Reckon you understand LOI’s

What is a letter of intent? Letters of intent are used in construction and engineering projects to allow the employer to mobilise a contractor before the employer is in a position to enter into the full building contact. The letter may only instruct the contractor to progress design and procurement in relation to the project, or it may authorise works to be commenced on site.Letters of intent vary in their form and complexity. A very simple letter of intent might only confirm a party’s present intention to enter into a contract for construction works in the future. In the absence of anything else, such a letter forms nothing more than a non-binding statement of present intention, akin to a comfort letter. However, most forms of letter of intent used for modern construction contracts are much more complex and seek to create contractual relationships between the parties. See Turriff Construction v Regalia Knitting Mills (1971) 9 BLR 20 (not available in Lexis®Library).Modern letters of intent usually set out the employer’s intention to enter into a contract with the contractor for construction works, and will set out the terms on which the contractor is authorised to commence works on site/undertake design work/pre-order materials etc before the main contract is executed. It is common for parties to include a limit on the value of the works permitted under the letter of intent and to express a date on which the instruction under the letter terminates. It is, however, also common for parties to subsequently fail to enter into a full building contract after signing a letter of intent. This can lead to uncertainty as to the terms that govern the parties’ relationship, and, as such, letters of intent have generated vast amounts of litigation over the years.‘Letter of intent’ does not have a precise legal meaning. Therefore, calling a document such does not mean that it will necessarily have the status in law that the party drafting it intended—and it is often the case that letters of intent ‘create many more problems than they solve’.In this Practice Note, the terms ‘contractor’ and ’employer’ are used, however the principles also apply to an arrangement of this type between other parties, eg a contractor and a sub-contractor.Why would a letter of intent be used? Given the potential for disputes arising out of letters of intent, the best advice for both parties is not to enter into one and to avoid entering into any contractual arrangements until all of the proposed contract terms have been agreed and it can be executed. However, it is often desirable, or even necessary, for parties to commence procurement and other activities before completion of the full contract documentation. There are various circumstances in which the parties may agree to proceed under a letter of intent:• it may be necessary to commence construction on site in order to prevent the expiry of a planning permission or for particular tax reasons• the contractor may not be willing to hold its current tender price unless it receives an instruction to mobilise before a certain date• the developer may not be able to award a full building contract until it has entered into a contract with a tenant or a purchaser of the proposed development, but wishes to safeguard the planned completion date• the developer may wish to complete construction by a certain date and, in order to achieve this, the contractor needs to commence construction even though all of the terms and conditions of the building contract have not been agreed• a letter of intent may instruct a contractor to place orders with key sub-contractors. This may be to ensure that prices do not rise or that long lead-in times do not extend the planned completion dateLegal issues arising out of letters of intent Litigation arising out of letters of intent is very common. Letters of intent are intended to be brief, and they therefore do not include all of the contractual machinery that the parties would include in the full contract. As illustrated in this Practice Note, this often leads to disputes about whether certain terms of the intended main contract have been incorporated, and in many cases the parties have disputed whether the letter of intent itself is a binding contract at all.In simple terms, a letter of intent could fall into any of these categories:• a non-binding letter stating one party’s intention to enter into a contract at a later date, ie a ‘comfort letter’• an ‘if’ contract whereby the letter of intent is an offer which is capable of acceptance to form a contract, ie the employer requests the contractor to carry out works/perform services, and if the contractor does so, it will be remunerated for the work/services—this is sometimes referred to as a ‘letter of instruction’• a binding agreement creating legal obligations regulating all the proposed works/services (which may or may not incorporate all the terms of the main contract the parties intend to enter into in the future), or only those works/services authorised under the letter of intentThe legal status of any letter of intent will be determined by the precise wording used and the facts of the particular case. It is very difficult to predict with any certainty how a letter of intent will be construed by a court in the event of a dispute.RTS v Muller, which went all the way to the Supreme Court, is a good illustration of the potential for uncertainty around letters of intent. Müller engaged RTS to install new production lines at one of its dairy product factories. RTS