Collateral warranties – key 2024 updates

 

2024 has seen two important court judgments which are relevant to those seeking to rely on collateral warranties.

First: is a collateral warranty a “construction contract”?

In July this year, the Supreme Court unanimously confirmed in the case of Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP [2024] UKSC 23 that collateral warranties are not “construction contracts”.

Why is this important? Section 108 of the Housing Grants, Construction and Regeneration Act 1996 (the “Act”) provides for a statutory right to refer any dispute which arises under a “construction contract” to adjudication. The Act defines a “construction contract” as an agreement “for the carrying out of construction operations”. Adjudication offers a faster and cheaper alternative method of dispute resolution which is often viewed as more desirable than litigation in a construction context. Until this year, it was widely accepted that a construction related dispute arising under a collateral warranty could be referred to adjudication in terms of the Act. That has now changed.

Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP

Simply Construct (UK) LLP was engaged to carry out the construction of a care home. In 2018, fire-safety defects were discovered in the care home and another contractor rectified the defects. In 2020, the freeholder of the care home requested that Simply execute a collateral warranty. 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 court held that for a collateral warranty to be classed as a “construction contract” there needs to be a “a separate or distinct obligation to carry out construction operations” and not just an obligation to perform the services/works already agreed as part of the building contract. Simply warranting the performance of obligations under a building contract is not sufficient to class a collateral warranty as a “construction contract” for the purposes of the Act. The collateral warranty in this case was therefore held not to be a “construction contract” because it was “an entirely derivative promise” and the contractor had not promised anything that was not already promised to the employer under the building contract.

This was a surprising decision and it overturned a previous 2013 case (Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC)) where it was held that a collateral warranty could be a “construction contract” for the purposes of the Act.

Key takeaways

Reaction to this judgment has been mixed. Some consider that the decision undermines the spirt of the Act but the other perspective is that disputes under collateral warranties are more likely to relate to defective works as opposed to disputes around payments and cash flow and therefore litigation may be a more appropriate forum than adjudication.

The effect of this judgment is that statutory adjudication will not be available in respect of disputes arising under most existing collateral warranties as they will not be classed as “construction contracts” unless they contain express and separate undertakings in relation to construction operations which are not already contained in the underlying agreement which the warranty is collateral to. Parties can of course agree to refer a dispute to adjudication but the statutory right to refer disputes to adjudication will likely not apply. Looking ahead therefore, if parties want adjudication to apply then this should be expressly provided for in the collateral warranty.

Second: time barring of right to request collateral warranty

Many construction contracts include requirements for collateral warranties to be delivered at particular times e.g. within seven days of the appointment of a key sub-contractor or simply when requested. The second significant case of 2024, Engine Yard Edinburgh Ltd and Allenbuild Limited v Bayne Stevenson Associates Ltd [2024] CSOH 13, looked at the time limits for making such requests for warranties.

Engine Yard Edinburgh Ltd and Allenbuild Limited v Bayne Stevenson Associates Ltd

Allenbuild appointed Bayne Stevenson as structural engineer for a project in Edinburgh and the appointment was signed in 2017 (the “Appointment”). The employer, Engine Yard Edinburgh Ltd, was not a party to this appointment. Clause 6.1 of the Appointment provided for the delivery of collateral warranties:

“The Engineer shall promptly execute in a self-proving manner and deliver a Collateral Warranty in the form annexed or in such other form as the Contractor reasonably requires within seven days of written request in favour of the Employer and/or any lessee and/or purchaser and/or provider of finance for the Project acquiring from the Employer an interest in or charge over the Project Development or any part of the Project.”

Some five years after the Appointment was signed, in 2022, Allenbuild requested that Bayne Stevenson provide a collateral warranty. Bayne Stevenson declined to deliver it. The request was made after the discovery of issues affecting the property which Allenbuild stated were the result of a failure by Bayne Stevenson to exercise reasonable skill and care in the performance of its services. Allenbuild and the Engine Yard therefore raised an action against Bayne Stevenson seeking damages for the cost of remedial works carried in 2021 and 2022. Although the employer was not a party to the Appointment, it argued that a ius quaesitum tertio (third party right) was created by the Appointment and it was therefore entitled to demand the execution and delivery of the collateral warranty from Bayne Stevenson.

Bayne Stevenson argued that any right to require the production of a collateral warranty in favour of the employer had prescribed as no relevant claim had been made within five years of the execution of the Appointment. It also argued that no third-party rights had been created by the terms of the Appointment due to the contractual structure adopted by the parties.

Third party rights

The Court rejected the employer’s argument on third party rights on the basis that the contractual structure pointed away from an intention to create third party rights and that any implication of ius quaesitum tertio would undermine the essential structure of the arrangements which the parties had put in place. It was also noted that the conferral of third party rights is now governed by the Contract (Third Party Rights) (Scotland) Act 2017 and that the issue only arose in this case because the Appointment pre-dated the coming into force of the legislation.

Time bar

The Court considered that the five-year prescriptive period for delivery of the warranty began when the Appointment was entered into in May 2017. Allenbuild could have enforced the obligation on Bayne Stevenson to execute and deliver the warranty at any time after the Appointment was entered into and did not have to wait until the occurrence of a particular event. Accordingly, when Allenbuild made the request for delivery of the warranty in August 2022 the obligation to provide the warranty had already prescribed and Bayne Stevenson did not require to deliver it.

Key takeaways

If warranties can be provided at the point of signature of the main construction contract/appointment agreement then this should be done. If warranties cannot be provided until a later point in time then parties must ensure that they are requesting such warranties within 5 years of the date on which the right to a warranty is created. Failure to do so will likely result in the entitlement to a warranty being lost. Not having a warranty will make it far more difficult to pursue a claim against a defaulting party.

Parties should also consider incentives for the delivery of warranties such as withholding certain sums until the warranty is delivered.

Concluding thoughts

Following these cases, parties should ensure that collateral warranties are properly drafted to reflect the intended dispute resolution process, and that they are requested and delivered in a timely manner in order to protect the parties’ interests and provide a basis for future claims.

For advice on the preparation or enforcement of collateral warranties please contact our Public Sector Real Estate, RSLs & Infrastructure team.