Collateral damage: parties lose their right to adjudicate under collateral warranties

In 2013, Akenhead J sprung something of a surprise on the world of construction: collateral warranties could be ‘construction contracts’ for the purposes of the Construction Act. Before that, the general view in the industry was that the Act did not apply to collateral warranties.

Why does it matter?

The Construction Act implies certain conditions into all ‘construction contracts’ (as properly defined) around two things: the right to payments, and the right to refer disputes to adjudication. As payments don’t typically arise under collateral warranties, the real value of the Act applying to them is for the parties (and really, the beneficiary) to be able to adjudicate.

Adjudication is the industry’s go-to dispute resolution procedure. It is far quicker, and cheaper, than court (or arbitration) proceedings: it gives the parties a decision within as little as 28 days at a fraction of the costs of full-blown proceedings. And it is binding on the parties unless and until a court or arbitral panel decides otherwise. As such, for a party looking to recover under a collateral warranty, it is an attractive option.

What’s changed?

Today, however, the Supreme Court has decided that the 2013 case in which Akenhead J decided that collateral warranties were ‘construction contracts’ – Parkwood Leisure Ltd v. Laing O’Rourke Wales and West Ltd – was wrongly decided. In Abbey Healthcare (Mill Hill) Ltd v. Augusta 2008 LLP, the Supreme Court was again asked to consider the wording of a collateral warranty and the enforceability of two adjudication decisions that had been gained on the back of the Parkwood case and the belief that the Construction Act implied a right to adjudicate.

In summary, it held that the collateral warranty was not a construction contract despite the promise that the contractor “has performed and will continue to perform” the obligations under the building contractor. In Parkwood the court had considered this wording meant there was an agreement to carry out construction operations, but the Supreme Court disagreed, saying that this obligation was merely derivative and reflective of obligations already owed under the building contract.

As such, the position now is that while some collateral warranties may be ‘construction contracts’ and therefore a right to adjudicate can be implied in by the Construction Act, most (certainly as currently drafted) will not be. The Supreme Court’s decision means that collateral warranties which merely replicate undertakings in the building contract will not be ‘construction contracts’, but those which give rise to separate or distinct undertakings for the carrying out of construction operations may be.

What does this mean in practice?

The obvious impact is that parties that thought they could adjudicate under existing collateral warranties may well no longer be able to. But the underlying rights under the collateral warranties will not be affected – it is just the dispute resolution process that will change. Rather than the ‘rough and ready’ justice of adjudication, parties will be forced to commence more expensive and drawn-out court or arbitration proceedings to determine liability.

Parties being pursued for payment may see that as an obstacle that many beneficiaries pursuing payment may not want, or be able, to pass. That said, for those that do still pursue things, it could end up being a double-edged sword for the pursued as legitimate claims will still proceed and will come with a hefty costs bill (something not possible in adjudication).

Going forward, it may give rise to a desire for parties to provide for a contractual right to adjudicate in collateral warranties. The advantages and disadvantages of adjudication will need to be weighed up, and negotiated on a case-by-case basis. Expect this issue, then, to be added to the long list of things to look out for in draft contracts.