and Müller entered into a letter of intent and RTS proceeded to carry out the works. The letter of intent expired, but the parties continued to progress negotiations and agreed contractual terms based on the MF/1 form (but not all of the schedules to be attached), and the price. The contract was never signed and once defects became apparent at the factory the parties disputed the correct terms of the contract. At each stage, the courts reached a different conclusion:• at first instance, the Technology and Construction Court (TCC) held that there was a contract, but with limited provisions (which did not include the MF/1 terms—this was detrimental to RTS, as limitations on liability in the MF/1 terms did not apply)• the Court of Appeal held that there was no contract between the parties• the Supreme Court held there was a contract between the parties on the MF/1 termsIn Spartafield v Penten, the court held that a binding letter of intent had been replaced by a construction contract, even though the contract had never been signed, as the key terms of the contract had been agreed. See News Analysis: Unexecuted JCT contract replaces letter of intent (Spartafield v Penten).Letter of intent—a binding contract? The basic rules applying to formation of a contract will apply when determining whether or not the letter of intent is a binding contract:• offer—the letter of intent itself is often identified as the offer• acceptance—the contractor may accept the offer expressly by signing and returning the letter of intent, or by conduct by commencing the activities stated in the letter of intent. For example, in Arcadis v AMEC the court considered that the best evidence of a binding contract between the parties was a letter of intent followed by the carrying out of the works set out in the letter. See News Analysis: Court of Appeal holds that liability cap had been incorporated into contract (Arcadis v AMEC)• consideration• intention to create legal relations—there is a rebuttable presumption that two commercial parties intend their agreement to be legally binding. Where the works have been carried out, the court may readily find that there was an intention to create legal relations (Trentham (G Percy) Ltd v Archital Luxfer Ltd [1993] 1 Lloyd’s Rep 25—not available in Lexis®Library)• certainty of terms—where a fundamental term has not been agreed there may be no binding contractCertainty of terms There are numerous letter of intent cases where failure to agree key terms has led the court to conclude that a letter of intent is not a binding contract.A commonly cited example of a case where a letter of intent was held not to be binding is British Steel v Cleveland Bridge. British Steel was a steel manufacturer and Cleveland Bridge had won a tender for steel fabrication works in the construction of a building. Cleveland Bridge sent a letter of intent to British Steel, which recorded its intention to enter into a contract with British Steel for the supply of cast-steel nodes. British Steel did not respond to the letter of intent, but there were subsequent discussions on the specification of the nodes and changes to British Steel’s quotation. The parties did not agree full contract terms. British Steel continued to produce the nodes but there was a delay to delivery. Cleveland Bridge refused to pay and British Steel claimed on the basis of quantum meruit. Cleveland Bridge counterclaimed, contending that a binding contract had been created by the various documents, especially the letter of intent, and by conduct as British Steel had proceeded to manufacture the nodes. Cleveland Bridge claimed damages for breach of contract for delay and delivery out of sequence.The court held that there was no contract—it was neither an ordinary executory contract where the parties have reciprocal obligations to each other, nor was it an ‘if’ contract where the letter amounts to an offer capable of acceptance. The parties had been unable to come to agreement on price, specification and other essential terms. Therefore there was no contract and British Steel could not be liable for damages for delay, and were entitled to be paid on a quantum meruit basis.What are considered to be the key terms of a contract will be a matter of fact in any case, but price is very likely to be considered a key term. In Courtney and Fairbairn v Tolaini Bros Hotels, Lord Denning held that where price was yet to be agreed, the letter was too uncertain as to have binding force, as price is ‘so essential a term that there is no contract unless the price is agreed or there is an agreed method of ascertaining it’. The letter of intent was held not to be a binding contract, only an agreement to negotiate fair and reasonable contract sums. See also Merit Process Engineering v Balfour Beatty where a difference of agreement in price between the parties of £37,500 could not, in the judge’s view, be held to be ‘de minimus or otherwise non-essential’.Consequences of a non-binding letter of intent If the letter of intent is not binding, there is effectively no contract between the parties and the letter of intent is said to be only a ‘comfort letter’. This can have negative consequences for the employer.Where there is no contract, time becomes ‘at large’ and the contractor will only have to complete the works in a reasonable time (see Practice Note: Time at large in construction contracts). This means that the employer loses any entitlement it may have thought it had to claim liquidated damages for delay to completion of the works because