When is a collateral warranty a ‘construction contract’?

In Parkwood Leisure Limited v Laing O’Rourke Wales and West Limited [2013] the TCC held that the parties’ collateral warranty was a construction contract within the meaning of section 104 of the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the “HGCRA”), and, as such, was subject to the statutory adjudication rules. This article considers when a collateral warranty will be a construction contract and looks at the implications of the decision in Parkwood.

What is a collateral warranty?

Collateral warranties are a common feature of building and engineering projects. A collateral warranty is a contract between a (1) third party, such as a purchaser, tenant or funder, with an interest in the project (the “beneficiary”) and commonly a (2) contractor, consultant or sub-contractor (the “warrantor”) involved in the project giving that third party the right to rely on the work of, and have recourse to, the warrantor if there is an issue with the work.

The main advantage of collateral warranties are that they create a direct contractual link between the beneficiary and the warrantor, providing additional security for stakeholders in a construction project who are not directly appointing the parties delivering it. Other benefits include:

• the construction project becomes more marketable;
• the beneficiary has a right of recourse for any defects in the design and/or the construction of the project;
• the beneficiary has the right to use the design information generated by the project; and
• step in rights give the beneficiary the option to ‘take over’ the underlying building contract, sub-contract or professional appointment to which the collateral warranty relates.

The HGCRA

The HGCRA (supported by the Scheme for Construction Contracts (England and Wales) Regulations 1998 (the “Scheme”)) sets out the meaning of a ‘construction contract’ and ‘construction operations’ in sections 104 and 105. The HGCRA implies a number of provisions, relating to the adjudication process and payment, into contracts which fall within the definition of a ‘construction contract’.

Parkwood Leisure Limited v Laing O’Rourke Wales and West Limited

(i) the facts

In 2006 Laing O’Rourke Wales and West Limited (the “contractor”) entered into a standard JCT Design and Build Contract with Orion Land and Leisure (Cardiff) Limited (the “employer”) to design and build a leisure facility in Cardiff (the “building contract”). Cardiff City Council let the leisure facility to the employer on a 25 year lease and the employer sub-let the leisure facility to Parkwood Leisure Limited (the “tenant”) who acquired an interest in the leisure facility.

The contractor provided a collateral warranty to the tenant, warranting that it would carry out the pool works in accordance with the building contract.

A dispute arose concerning the defective design and/or installation of air handling units at the leisure facility. The tenant sent a Pre-Action Protocol for Construction and Engineering Disputes letter setting out their claim. The contractor rejected the claim and so the tenant issued CPR Part 8 proceedings seeking a declaration that the collateral warranty was a construction contract for the purposes of Part II of the HGCRA.

(ii) the TCC decision

Akenhead J held the parties’ collateral warranty was a construction contract for the purposes of Part II of the HGCRA.

In arriving at this decision, the meaning of ‘construction contract’ in section 104 and ‘construction operations’ in section 105 were considered. Referring to section 104(1) which provides that a construction contract is an agreement “for the carrying out of construction operations”, Akenhead J commented that parliament intended a wide definition of this section. Highlighting that it is common for construction contracts to be finalised after the works have started; Akenhead J confirmed that a construction contract does not have to be “wholly or partly prospective”.

In considering the collateral warranty wording, the TCC held the collateral warranty was “for the carrying out of construction operations” for the following reasons:

• the building contract was “for the design, carrying out and completion of the construction of a pool development”, wording which was also included in the collateral warranty;
• clause 1 of the collateral warranty provided that the contractor “warrants, acknowledges and undertakes”. Specifically, the contractor’s acknowledgement related to the fact that significant work and design had been completed, the undertaking related to the contractor completing the remaining works and the warranty related to the work and design already carried out as well as the work to be carried out;
• the contractor gave an undertaking to the tenant that it would carry out and complete the works in accordance with the building contract; and
• the collateral warranty entitled the tenant to claim damages for breach of contract if the works were not completed in accordance with the building contract.

(iii) exceptions to the decision

The TCC noted that not every collateral warranty will be a construction contract and that in each case specific wording and the factual background will be considered.

If the warrantor is undertaking to the beneficiary to ‘carry out’ construction operations then this would support a collateral warranty being a construction contract. In contrast, if all the works are completed and the warrantor is warranting to the beneficiary that the works and/or services have reached a certain level, quality or standard this would suggest that a collateral warranty is not a construction contract.

(iv) effects of the decision

An implication of the judgment in Parkwood Leisure Limited v Laing O’Rourke Wales and West Limited is that claims under collateral warranties may be referred to adjudication under the HGCRA.

Being able to refer a claim under a collateral warranty to adjudication will be an advantage to its beneficiaries because compared to litigation or arbitration; they will have a quicker and cheaper dispute resolution method. However, the change in law is less likely to be welcomed by contractors, sub-contractors and consultants who regularly provide collateral warranties as having a quicker and cheaper dispute resolution may increase the number of claims under collateral warranties being referred to adjudication.

(V) questions arising out the decision

The judgment also raises a number of questions;

1. what will happen to the payment and suspension rights that are also implied into a construction contract by the HGCRA? Whilst the HGCRA provides that in the absence of express HGCRA compliant payment provisions the Scheme will be implied, given that it would not be in the contemplation of the parties to the collateral warranty that the beneficiary would be responsible for payment of the works and/or services under the underlying appointment or building contract, there is no need for payment and suspension rights to be incorporated into a collateral warranty;

2. will parties in construction projects rely on the statutory rights granted by the Contracts (Rights of Third Parties) Act 1999 instead? Two years have now passed since the Parkwood decision and collateral warranties are still preferred by banks and purchasers over third party rights (it is possible to include a schedule of third party rights in the building contract and/or professional appointment) as they increase the marketability of a project; and

3. will ancillary documents to a building contract / professional appointment be a construction contract? Whilst ancillary documents, such as parent company guarantees and bonds were not expressly considered by the judgment in Parkwood, depending on their wording, such documents to a building contract and/or professional appointment may be considered as construction contracts following the decision.