a significant one given that it directly addresses a fundamental question about the scope of the construction industry’s key piece of legislation – the Construction Act. To this end, the decision appears to finally put an end to an eleven year tug of war over the position of collateral warranties within the definition of a “construction contract” under that piece of legislation.

Given its significance, the Court’s ruling has broad ramifications.

Direct implications

• Certainty. The decision, for now at least, puts the debate to bed and provides certainty that collateral warranties are not construction contracts for the purposes of the Construction Act (unless there is an express, distinct construction obligation – see point two below). In the words of Hamblen LJ, “collateral warranties are generally outside the 1996 Act rather than everything being dependent on the wording of the particular collateral warranty in issue”.¹⁷ As a result, the statutory right to adjudication is not automatically available to parties to a collateral warranty. This certainty will be welcomed by those operating in the construction industry and construction practitioners.
• Clear route to adjudication. Abbey has not entirely closed the door to adjudication on parties to a collateral warranty. Parties who still want to adjudicate under a collateral warranty can still agree to do so either by:
  1. including an express provision for a dispute to be referred to adjudication; or
  2. drafting the collateral warranty such that the warrantor owes a distinct and separate construction obligation to the beneficiary.

This raises the possibility that express adjudication clauses will now become boiler plate in collateral warranties given the efficiency, cost and cash-flow benefits of adjudication discussed above (see Adjudication section).

Indirect implications

• Possible recall of sums paid pursuant to concluded adjudications. An immediate impact of the decision is that collateral warranty adjudication decisions made under the Parkwood/Court of Appeal approach would, if made today, be invalid for lack of jurisdiction. Parties who have paid out in light of these decisions may therefore consider calling on the return of these sums.
• Existing disputes will be litigated, not adjudicated. Parties to a collateral warranty wishing to resolve existing disputes will now need to litigate such disputes rather than being able to refer them to adjudication. Although this may be criticised on efficiency and even access to justice grounds, there is the possibility that a dispute concerning, for example, defects will soon be resolved in the courts as opposed to the private forum of adjudication meaning that an accepted principle may be established which could avoid further disputes being adjudicated, as they could be settled in line with judicial principle instead.
• Funding. Most project funders have a right to receive an assignment of the original building contract as a condition of funding. The Abbey decision did not deal with arrangements other than collateral warranties that may provide access to adjudication, however, the decision may have implications for how such funding arrangements are treated. A novation of the original building contract to the funder, or an assignment of the rights under a construction contract (particularly any construction rights/obligations, or specific assignment of the adjudication rights), could mean that a funding arrangement is considered a construction contract, or at least an assignment of the right to refer a dispute to adjudication under the original construction contract. In this way, assignment and novation may be an effective means of keeping the automatic right to adjudicate alive by effectively rendering a third-party funder a party to the original building contract.

Theoretical implications

The Supreme Court has signalled a retreat from an all-inclusive approach to s.104 of the Construction Act which tried to shoehorn all peripherally related construction disputes into the adjudication system. As Hamblen LJ noted in his decision, “[p]rior to Parkwood the general understanding in the construction industry appears to have been that the 1996 Act did not apply to collateral warranties and we have been shown no textbook or commentary at that time which suggested otherwise. This is why the decision is said to have been a surprise”.¹⁸

The position now, however, is that automatic adjudication should not be all encompassing; a definitive dividing line has been drawn between “collateral warranties which merely replicate undertakings given in the building contract and those which give rise to separate or distinct undertakings for the carrying out of construction operations”.¹⁹

Although Parkwood and the Court of Appeal in Abbey muddied the waters for 11 years, those waters now seem clear again and we are left with a simple and workable approach which practitioners can apply.

¹ Murphy v Brentwood District Council [1991] 1 AC 398.

² Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC).

³ Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC).

⁴ Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC), at paragraph 28.

⁵ Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC), at paragraph 27.

⁶ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWHC 2110 (TCC).

⁷ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823.

⁸Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823, at paragraph 31.

⁹Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823, at paragraph 62.

¹⁰ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23.

¹¹ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 77.

¹²Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 70.

¹³ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 64.

¹⁴ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 65.

¹⁵ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 66.

¹⁶ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 72.

¹⁷ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 78.

¹⁸ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 82.

¹⁹ Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 76.