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Clear Intentions – a health warning about letters of intent

  • United Kingdom
  • Construction and engineering - Articles

15-11-2018

Letters of intent have been considered by the Courts in a number of cases over the past few years. So what are the common pitfalls and what advice can we take from recent case law to ensure the contractual relationship between Employer and Contractor is properly defined and managed under a letter of intent? 

The starting point must be to avoid letters of intent wherever possible.   However, in circumstances where a letter of intent is unavoidable, we have set out some key considerations below.

How do letters of intent operate in practice?

Letters of intent are adopted in circumstances where it is necessary to mobilise a Contractor before the parties have concluded their contractual negotiations for the construction contract. Once the contract is completed, the terms of the letter of intent will fall away, and the contract will represent the entire agreement between the parties.

Letters of intent may be used;

  • where parties have entered into protracted negotiations of the contract terms but do not want to delay the commencement of the works;
  • to operate as a ‘stop gap’ in situations where parties have left the drafting and negotiating of the contract too late whilst focussed on the practical works required on site; or
  • where a project demands that the works be mobilised very quickly, for example because planning permission or an offer of funding may be due to expire. 

A letter of intent should refer to the proposed draft contract and seek to incorporate as much of the agreed contract terms as possible, to aid commercial certainty.

What are the elements of a binding letter of intent?

There is no legal definition of a ‘Letter of intent’. It is a generic term used to cover documents which set out the basic contractual terms between parties, in contemplation of the full contract being entered into at a later date. There are therefore no formal elements required for a document to be considered a ‘letter of intent.’   That said, for the purposes of commercial certainty, the following should be considered and including within a letter of intent wherever possible:

(i)           Scope

A letter of intent should include a precise definition of the works covered by the letter which the Contractor is required to undertake. This should be drafted as narrowly as possible to limit the scope of the works due to be undertaken before the contract is entered into and to ensure the parties remain focussed on getting the contract concluded.

(ii)          Express terms

A letter of intent should contain express terms relating to:

  • price – the amount which the contractor should be entitled to claim for works under the letter of intent should be fixed and limited to the agreed scope;
  • duration – the letter of intent should be expressed to be in place for a specific period of time (subject to any right to extend).  The duration should be based on the time it will take the contractor to complete the work scope or the time estimated to conclude the contractual negotiations;
  • limits on liability - if applicable any caps or limits on liability should be clearly defined;
  • insurance – agreement must be reached on the types and levels of insurance cover that the Contractor, and the professional team, are required to maintain for the project and evidence that this cover is in place must be obtained from the Contractor before works commence; and
  • rights to terminate – the letter should make clear who can terminate the letter and on what grounds.  The backstop may be the agreed duration (see above) and the letter can provide that it will automatically terminate on that date.  If this approach is taken, the parties must ensure the date is diarised and that the works do not continue thereafter without further agreement.

(iii)         Implied terms

It should be borne in mind that certain terms may be implied into a letter of intent if not dealt with expressly. For example, if the letter does not contain express provisions relating to quality or time, the law will imply these terms.

If there is no express provision providing that the materials used in the works must be of a certain quality, the law will imply that the materials will be of a satisfactory quality and fit for purpose. Similarly, if the letter does not expressly provide for a time period during which the works must be completed, it will be implied that the Works must be completed within a reasonable period of time.

In addition, if the letter of intent falls within the definition of a ‘construction contract’ under the Construction Act, i.e. it is a contract for either carrying out construction operations, or for providing labour for the carrying out of construction operations, then it will be subject to the terms of the Construction Act and the Scheme for Construction Contracts. If there are no express terms to the contrary, the Construction Act and the Scheme will imply payment provisions into the contractual arrangement governed by the letter of intent.

Parties should be aware of these implied terms and make an assessment as to whether they are suitable for their requirements during negotiation. It may be necessary to agree upon an express term to be inserted into the letter, which will override any unwanted implied provisions.

(iv)         Contractual principles apply

In order for a letter of intent to be binding, all of the elements of a contract must be present namely: offer, acceptance, consideration, intention to create legal relations and certainty of terms.

