Francis Ho considers a world where parties can adjudicate under collateral warranties and asks what can be done to put the genie back in the bottle

Francis Ho

Once in a while a judgment comes along which hits the industry for six. Initial uproar, however, is often dampened by measures to curb any meaningful change.

Contractors’ concerns following Blyth & Blyth Ltd vs Carillion Construction Ltd were addressed through changes to novation agreements and services schedules. When the line between different design liabilities was blurred by the Co-operative Insurance Society Ltd vs Henry Boot Scotland Ltd & Others ruling, the JCT altered its drafting. One might have expected Parkwood Leisure Ltd vs Laing O’Rourke Wales and West Ltd to fare likewise. It was here that a collateral warranty was held to be a “construction contract” for the purposes of the Construction Act (1996). Not only did this make it subject to the act’s payment and suspension provisions but, significantly, to those relating to adjudication.

Collateral warranties grant purchasers, tenants, funders and other third parties duties of care from construction parties for works or services performed. They were not traditionally regarded as construction contracts. Why then did the Technology and Construction Court defy conventional wisdom?

The answer is that, in addition to warranting completed works, the collateral warranty included an undertaking from Laing O’Rourke to perform those works yet to begin. These fell within the act’s remit of “construction operations” making it straightforward to establish a construction contract. What makes contractors and professionals apprehensive is that the undertaking encountered in Parkwood Leisure is typical of many collateral warranties.

Like the weather, everybody’s talking about the judgment but nobody is doing anything. Those prejudiced by the decision - warrantors and their insurers - cannot summon a practical solution

And yet, like the weather, everybody’s talking about the judgment but nobody is doing anything. Those prejudiced by the decision - warrantors and their insurers - cannot summon a practical solution. Beneficiaries, unsurprisingly, aren’t about to look a gift horse in the mouth.

Hurley Palmer Flatt Ltd vs Barclays Bank plc confirmed the situation to be different under third party rights. But despite their key advantages, embracing this alternative to collateral warranties may not be the quick fix that warrantors crave. With some beneficiaries already reluctant to accept third party rights, the absence of statutory adjudication may deter them further.

What’s left? Collateral warranties could be drafted to avoid incorporating undertakings relating to undischarged obligations. They would then become effective once the warrantor’s obligations have been discharged. It’s doubtful that funders would appreciate such changes though, which undermines their probable efficacy.

Hence, the problematic wording will continue to be included in collateral warranties in the short term. How beneficiaries will use adjudication is another matter.

For more complex disputes, adjudication could create leverage. These claims tend to be less suited to adjudication’s timeframe and the unavailability of court processes such as disclosure, joinder or consolidation, but the threat of adjudication may dissuade defendants from dragging matters out. Or it might `push a settlement by resolving one aspect on which the facts are clear-cut, such as liability.

Collateral warranties could be drafted to avoid undertakings relating to undischarged obligations. It’s doubtful that funders would appreciate such changes though

In other circumstances, the beneficiary may accept an adjudicator delivering a rough and ready award. Perhaps the claim value or prospects of success are low enough that a gamble is worthwhile, especially since adjudication costs are lower. Adjudications are binding on an interim basis but even if the warrantor disputes the award, it has to weigh up the risk of further losses from an unsuccessful challenge. The same goes for claims where the warrantor’s liability is assured.

Adjudication under collateral warranties presents a dilemma for the industry that cannot easily be rectified. How then to return the genie to the bottle? While the decision has been criticised because collateral warranties were never meant to be construction contracts, the act’s broad drafting may make it hard for Justice Akenhead’s interpretation to be distinguished or overturned.

Ironically, the solution may be one mentioned in the case, albeit in a differing context. Surety and insurance contracts, like collateral warranties, form part of a body of construction security, but are exempted from the act by virtue of an exclusion order. The government could be lobbied to make a similar exception for collateral warranties to restore the former state of affairs.

Could this be first order of the day for a freshly-merged UKCG-NSCC?

Francis Ho is head of construction at Olswang