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The Importance of Collateral Warranties & their Drafting

Collateral warranties are important where a direct contractual link does not exist between parties involved in a construction project. Without these in place, should any defects or issues arise with works or services carried out, beneficiaries will be required to pursue third parties via a claim for negligence. If not correctly drafted or understood, problems can arise when seeking to enforce collateral warranties. Through recent and previous case law, we have discussed why a collateral warranty is important but also recent decisions that has provided further guidance on the drafting of them.

Why should I have a collateral warranty in place?

It was seen in the outcome of Multiplex Construction Europe Ltd v Bathgate Realisations Civil Engineering Ltd & Others [2021] EWHC 590 (TCC), that where there is no contract, there is no claim. This case serves as a reminder for parties engaged in construction projects to ensure that their contractual relationships are clearly defined and to make it a condition of any contract with downstream contractors that any third parties engaged by them are required to provide collateral warranties.

The importance of ensuring accurate drafting of collateral warranties

Last year, there were two key decisions made relating to collateral warranties; covering whether collateral warranties can be a 'construction contract' and the effect of assignment on the rights under a collateral warranty. We have discussed both these cases further below.

• Abbey Healthcare (Mill Hill) Ltd v Simply Construct (UK) LLP [2022] EWCA Civ 823:

The question of whether a collateral warranty is a construction contract, is an important one because if it is, then the beneficiary has certain rights under the Construction Act 1996 including the right to adjudicate. The statutory process of adjudication is often a quicker and cheaper way to resolve disputes than litigation or arbitration. In this case Abbey Healthcare was the beneficiary which, under a collateral warranty, sought to enforce its rights through adjudication when fire safety defects were identified in the building that required remediation. Simply did not pay on the basis that the collateral warranty was not a construction contract. The Court of Appeal decided that whether a collateral warranty was a construction contract depended on its wording. In this case the collateral warranty related to both past and future performance and so it was a construction contract. The Court of Appeal also confirmed that if a collateral warranty was akin to a performance guarantee, then the collateral warranty was not a construction contract.

• Orchard Plaza Management Co Ltd v Balfour Beatty Regional Construction Ltd [2022] EWHC 1490 (TCC):

In this case a collateral warranty was granted to the funder of the development, which was then assigned several times and eventually vested in Orchard. Defects arose in the cladding of the development and the building owner then sought to recover the cost of remedial works from the contractor under the collateral warranty. The contractor argued that the building owner's losses were too remote from the warranty and the losses were not a natural consequence of breaches of the collateral warranty and the claim could not succeed. It was held by the court that the losses suffered by the building owner were not too remote and it clarified the test for remoteness, which is whether the kind of loss now claimed was, at the time the contract was made, reasonably contemplated as a serious possibility. It was decided here that it was in the contractor's reasonable contemplation as a serious possibility that an assignee would incur repair costs because of a breach by the contractor.

Our comments

The collateral warranty in Abbey contained market standard wording and the court made it clear that unless collateral warranties evolve to be as sparsely worded as performance guarantees, then clever drafting alone will not exempt a collateral warranty from the scope of the Construction Act 1996. In practice you need to be aware that you could face adjudication claims under collateral warranties, and you therefore need to ensure that they are correctly drafted, depending on whether you accept adjudication or whether you wish to avoid this.

The case of Orchard is of relevance for those who are party to assignment of collateral warranties as where there is a serious possibility that an assignee may seek to recover the costs of repairs to defects under it, losses could not be considered too remote to be claimed by a future assignee. You need to be aware of this when drafting and understanding collateral warranties and seek advice on collateral warranties developers grant or receive through assignment.

For more information contact John Pickervance in our Construction & Infrastructure department via email or phone on 0333 207 1134. Alternatively send any question through to Forbes Solicitors via our online Contact Form.

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