Certainty of terms is a common issue for letters of intent as the concept does not sit comfortably with the ethos behind letters of intent, which are designed to only define the most basic terms of the agreement in advance of the full terms of the contract being entered into. It is for this reason, that where possible the draft form of contract should be annexed to the letter of intent in so far as it has been agreed.

From an Employer perspective, it will be important to ensure that the letter of intent does not go so far as to remove any impetus for the Contractor to enter into contract, or results in the Contractor hardening its bargaining position. However, if the letter of intent is too narrow, it is more likely the parties will exceed the limits, caps or timescales contained within the letter, leaving the parties without a clear contractual position.

This is often a difficult line to tread and parties may therefore wish to obtain legal advice about the terms of a letter of intent before entering into it, especially if the deal is commercially sensitive, the contract negotiations are likely to be protracted, or the contract price is high.

(v)          Signature

Finally, to ensure a letter of intent is binding, as with any commercial contract, it will need to be signed by both parties.

Common pitfalls

Following entry into a binding letter of intent, the parties cannot rest on their laurels. It is important to monitor and review the terms of the letter on a regular basis to avoid common pitfalls, examples of which are set out below.

(i)           Impact upon the Employer’s negotiating position

A letter of intent can have a detrimental effect on contractual negotiations. It is common for a Contractor to consider itself inextricably involved in the project one the letter has been signed and it is allowed access to the site to commence works, which can have the effect of hardening the Contractor’s position during negotiations.  The Contractor will naturally form the view that it will be less cost and time effective for the Employer to appoint a third party going forward.

(ii)          Loss of impetus for the Contractor to enter into contract

If the letter of intent is wide enough to incorporate a substantial portion of the Works, and is of significant value, the impetus on the Contractor to continue contractual negotiations will diminish. Negotiating the terms of a construction contract can, for larger projects, be a long process and can take up significant amounts of management time. If the Contractor is able to press on with a large portion of the value of the works, it may be less motivated to negotiate and enter into the contract.

(iii)         No binding agreement

If the parties fail to execute the letter of intent correctly, there may be no binding agreement between the parties. As a result, the contractual provisions governing the relationship between Employer and Contractor will be uncertain and in such circumstances, the courts will turn to common law principles to determine the terms on which the parties have been or are contracting.

If there is no binding agreement, and therefore no specified contract price, a court may infer that the Contractor should be paid on a quantum meruit basis, i.e. be paid a reasonable sum for the goods and/or services provided. This can present problems for both parties.

Similarly, without an express provision stating otherwise, time will be at large under the contract, meaning the Employer will not be able to claim liquidated damages if the Contractor’s works are delayed.

There is also the risk that the Employer will have limited recourse against the Contractor for defective works. Under common law principles, the Employer may only be entitled to damages up to the value required to put the Employer back into the position it would have been in had the contract been performed without defects. This is subject to a ‘reasonability’ requirement, meaning that if the damages required to rectify the defective works are disproportionate to the harm suffered by the Employer as a result of the defective works, the Employer is unlikely to be able to claim the full amount of these damages.

To seek to avoid these issues arising, an Employer is advised to sign the letter before it is issued to the Contractor.  Whilst the Employer should also then press for a signed copy to be returned by the Contractor, where the Contractor does not countersign the letter and return it, but proceeds with the works required under the letter of intent, it is likely that the terms of the letter will be deemed to have been accepted by the Contractor by conduct.

(iv)         Contractor exceeds the limits set out in the letter of intent

As considered above, a standard form letter of intent will usually include a financial ‘cap,’ and once this has been exceeded the Contractor should stop works until further arrangements are put in place. If the Employer requires the Contractor to undertake further works in excess of this financial cap, and the terms of the underlying contract have not yet been agreed, a new letter of intent should be agreed between the parties covering this additional work.

The position where the Contractor does not stop work having exceeded the financial cap is unclear, and has been the subject of a number of cases in recent years. The courts will look at a number of different elements, including the terms of the draft contract and whether the Employer authorised or was aware the Contractor had exceeded the financial cap. The overriding message from the courts seems to be that each case of this kind will turn on its facts, resulting in further uncertainty for the parties.

