UK: Collateral Warranties As 'Construction Contracts'

Last Updated: 18 December 2013
Article by Justin Mort

The decision has given rise to a certain amount of negative comment, with many commentators expressing surprise, or even suggesting that the case was wrongly decided.

The case is of immediate interest for anyone who has the benefit of a collateral warranty, or has given one, or was contemplating granting a collateral warranty to a third party such as a tenant, lender, or an employing party further up the contractual chain.

The practical consequence is that collateral warranties, at least those made in similar or equivalent terms to those considered in Parkwood, import the right to adjudicate contained in section 108 of the 1996 Act. The beneficiary of such a warranty, as Parkwood, can commence adjudication proceedings in order to recover damages for defective work rather than being limited to court or arbitration proceedings.

My own experience of adjudication is that it has certain advantages over court or arbitration proceedings, advantages for all involved.

It was my impression that that was everyone's experience: adjudication is cheaper, it is quicker, and, in many cases, no less likely to reach a broadly correct outcome than a more formal dispute resolution process.

It is possible that adjudication reduces the effort invested in negotiating out of conflict, because the referring party has so immediate a solution to its problem if it finds the progress of the negotiations unsatisfactory.

The difficulty is that the cost of litigation is now such that a party to a construction contract (be they employer, contractor or some other species of party) in practice has no effective method of enforcing its rights, save in a relatively substantial case, absent the right to refer disputes to adjudication. Insofar as it is necessary or appropriate to look at the mischief at which the 1996 Act was directed, the cost of constructionrelated dispute resolution was cited by Sir Michael Latham as being part of the overall problem in his report 'Constructing the Team'.

In any event, the outcome of Parkwood was, surely, more or less inevitable.

Parliament has created a test of what is a 'construction contract' for the purposes of the Act. In the interests of clarity and/or simplicity, the test is a straightforward one: whether the contract is for the carrying out of construction work.

That is, therefore, the sole element of any transaction that one needs to focus on and not, for example, what, if any, provision is made about payment.

The simplicity of that test assists in its application, hence the question of what is a 'construction contract' has not given rise to extensive consideration by the courts in the 15 years since 1 May 1998, despite the infinite ingenuity of those seeking to resist the enforcement of adjudicators' decisions. (The meaning of 'construction operations' has given rise to some issues, as has section 104(5), but not section 104(1).)

The test no doubt also sweeps up some types of contract within the scope of the Act which no one had particularly in mind when making the legislation. But that is an inevitable side effect of adopting a simple test for the application of the Act: it is going to be less discriminating than a complex test, but one easier to apply.

It is no part of the test of whether an agreement is a construction contract that the party not carrying out the work has any liability to pay for the work, or has any say over what work is carried out.

There may be many cases, away from collateral warranties, where an employer under a building contract is not funding the work or has no obligation to pay for it.

A possible example might be where an insurer is responsible to the contractor for paying for the remedying of damage caused by an insured event, but where the insured is nonetheless named as the employing party.

A further example might be where there are joint employers under a contract, but it is agreed that only one party has any liability to pay for the work.

The payment provisions of the 1996 Act are obviously irrelevant in those circumstances; the Act nonetheless applies. But the right to adjudicate under the English legislation, as contrasted with equivalent legislation made in other jurisdictions, is not tied securely to payment obligations or to the need to preserve contractor or subcontractor cashflow.

Adjudication is available to a party seeking damages in respect of defective work, and/or where the project is long completed and all payment obligations long discharged.

The right to adjudicate under a collateral warranty is consistent with that arrangement.

The most interesting aspect of the case is the issue of timing. In Parkwood, the collateral warranty was granted prior to practical completion (just), so that construction work was ongoing and it could also be argued that the contractor owed a duty to put right all patent defects prior to handing over the site.

In giving general guidance as to whether a warranty would be within the ambit of the Act, the learned judge stated:

"A point 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."

This part of the case is interesting for two reasons. Firstly, some commentators have suggested that a party giving a collateral warranty could avoid the importation of the Act by providing the warranty only upon or after practical completion.

I am not convinced that that would make any difference, so long as the contractor has any ongoing obligation to carry out work on site at the time of giving the warranty (or specifically: makes any promise to the beneficiary under the warranty in respect of the future performance of such work).

Under any conventional building contract, the contractor has an obligation to return to site after Practical Completion (PC) and remedy defects as and when instructed to do so, provided that the defects manifest themselves within the defects liability period.

Where the beneficiary is the proposed occupant of the site, such occupation is likely to commence from or shortly after PC.

In those circumstances, as was the case in Parkwood, the contractor's promise to the beneficiary to adhere to the terms of the underlying building contract is likely to become more significant at that stage of the process.

The issue of time of performance is also of interest when one considers the application of the Act to a conventional building contract. ...adjudication is cheaper, it is quicker, and in many cases, no less likely to reach a broadly correct outcome than a more formal dispute resolution process. Many building contracts and professional appointment documents contain warranties about past or present matters. Most would accept that the Act is intended to apply to such obligations, and does not apply only to such parts of the contract as provide for the (future) performance of physical work.

In addition, it is sometimes the case that a contract is only entered into after performance of some or all of the construction work or professional services.

Again, everyone would accept that the Act is intended to apply to such past performance. In some of the early cases on interpretation of the Act (e.g. Yarm Road Ltd v Costain Ltd), the past performance pre-dated the implementation of the Act, yet the Act was held to apply.

The application of the Act to a collateral warranty is a relatively mild development by comparison.

The articles and papers published by Keating Chambers are for the purpose of raising general awareness of issues and stimulating discussion. The contents must not be relied upon or applied in any given situation. There is no substitute for taking appropriate professional advice.

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