Is your collateral contract a damp squib?

The Technology and Construction Court has recently considered a funder’s liability in relation to a construction project on which the employer defaulted providing a useful reminder on the subject of collateral contracts.

Collateral Contracts

Collateral contracts are separate and independent agreements which sit alongside a primary contractual agreement or “main contract”. These are often entered in to at the same time as the main contract, with the entering into of the main contract being the required consideration for the collateral contract. As such, collateral contracts may often arisen informally, particularly where one party requires a particular assurance or backing from another party before entering into the main contract.

Similar informal agreements may also arise from discussions and informal meetings held during the course of a project, potentially giving rise to binding obligations on those involved. Although not collateral contracts as such, they arise in similar circumstances often where one party is seeking assurances from the other in return for continuing to work and/or fund the main contract.

Such agreements need not adhere to any formalities and are often made orally, even where the main contract is required by law to be in writing. The existence of such contracts may therefore catch parties by surprise.

Squibb Group Limited v London Pleasure Gardens Limited and Another

Whether collateral / informal contracts had come into existence formed the main issues arising in the case of Squibb Group v London Pleasure Gardens.

London Pleasure Gardens Limited had acquired an interest in a 20 acre site which it was to develop in time for the London 2012 Olympics. The works were of strategic importance to the London Borough of Newham (“LBN”) who agreed to act as funder. LBN provided LPG with a loan totalling £3 million, in the hope that this would allow LPG to engage contractors and lead to the long-term regeneration of the site. Squibb Group Limited (“Squibb”) had been appointed by LPG to carry out ground works at the site. LBN were noted as funders in the construction contract, which also included step-in rights in favour of LBN but included no further funder obligations.

When LPG went in to administration, Squibb sought to recover the money it was owed from LBN, claiming that collateral or informal contracts had been entered in to between Squibb and LBN as funder. Squibb claimed such contracts arose (i) at the time the construction contract was entered into, and/or (ii) at the meetings between the contractor and funder after the employer’s default.

Mr Justice Stuart-Smith found that:

• The structure of the relationship between the parties (funder-employer-contractor), was entirely conventional and LBN had not given any assurance (express or implied) that LBN “would not allow the project to fail” as Squibb had suggested.
• Whilst LBN were identified as funder under the construction contract, they had no further obligations which Squibb were entitled to rely upon.
• Squibb was not privy to the funding agreement, but even if they had been the funding agreement made no reference to any ‘out of the ordinary’ relationship between the funder and the contractor.
• A limited informal contract came into existence after LPG’s default, whereby LBN agreed to ensure that two payments would be made by LPG to Squibb in return for Squibb agreeing to carry out certain additional work and refraining from commencing legal proceedings against LPG. Squibb had argued that this agreement amounted to a full guarantee by LBN for all payments due from LPG, but the court was not persuaded on the evidence.

Summary

In summary, whilst in certain circumstances it is clear that collateral contracts can arise, trying to argue that a funder had impliedly become bound by such an agreement is going to be a hard ask. Whilst the involvement of a funder may be seen as beneficial to all parties, generally there is no obligation on the funder to step-in and guarantee the employer’s obligation should the contractor go insolvent.

Where works continue once an employer starts to have financial issues, it is important that any discussions between parties are regularly and accurately recorded to prevent any ambiguity in the parties’ positions becoming entrenched. It is also worth noting that an entire agreement clause in a main contract may preclude a claim based on a collateral contract (but not later informal contracts during the course of the project).

Reference: Squibb Group Limited v (1) London Pleasure Gardens Limited and (2) London Borough of Newham [2013] EWHC 3275 (TCC)