Do you agree with the following definition:
"A Letter of intent is usually a unilateral assurance intended to have contractual effect if acted upon, whereby reasonable expenditure reasonably incurred in reliance upon such a letter will be reimbursed". (Hall & Tawse v Ivory Gate (1998))?
Or this one:
"a preliminary agreement negating legal binding force" (Furmston,1999)?
There is no correct answer: the effect of a letter of intent will depend on how it is drafted and the surrounding circumstances.
Letters of intent are used to require contractors to commence works, so that time is not lost while full contractual terms are being agreed. (This article refers to employers and contractors but equally applies to contractors and subcontractors).
Understandably, employers are reluctant to send draft letters of intent to lawyers for comment as they know that their lawyer will first lecture them on the dangers of failing to negotiate, agree and sign up to a comprehensive, beautifully bound contract complete with specification and drawings before the contractor sets a boot on site.
Such lectures are of course commercially unrealistic as timescales are tight and contractual negotiations are lengthy: no tender is accepted unqualified and no project can afford 6 months of inactivity while a contract is being negotiated. However, steps can be taken to minimise the risks of letters of intent, and the first step is to understand the purpose of the letter.
What should employers and contractors expect from a letter of intent?
This depends on the reason why a letter of intent is being used in place of a contract. If the contract is agreed but time is needed simply to put the documents together, engross them and execute them, (this can take a surprisingly long time!) then there is no real disadvantage in using a binding letter of intent. In this situation the key is to incorporate the terms of the agreed contract in the letter so that if the formal document is never signed, there is evidence that it is nevertheless binding.
This should also apply if the outstanding points to be negotiated are, in the minds of the parties, inessential to the contract.
To avoid subsequent judicial doubt that the incorporated contract document was binding, the employer should act in accordance with that document throughout the project: making payments in accordance with those terms, referring to the correct clauses where notices are given and so forth.
If the letter of intent is binding, remember that the payment and adjudication provisions in the "Construction Act" will apply.
The undesirable situation is needing work to commence urgently while major terms are still to be agreed, such as: should there be a cap on the contractor's liability? Here, a letter of intent should be non-binding so that relations can be terminated without grounds or notice if an impasse is reached on negotiations.
Another situation calling for a non-binding letter of intent is where the project may be aborted (eg because planning permission is not granted) or where the contractor may not eventually be selected for the work.
The risk of a non-binding letter of intent is that if a contractor continues to work beyond the maximum sum in the letter on the instructions (or in the knowledge) of the employer, the letter of intent may not cover the further work. The employer will be exposed to a quantum meruit claim if a contract is never concluded.
Current law
Humphrey Lloyd LJ recently summarised the relevant law in the case of Durabella Ltd v J Jarvis & Sons Ltd [2001]. These are the four key points:
- "… where a ‘letter of intent' authorises work, materials or services to be provided pending the conclusion of some further agreement it will, if accepted, constitute a contract (or part of a contract) for what it requires.
- "The ‘letter of intent' may never be supplanted by a further agreement. It will be the contract for the work."
- "… in a commercial relationship the court will try to establish a contract since that would be consistent with the parties' presumed expectations."
- "On the other hand a contract cannot exist unless it is clear that, viewed objectively, the parties were in fact agreed on all the matters which they considered necessary and which are necessary to form a contract."
In this particular case:
- The scope of work was established;
- The rate was agreed;
- The programme had yet to be agreed but it was not considered to be a problem;
- Durabella's reply to the Letter was clearly an acceptance: it did not constitute a counter-offer as there was nothing in it which was inconsistent with Jarvis' letter;
- The formal order was postponed solely so that Jarvis could record the results of a measurement survey, ie the quantity to be paid for at the agreed rate.
This conclusion was helpful to Jarvis as the binding nature of its letter of intent meant that it had successfully incorporated the terms of DOM/1 and could rely upon a pay-when-paid clause in that form.
A letter of intent will be non-binding when:
- The intention to create legal relations is excluded;
- There is an express reference to the fact that the execution of a further document is required and that this is a condition of any contract between the parties;
- There is a statement that essential terms are still to be agreed;
- A "subject to contract" heading or clause is used;
- If there are execution provisions for the contractor, then these do not indicate an acceptance of an offer;
- There are no other presumptions to the contrary – eg incorporation of "Construction Act" provisions indicates a belief that the letter is a "Construction Contract"
A well-drafted letter of intent
A well-drafted letter of intent (binding and non-binding) should:
- Specify a "maximum sum" which will be paid to the contractor in respect of authorised works carried out and materials ordered, and say that any work carried out in excess of that maximum sum will be at his own risk. (Once the sum is reached, the employer should not knowingly allow the contractor to carry out further work or order more materials. If further work is required a variation letter increasing the maximum sum in the letter of intent should be issued. Conversely, the employer can not use the maximum sum as an excuse not to pay the contractor if the employer himself has instructed the further works);
- Contain a clear description of the authorised works/materials/services, and make it clear that all such work and materials are included in the maximum sum;
- List the contract documents that will eventually form the contract – eg drawings, specifications, correspondence, form of contract;
- Either list the final points under negotiation (and indicate if they are essential) or state that the documents listed in the bullet point above are agreed and that engrossments are being prepared;
- Include an obligation to execute the contract documents;
- State what happens upon execution – eg payments made under the Letter are to be on account, and the terms of the contract are to apply to the subject matter of the Letter;
- Include a copyright clause;
- Include a termination clause.
If you really want to make your lawyers happy however, there is no substitute for a signed contract!
For further information please contact Vanessa Hall at vanessa.hall@cms-cmck.com or on +44 (0)20 7367 2670.