there is no longer a completion date from which damages will run—it can only claim general damages for late completion if the contractor fails to complete in a reasonable time. The employer would have to demonstrate that the amount of time taken by the contractor to complete the works was not reasonable.If there is no contract, it does not however then follow that the contractor is not entitled to payment. The employer may be ordered to pay the contractor for the work performed on a quantum meruit basis, or as a restitutionary claim to provide a remedy for the contractor. In a quantum meruit claim, the contractor claims a reasonable sum, ie the amount that it deserves, taking into account the works or services that it has performed. See Practice Note: Quantum meruit in construction.In addition, if there is no contract to govern the contractor’s works, then the contractor cannot be in breach of other contractual provisions that the employer may have believed applied. For example, the contractor cannot be in breach in respect of defects (although defects could affect a quantum meruit claim). It is therefore usually in the employer’s interests for the letter of intent to be a binding contract. From the contractor’s perspective, however, the contractor may lose the benefit of caps on liability (or other exclusions of liability) that would have been applicable had the full contract terms been held to apply.Subject to contract Parties often include the words ‘subject to contract’ in letters of intent where the employer wants the contractor to commence work, but the contract terms which will apply to the works are yet to be agreed. Including these words, however, does not automatically guarantee that the letter of intent is not a binding contract—the court will look at the parties’ conduct and the other provisions of the letter, which may indicate that the parties have entered into a binding contract. The parties may be held to have waived the subject to contract requirement applying the ‘reasonable honest business man’ test as the Supreme Court held in RTS v Müller (see also Global Asset Capital v Aabar Block, News Analysis: Court of Appeal overturns refusal to strike out as no enforceable agreement (Global Asset Capital v Aabar Block S.A.R.L.)).Can the letter incorporate the full contractual terms? A letter of intent may be held to incorporate all of the terms of the intended main contract, even if the main contract is never signed. This can occur where the proposed contract (including any amendments and other project specific matters) has been included as part of the tender documentation or other correspondence, or where negotiations have progressed after issue of the letter of intent, and there are no other essential matters for the parties to agree.In Bryen & Langley v Boston, a letter of intent was issued for works to a residential property stating that the contract would be executed under the JCT 98 form, but the contract was never signed. When a dispute arose over payment, Bryen referred the dispute to adjudication under the rules in the JCT 98. Boston argued that Bryen was not entitled to do so, as the JCT 98 terms did not apply to their agreement. The Court of Appeal held that, on the facts, the details included in the tender and the letter of intent meant that the parties had agreed all of the terms by the time Bryen started work, including the JCT 98 terms, and therefore the adjudication provisions could be enforced. Formalisation of the JCT contract was not a condition precedent to the bargain between the parties. At first instance, the TCC held that although a contract may have been formed between the parties, the letter had not incorporated the JCT 98 terms therefore the HGCRA 1996 residential occupier exclusion applied, and so the right to refer disputes to adjudication would not be implied into the contract.In Harvey Shopfitters v ADI, the Court of Appeal confirmed that where a letter of intent envisages the parties executing further contractual documentation, this does not prevent the court from concluding that a binding contract has been entered into (provided all the necessary ingredients of a valid contract are present). In that case, the letter of intent provided: ‘If, for any unforeseen reason, the contract should fail to proceed and be formalised, then any reasonable expenditure incurred by you in connection with the above will be reimbursed on a quantum meruit basis’—although the contract was not signed, the contractor’s claim for payment on a quantum meruit basis failed and the court held that the parties had concluded a lump sum contract on the basis of the JCT contract. See also Stent v Carillion and the Supreme Court’s decision in RTS v Muller where it held that the terms that had not yet been agreed by the parties were not essential to concluding that the MF/1 terms applied.Whether or not the letter of intent incorporates the intended main contract conditions, or whether it stands as a contract on its own terms will depend in each case upon the wording used in the letter of intent and also on the conduct of the parties. In contrast to the cases above, in numerous other cases the courts have held that terms of the intended main contract have not been incorporated by the letter of intent. In Diamond Build v Clapham Park Homes, for example, the letter of intent confirmed Clapham Park’s intention to enter into a contract with Diamond Build on the JCT Intermediate Form of Building Contract (2005 edition). Works proceeded, but later Clapham purported to