The Continuing Dangers of Acting on Letters of Intent

Letters of Intent (LOI) are much used by parties at the start of their contractual relationship – usually where there is a need to place orders or start work but the contract and its terms have not been fully finalised. They are either a mini contract in their own right (if legally binding) with all the issues that brings, or not legally binding and represent nothing more than an expression of the parties’ aims and objectives.  

LOI have come before the court on two occasions in recent weeks, reinforcing my view that, wherever possible, it is better to focus on finalising a contract than starting a relationship based on a LOI.

Spartafield Limited  -V-  Penten Group Limited

This first case came before the Technology and Construction Court following on from an initial decision by an adjudicator.  The parties had entered into a binding LOI to enable the supplier to place orders – and each agreed that following the LOI they would negotiate and agree the terms of the final contract.  The issue that arose was whether or not this LOI had been superseded by a JCT intermediate building contract 2011 edition (ICD2011). There was lengthy correspondence between the parties attempting to finalise the end contract on ICD2011, but the ICD2001 had not been signed.

Arcadis Consulting (UK) Limited -V- AMEC (BSC) Ltd

This second case came before the High Court and related to a design contract. The Claimant was employed to carry out design works. There was an allegation that the building was defective and the question then arose as to whether the work that was carried out by the Claimant caused the defects and if it did whether the Claimant’s liability for losses was in any way limited.  This in turn depended upon the contractual terms that had been agreed between the parties. There was extensive correspondence between the parties which commenced with a letter confirming instructions to the Claimant to proceed with the work and enclosing various terms and conditions.  Further versions of the terms and conditions followed (each with differing terms in – including different liability clauses).  The Claimant’s case was that there had been a concluded contract with a term limiting its liability.  The Defendant disagreed.

The Courts’ Conclusions

Each case was decided on its own facts. However, in coming to their conclusion, each Court applied the principles set out in the case of RTS Flexible Systems Limited -V- Molkerei Alois Müller Gmbh & Co KG in ascertaining whether or not there was a binding contract between the parties and if so what the terms of that contract might be. The RTS case supports the principle that a contract is concluded when the facts of the case show that the essential terms of the contract have been agreed between the parties (based on the objective assessment of the correspondence and facts of the case by an honest and reasonable businessman).  Note that it refers to essential terms, not all terms.

The application of these principles to the facts of each case led to the Courts making the following decisions:

Spartafield Limited -V-  Penten Group Limited

• the parties did originally operate on the basis of the LOI, and

• the LOI was subsequently superseded by the ICD2011 despite the contract not being formally executed in accordance with the anticipated methods of execution of the standard form JCT contract, and

• there was a concluded contract even though all of the terms had not been agreed as it was possible to distinguish between the terms that were a precondition of the formation of any contract and those which were not.

Arcadis Consulting (UK) Limited -V- AMEC (BSC) Ltd

• there was a simple binding contract between the parties (acceptance being evidenced by the Claimant’s conduct in undertaking the work rather than by any specific correspondence), and

• there had been no agreement on the terms sent back and forth between the parties – so none of those terms formed part of the contract, and

• there was therefore no limit on the Claimant’s liability for any defect (even though all sets of terms exchanged by the parties contained such a limit).

Lessons to Learn

Both cases show that it is important for both parties that the terms of any contract are clearly set out and agreed.  Whilst it is not unusual for work to be commenced on the basis of an LOI whist negotiations continue, it is important that the parties understand the risks in doing so. On the one hand they may end up with a contract which does not contain the provisions that they expect, alternatively a contract may be concluded by the parties’ conduct which again may not suit their purpose.  Clear correspondence and clarity on actions is always the best way. And, in so far as LOI and contracts are concerned consider carefully the advice of Lord Clarke in the RTS case

“The moral of the story to is to agree first and to start work later.”