Can disputes relating to collateral warranties be determined through adjudication?
Alice Toop, an Associate Solicitor specialising in Construction Disputes, considers the recent unanimous Supreme Court decision in Abbey Healthcare (Mill Hill) Ltd v Augusta 2008 LLP (formerly Simply Construct (UK) LLP) [2024] UKSC 23, which decided that a collateral warranty will generally not be a construction contract for the purposes of the Construction Act 1996.
What is a collateral warranty?
Collateral warranties are commonly used in the construction industry to create a contractual relationship between a third party with an interest in a project (such as a funder, purchaser or tenant) and a contractor who designed and built the project.
The contractor providing the warranty will usually warrant to the third party that it has complied, and/or will comply, with the main construction contract. This means a collateral warranty protects the third party’s interest in the project by enabling it to bring a claim for breach of contract against the contractor if it breaches the terms of the collateral warranty. In reality, a claim normally arises if the works carried out by the contractor are defective.
What is Adjudication?
Adjudication was initially introduced by the Housing Grants, Construction and Regeneration Act 1996 (Construction Act 1996).
Adjudication is a compulsory alternative dispute resolution process to resolve disputes relating to ‘construction contracts’ (as defined in the Construction Act 1996). When a construction contract exists, the parties to that contract cannot contract out of the adjudication process to resolve their disputes.
Adjudication was introduced with the general intention to preserve cashflow during a construction project by resolving disputes far more quickly and cost-effectively in comparison to Court proceedings.
Since, the disputes that are regularly referred to adjudication extend far beyond the confines of those relating to payment and cashflow. Today, adjudication is the primary form of dispute resolution for construction disputes (including those relating to defective works, extensions of time and delay & disruption to works).
Adjudication is a speedy way to resolve disputes - it is a 28-day process (although the parties can agree to extend this period). This can lead to what is described in the industry as ‘rough justice’ because sometimes the matters relating to the dispute cannot be fully explored and there tends to be no opportunity to cross-examine witnesses.
Adjudication, however, resolves disputes on a temporarily binding basis because adjudicators' decisions are binding on the parties only until the dispute is finally determined by legal proceedings, by arbitration or by agreement.
Background facts – Abbey v Simply
In 2015 Simply was engaged under a JCT Design and Build Contract to design and carry out the construction of a care home. In 2017, a long lease of the care home was granted to Abbey. In 2018, fire-safety defects were discovered. Another contractor rectified the defects. In 2020, the freeholder of the care home requested that Simply execute a collateral warranty in favour of Abbey. After initially refusing, Simply executed a collateral warranty, under which it warranted that it "has performed and will continue to perform diligently its obligations under the contract".
The freeholder and Abbey both began adjudication proceedings in respect of the defects, and both were awarded sums against Simply by the adjudicator.
Simply failed to pay the sums due so the freeholder and Abbey both applied to the court for summary judgment to enforce the adjudicator's awards.
In respect of Abbey's application, Simply argued that the collateral warranty delivered to Abbey was not a construction contract under the Construction Act 1996 and that this meant the adjudicator had had no jurisdiction and so summary judgement should not be granted.
The Judge at first instance agreed with Simply and dismissed Abbey's summary judgment application.
Abbey successfully appealed to the Court of Appeal and was granted summary judgment. All judges at the Court of Appeal agreed that a collateral warranty could be a construction contract under the Construction Act 1996. A majority held that the collateral warranty in this case was such a contract.
Simply appealed to the Supreme Court on the question of whether or not the Abbey Collateral Warranty is a construction contract within the meaning of the Construction Act 1996.
Supreme Court decision
The Supreme Court has overturned the Court of Appeal decision and held that the collateral warranty in this case was not a construction contract for the purposes of the Construction Act 1996 and that there are "good reasons for concluding that, in general, such warranties were not intended to fall within the scope of the 1996 Act" and "most collateral warranties will not be construction contracts".
The Supreme Court also confirmed that the test for whether a collateral warranty will be a construction contract under the Construction Act 1996 is as follows:
"(1) A collateral warranty will be an agreement "for … the carrying out of construction operations" if it is an agreement by which the contractor undertakes a contractual obligation to the beneficiary to carry out construction operations which is separate and distinct from the contractor's obligation to do so under the building contract.
(2) A collateral warranty where the contractor is merely warranting its performance of obligations owed to the employer under the building contract, will not be an agreement "for" the carrying out of construction operations."
Contractual agreement for adjudication?
The Supreme Court also stated that, whilst the statutory adjudication regime under the Construction Act 1996 is unlikely to apply to most collateral warranties, if parties wish to adopt adjudication as a dispute resolution mechanism in their collateral warranty they can do so by including a contractual adjudication clause in their contract.
It remains to be seen whether the construction industry will generally take up this approach.
Incorporating a contractual adjudication clause in collateral warranties may, on face value, be advantageous given the popularity of adjudication proceedings in the construction industry. There is a common desire to seek to avoid excessive costs and resolve disputes as quickly as possible.
Adjudication also offers parties flexibility to determine the identity and powers of the adjudicator, procedure, timetable and the effect of the decision. It is also a private process, which assists parties in managing the commercial risks of their disputes.
However, on the other hand, the adjudication process is often too ‘high level’ for complex construction disputes, which are often more appropriately addressed by arbitration or proceedings in the Technology and Construction Court.
Moreover, adjudication limits the parties' ability to join other parties to the dispute. This is relevant when a party may want to join in a consultant or sub-contractor.
Furthermore, when parties pursue adjudication, they will not be able to recover legal costs unless that is explicitly provided for in the contractual adjudication clause.
Finally, an adjudicators decision must be enforced through the Court if the losing party refuses to comply with it.
Commentary
Whilst the Supreme Court’s decision has not ruled out the possibility that some collateral warranties may constitute construction contracts for the purpose of the Construction Act 1996, it means that most collateral warranties will not be construction contracts and so disputes relating to them cannot be resolved through adjudication unless the parties have explicitly agreed a contractual adjudication provision.
This means they will likely need to pursue alternative dispute resolution methods, such as mediation or litigation (the latter of which can be more time-consuming and expensive).
The Supreme Court’s decision is likely to also affect the enforceability of adjudicator's decisions issued pursuant to collateral warranties prior to the Supreme Court's judgment and also impact ongoing disputes where parties were wishing to rely on adjudication to resolve claims under collateral warranties. It is crucial to seek early legal advice to understand the specific implications for your case.
Alice predicts that, on the whole, parties to collateral warranties are unlikely to adopt a contractual adjudication clause. Historically, there has not been a trend towards including express contractual adjudication provisions in collateral warranties and Alice doubts the position will substantially change following the Supreme Court’s decision.