terminate the engagement before the contract was ever signed. Diamond Build argued that Clapham Park was not entitled to terminate its engagement under the letter of intent, on the basis that the JCT contract applied, and therefore the JCT procedures had to be followed. The court disagreed, holding that the full JCT contract did not apply, the letter of intent itself had enough certainty and bound the parties until they entered into the JCT.Whether or not the full contract terms or the terms of a letter of intent apply has also created many difficulties in determining the appropriate method of dispute resolution, increasing the length of disputes and costs. For example, in Twintec v Volkerfitzpatrick, the court granted a rare injunction restraining an adjudication. The letter of intent between the parties stated that the works would be carried out ‘in accordance with various documents’, including the DOM/2 terms. Volkerfitzpatrick applied to the RICS to appoint an adjudicator using the procedure specified in the DOM/2 contract. However, the court concluded that the DOM/2 terms were not incorporated as a whole. Twintec was obliged to carry out the works so as to comply with the documents referred to in the letter of intent in a manner that did not put it in breach of the DOM/2 terms, but terms such as the disputes provisions were not incorporated into the letter of intent—such a term was not necessary to give business efficacy to the letter.Similarly, in Merit Process Engineering v Balfour Beatty, Merit had proceeded under a letter of intent, the permitted value of works under which was increased to £1.6 million, and was stated to be subject to contract. The court held that, on the facts, the draft sub-contract did not apply to works carried out. Therefore Balfour Beatty could not rely on the arbitration clause included in the sub-contract.In Spartafield v Penten, the court held that the JCT Intermediate Contract 2011 conditions governed work carried out pursuant to the letter of intent, even though this was not expressly provided in the letter of intent. This was for several reasons, including that the letter of intent was based on a costs plan which followed the conditions. However, any conflicting terms of the letter of intent took precedence over the conditions and either party could withdraw at any time. The court distinguished Twintec v Volkerfitzpatrick, noting that each letter of intent must be construed on its own terms. See News Analysis: Unexecuted JCT contract replaces letter of intent (Spartafield v Penten).In Arcadis v AMEC, the Court of Appeal, overturning the decision of the TCC, held that a contract based on a letter of intent incorporated draft terms and conditions set out in a separate document, which were intended to form part of a protocol agreement which never materialised. The court considered that, as the designer had accepted the letter of intent by conduct, without any objection, it followed that it had agreed to all of the terms of the letter of intent. The court also drew a distinction between the interim contract (being the letter of intent and its acceptance) and the final agreement (the protocol agreement). See News Analysis: Court of Appeal holds that liability cap had been incorporated into contract (Arcadis v AMEC).Commercial problems with letters of intent In addition to the potential for legal disputes to arise, there are also commercial drawbacks to using a letter of intent, particularly for the employer. Perhaps most significantly, the employer’s bargaining power is considerably reduced once a letter of intent is agreed. If the final contract sum is still to be agreed, the contractor will realise that it is no longer in an open competition once the letter of intent is signed and, as a result, is unlikely to be as flexible on price and terms as it would have been. Where works on site have commenced, it will become increasingly difficult (and inconvenient) to remove the contractor. In addition, where key sub-contractors have commenced works prior to the selection of the contractor, the contractor may refuse to be responsible for this work, fearing that such work may lead to claims not allowed for in the contract sum.From the contractor’s perspective, it could also find that in accepting a letter of intent it may, inadvertently, agree to the inclusion of standard terms even though it may be intending to reject certain clauses in negotiations for the main contract.It is also often the case that the parties lose the impetus to agree the contract once a letter of intent is signed, extending the time to conclude negotiations and in some cases leading to the parties failing to agree the contract at all. Ampleforth Abbey v Turner & Townsend is a salient reminder of the dangers of entering into successive letters of intent without signing the full contract:Ampleforth had engaged Turner & Townsend as its project manager in relation to building works at the college. Kier was to be the contractor under a JCT contract, which contained a liquidated damages clause. Execution of the building contract was delayed and Kier was appointed under a series of letters of intent, all of which stated that the parties were not bound by the terms of the JCT contract until it was executed. Eventually all of the work was completed under the letters of intent. The works finished late and Ampleforth tried to claim liquidated damages from Kier as per the terms of the draft JCT. Kier counterclaimed and the dispute was referred to mediation. The dispute was settled, but