The Supreme Court held that a collateral warranty given by a contractor to a tenant was not a 'construction contract' under the Housing Grants, Construction and Regeneration Act 1996, as it merely replicated obligations owed under the building contract rather than creating separate obligations for carrying out construction operations. The decision overruled Parkwood Leisure.
Background
Augusta 2008 LLP (formerly Simply Construct (UK) LLP) (‘Simply’) was engaged as contractor under a JCT Design and Build Contract dated 29 June 2015 to design and build a 65-bedroom care home in Mill Hill, London. The employer under the building contract was Sapphire Building Services Ltd (‘Sapphire’), which subsequently novated the contract to the property owner, Toppan Holdings Ltd (‘Toppan’). The respondent, Abbey Healthcare (Mill Hill) Ltd (‘Abbey’), was the tenant of the property, operating the care home business.
The building contract required Simply to execute collateral warranties for the benefit of tenants. Following the discovery of alleged fire safety defects in August 2018 — specifically that internal plasterboard wall linings did not provide the required 60 minutes of fire resistance — Toppan requested Simply to provide a collateral warranty to Abbey. After Simply failed to respond, proceedings for specific performance were issued and the parties eventually entered into the Abbey Collateral Warranty, executed in September and October 2020, some four years after practical completion of the works and after remedial works had already been completed by a third party contractor.
Under clause 4.1 of the Abbey Collateral Warranty, Simply warranted to Abbey that: (a) it had performed and would continue to perform diligently its obligations under the building contract; (b) in carrying out the works it had exercised and would continue to exercise reasonable skill, care and diligence; and (c) in carrying out design work it had exercised and would continue to exercise reasonable professional skill, care and diligence. The consideration was a nominal payment of £1.
Both Toppan and Abbey referred disputes to adjudication in December 2020. The adjudicator awarded Abbey damages of £869,500 for loss of profit plus interest. Simply refused to pay, challenging the adjudicator’s jurisdiction on the ground that the Abbey Collateral Warranty was not a ‘construction contract’ within the meaning of section 104(1) of the Housing Grants, Construction and Regeneration Act 1996 (‘the 1996 Act’).
The Issue(s)
The central question was whether the Abbey Collateral Warranty was a ‘construction contract’ within the meaning of section 104(1) of the 1996 Act, thereby giving rise to a statutory right to adjudication. This raised two sub-issues:
Statutory interpretation
What is the meaning of an agreement ‘for… the carrying out of construction operations’ in section 104(1)?
Contractual interpretation
How should the Abbey Collateral Warranty be construed and, so construed, did it fall within that statutory definition?
The Court’s Reasoning
Approach to statutory interpretation
Lord Hamblen, delivering the unanimous judgment, rejected Coulson LJ’s ‘broad’ approach to interpreting section 104(1). The Court held that the word ‘for’ in the phrase ‘an agreement… for… the carrying out of construction operations’ indicates purpose or object. Lord Hamblen endorsed the approach taken by all three Court of Appeal judges on this point:
The natural and ordinary meaning of ‘for’ was recognised by Coulson LJ at para 37: ‘Dictionary definitions refer to it as a function word to indicate purpose, or to indicate the object of an activity.’
The Court rejected reliance on section 104(5) as expanding the scope of section 104(1), and held that policy arguments about the benefits of adjudication could not justify expanding the statutory right beyond its proper province:
The statutory scheme for adjudication is generally regarded as beneficial but the legislature has chosen to impose limits upon it.
The nature of collateral warranties
Lord Hamblen reasoned that, as a generality, the object or purpose of a collateral warranty is not the carrying out of construction operations but rather to afford a right of action in respect of defectively carried out construction work:
As 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.
The Court drew a critical distinction between a warranty that merely promises the beneficiary that obligations under the building contract will be performed and an agreement that itself gives rise to the carrying out of construction operations:
A collateral warranty that merely promises to the beneficiary that the construction operations undertaken under the building contract will be performed does not do so. In such a case, it is the building contract that gives rise to the carrying out of the construction operations; not the ‘collateral’ warranty.
Lord Hamblen further observed the practical disconnect between a collateral warranty and control over construction operations: the beneficiary has no right to instruct how works are carried out, order variations, or suspend or terminate works.
Application to the Abbey Collateral Warranty
The Court rejected the majority of the Court of Appeal’s reliance on the wording of clause 4.1(a) — that Simply ‘has performed and will continue to perform’ its obligations. While accepting this was potentially ‘a warranty as to future performance’, Lord Hamblen held it was ‘an entirely derivative promise’:
The contractor is not thereby promising anything that is not already promised to the employer under the Building Contract. It does not in itself give rise to any construction operation.
The Court explained that such wording was necessary in any collateral warranty to cover all the contractor’s obligations regardless of whether the warranty was executed before or after practical completion, and could not bear the significance placed on it by the majority below:
A collateral warranty has to be expressed in such terms because it needs to cover all the contractor’s obligations under the building contract and it may well be given while the works are still being carried out. It therefore needs to be drafted in terms which cover past and future performance.
The dividing line
Lord Hamblen endorsed a principled and workable dividing line:
I agree with Ms Day for Simply that a far more principled and workable approach is for the dividing line to be 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.
The Court noted that under this approach most collateral warranties would not be construction contracts, but that this was consistent with the legislative scheme. The payment-related provisions of the 1996 Act (sections 109–113) are simply inapplicable to collateral warranties where consideration is typically nominal, and one of the twin purposes of the Act — improvement of cashflow — is not furthered by its application to such warranties.
Overruling of Parkwood
The Court overruled the decision of Akenhead J in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC), which had first held that a collateral warranty could be a construction contract. Lord Hamblen concluded that the collateral warranty in Parkwood could not be satisfactorily distinguished from the present case and that the substance of the promises made was the same:
The fact that a warranty was given rather than a warranty and an undertaking makes no difference. What matters is the substance of the promise made rather than its label.
The Court noted that prior to Parkwood, the general understanding in the construction industry was that the 1996 Act did not apply to collateral warranties, and that the decision had been received with surprise and criticism.
Practical Significance
This decision is of major importance to the construction industry. It establishes that collateral warranties which merely replicate or mirror obligations owed by the contractor under the building contract are not ‘construction contracts’ within section 104(1) of the 1996 Act and therefore do not attract the statutory right to adjudication. Only a collateral warranty containing a separate or distinct obligation to carry out construction operations for the beneficiary — as opposed to a derivative promise reflecting obligations already owed to the employer — will qualify.
The decision overrules Parkwood Leisure, restoring the position as it was generally understood before that case. Parties wishing to have a right to adjudication under a collateral warranty must now expressly provide for it contractually; adjudication will be voluntary rather than mandatory in such cases. The Supreme Court’s emphasis on certainty and a clear dividing line provides welcome clarity for practitioners drafting and advising on collateral warranties in construction projects.
Verdict: The Supreme Court unanimously allowed Simply’s appeal. The Abbey Collateral Warranty was held not to be a ‘construction contract’ within the meaning of section 104(1) of the Housing Grants, Construction and Regeneration Act 1996, because it merely warranted Simply’s performance of obligations owed to the employer under the building contract rather than containing a separate or distinct obligation to carry out construction operations for Abbey. The decision of the Court of Appeal majority was reversed, and the decision in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC) was overruled.