Recent Case Law

  • Arcadis Consulting (UK) Ltd v AMEC [2018][1]

This case concerned a dispute between a contractor (Arcadis) and a specialist concrete sub-contractor (AMEC) engaged to carry out design works to a car park. The parties entered into a letter of intent in advance of agreeing the contract.  The contract never materialised and the carpark was completed by the sub-contractor under the terms of the letter of intent. During negotiation, the parties exchanged correspondence which attached a number of different versions of a set of terms and conditions which had been agreed between the parties in connection with another project.

The carpark was alleged to be defective and in need of demolition and rebuild, at significant cost to the contractor. The sub-contractor argued that the letter of intent constituted the only agreement between the parties, that it included a financial cap of £610,000 provided for within the terms and conditions and therefore that its liability was limited to this amount.

A key question before the court was whether the terms and conditions agreed between the parties on the other project had been incorporated by reference. This would determine whether the sub-contractor’s liability for the defective works was capped at the sum stated in the letter of intent, or whether it was uncapped.

The Court of Appeal overturned the decision of the TCC which had concluded the cap had not been incorporated into the letter of intent.  The Court of Appeal considered the construction of the letter of intent and reviewed the correspondence between the parties and their conduct to reach the inclusion that the terms and conditions including the cap were incorporated.

  • Merit Holdings Limited v Michael J Lonsdale Limited[2].

This case concerned a dispute between a contractor (Merit) and a sub-contractor (MJL) in respect of the site at One Angel Court, London. The parties entered into 3 letters of intent between November 2015 and April 2016. The initial letter set a cap on the amount payable to the sub-contractor of £330,000, which was subsequently revised upwards to £430,000. The letter also included an automatic termination date of 29 April 2016. Payment was made under this agreement by the sub-contractor submitting monthly applications to the contractor.

The work exceeded the financial cap and the parties continued with the arrangement past the termination date included in the letter.  No further contractual documents were put in place to govern the terms of the subsequent work undertaken by the sub-contractor. Further, the sub-contractor continued to submit applications, and the contractor continued to pay the sub-contractor under these applications, in accordance with the terms of the exhausted letter of intent.

A payment dispute arose and the parties began a series of adjudications, with the sub-contractor eventually applying to court under the Part 8 procedure to enforce the decisions. The sub-contractor’s position was that the contract which existed between the parties did not include the financial cap contained in the letter of intent, and the sub-contractor was therefore entitled to recover the full value of all additional works undertaken.

The court concluded that there was no evidence of any agreement to remove the financial cap and no evidence from the parties conduct that they had agreed on payment on a cost basis for work in excess of the cap.  The most obvious inference to be drawn from the parties conduct was that after 29 April, payments would continue to be made for the value of work done.

As the contract sum has been agreed, it was commercially sensible that the sub-contractor would continue to be paid in excess of the cap on the basis of the contract sum and the parties could be taken to have reached agreement to that effect.

Summary

These cases act as a pertinent reminder of the dangers and uncertainty that can arise where a binding contract is not in place. The Arcadis case was appealed to the Court of Appeal which undoubtedly involved significant time and costs on behalf of both parties, for what was a relatively small project. Similarly, Merit involved several adjudications and a court application between the parties before the matter was resolved.

The overriding message must therefore be that to avoid disputes and potentially complex litigation about the terms of a letter of intent, parties should ensure the terms on which they are contracting are clearly defined.  The unpredictable approach adopted by the courts emphasises the reasons why parties should avoid letters of intent where possible.

Where letters of intent are required, obtain legal advice on the terms, which often require careful drafting and consideration of the facts of the particular matter.

Where a letter of intent has been entered into, parties should monitor its terms and any financial caps and time limits contained within it.

For further information and advice about letters of intent, please contact Jennifer Hurley in our Construction and Engineering team.



[1]                 Arcadis Consulting (UK) Ltd v AMEC (BCS) Ltd [2018] EWCA Civ 2222

[2]                 Merit Holdings Ltd v Michael J Lonsdale Ltd [2017] EWHC 2450 (TCC)

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