Ampleforth had to agree that no damages were payable due to the fact that the letters of intent contained no damages provisions.Ampleforth brought a claim against Turner & Townsend for breach of contract and negligence. The court held that Turner & Townsend was in breach of its duties by failing to advise Ampleforth of the dangers of allowing the works to proceed using letters of intent and by not encouraging Kier to sign the contract. Had they done so, Ampleforth may have been able to succeed in its claim for liquidated damages.Alternatives to letters of intent As an alternative to a letter of intent, the parties may consider entering into a full contract (eg using a simple form of contract such as JCT Minor Works, or the form of contract proposed for the main contract) which only covers the preparatory works/ordering of materials. If completed correctly, this removes the uncertainty of a letter of intent being held not to be a binding contract. Any works/services performed and costs paid under this contract should be subsumed into the main contract when the main contract is completed in the same way as a well-drafted letter of intent should.From the inception of the project, the employer can reduce the possibility of needing to use a letter of intent by selecting the appropriate procurement route. For example, if the employer’s key concern is time, entering into a design and build arrangement may be a better alternative to traditional procurement, as the employer’s design team does not have to have completed the design before the contract is entered into (although of course design and build has its own drawbacks such as the loss of control over quality—see Practice Note: Design and build procurement). Management contracting can also be a viable alternative to traditional procurement where commencing works quickly is a priority, as works and design can proceed simultaneously (see Practice Note: Management contracting).Increasingly, employers are using a two-stage tender approach when procuring construction works, ie the employer selects one contractor for the first stage and then works with them during the second stage, while the contractor calculates its final tender price for the works. This allows the contractor to input on the design, buildability and value engineering aspects of the project while arriving at its final price for the works—but the employer is not committed to entering into the building contract with the contractor. See Practice Note: What is two-stage tendering?. If this is the route the employer has selected, a pre-construction services agreement should be used to document the parties’ relationship before the building contract is entered into, rather than a letter of intent (see Practice Note: Pre-construction services agreements). Pre-construction services agreements are much more detailed than letters of intent, and are more akin to a consultant’s appointment.Standard forms If, having weighed up the risks, the parties wish to proceed under a letter of intent, standard forms are available. The City of London Law Society (CLLS) published a standard form letter of intent in 2005. A copy is available on its website. If this is used, some amendments will need to be made to ensure it is up to date. See Precedent: Amending the CLLS Standard Form Letter of Intent.For bespoke Lexis®PSL Precedent letters of intent, see: Letter of intent—construction—employer friendly and Letter of intent—construction—contractor friendly.Limits in letters of intent To protect both parties, it is important that any letter of intent is carefully drafted so as to be a binding contract. Caps on the sums payable under the letter and an expiry date are also advisable. See Letter of intent—construction—contractor checklist and Letter of intent—construction—employer checklist for drafting tips on how to prepare a binding letter of intent and the core clauses it is advisable to include.In practice, the parties should be careful not to allow the works to continue beyond any limits contained in the letter of intent regarding time and cost. If the employer allows the contractor to continue where the value of works permitted by the letter has been exceeded, or the termination date for the letters has expired, the employer risks having to pay the contractor for the works carried out on a quantum meruit basis (see Practice Note: Quantum meruit in construction).On the other hand, from the contractor’s perspective, the contractor may not get paid if it continues to incur costs in excess of the stated maximum limit without the employer’s written authority. In the case of Mowlem v Stena Line, the parties had entered into a number of successive letters of intent. The parties agreed that each letter was an ‘if’ contract as per British Steel v Cleveland Bridge, ie Mowlem was offered the work and if it accepted it and carried out the work, Mowlem was entitled to payment. The final letter limited Mowlem’s entitlement to payment to £10m. Mowlem continued to carry out work in excess of £10m and argued that it was entitled to payment on a quantum meruit basis above the limit. The court disagreed, holding that the final letter of intent governed the relationship between the parties and noting that it made no commercial sense to include the cap if Mowlem could avoid this by simply carrying on the work. See also Monk Construction v Norwich Union Life Assurance Society (1992) 62 BLR 107—not available in Lexis®Library, and Diamond Build v Clapham Park Homes.

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