Letter of Intent – The Need to Know

This article considers some of the merits and potential pitfalls of proceeding with construction works under a Letter of Intent.

The practice is fairly commonplace, but it is worth noting at the outset that best practice will always be to agree terms and conditions and sign a contract before commencing works. As Lord Clarke once said when considering the perils of beginning work without agreeing terms, “The moral of the story is to agree first and start work later”.

That said, the Letter of Intent does serve a practical purpose (as considered below), but parties must be careful to get the drafting right and be certain of the contractual position, otherwise they risk facing a number of problems down the line.

What are they and why might you need one?

Starting with the basics, a Letter of Intent is a written document recording the terms under which a party (say a contractor) will conduct certain works prior to entering a contract. These might be preparatory works or involve the procurement of materials, but can even extend to starting the intended contract works.

There are several reasons why this might be necessary, but it will typically be that the parties have not yet been able to finalise all the intended terms of their contract and are under pressure to get started with the works, possibly from the employer or due to a need to complete by a certain date.

What is the legal effect of a Letter of Intent?

A Letter of Intent may of itself be considered a form of contract between the parties. This will depend on whether it is considered “binding” upon the parties, which it will be if it includes all the features of a contract.

A binding Letter of Intent will usually provide the parties with increased certainty on important matters, such as the extent of works to be completed and the terms of payment. If parties do wish for the Letter of Intent to be binding, they would be well served to expressly state as such in the letter and ensure it is signed by both parties.

The Letter of Intent should make clear what terms govern the works to be carried out, and will ordinarily provide that once a final contract has been agreed, the terms of that contract will apply retrospectively to those works and supersede the Letter of Intent.

What should you include?

Letters of Intent can address many of the same issues that will ultimately be included in the final contract. Indeed, a good Letter of Intent will include many similar terms to the final contract and specifically list the matters which remain to be agreed between the parties.

While the contents of a Letter of Intent will to some extent be project-specific, there are certain key inclusions that we would always recommend to avoid a nasty surprise later. These include:

• Scope of works – making clear what works are covered by the Letter of Intent;
• Adequate payment mechanism – giving the contractor certainty of payment;
• Cap on total payment under the Letter of Intent – helping to avoid a scenario whereby extensive works are completed and payments made without agreeing a final contract;
• Standard of care – should be the same as the standard intended for the final contract to ensure consistency in the quality of works completed throughout the project;
• Expiry date and provision for renewal – again encouraging agreement of contract but avoiding a “limbo” scenario if the letter is approaching expiry but contract still not agreed;
• Termination provisions – it is perfectly plausible that a party may materially breach the terms of a binding Letter of Intent, in which case provisions for termination will be desirable;
• Boilerplate clauses – such as governing law, third party rights, dispute resolution, insurance, and copyright licencing. These are equally as important in a Letter of Intent as they would be in any other construction contract.

It is particularly important to keep an eye on any expiry date or cap on total payment included in a binding Letter of Intent, as if they are overlooked and exceeded, the terms of the Letter of Intent may not apply to works completed and payments made thereafter.

What could possibly go wrong?

Problems will usually arise when parties fail to make certain some aspect of their agreement. A common example is when the Letter of Intent expires but a final contract has not yet been agreed. Conversely, parties may unintentionally enter a final contract and no longer be able to rely on the terms of the Letter of Intent.

As hinted at previously, parties may find themselves in “limbo” when a Letter of Intent expires before a final contract has been entered. There will then be a question of what terms apply to works completed during this time, which is potentially detrimental to both parties. For example, the contractor will have no certainty as to his entitlement to payment for those works, while the employer may no longer be able to rely on a previously agreed standard of care.

It is possible, through correspondence and conduct, for parties to unintentionally enter a contract and be lumbered with terms that do not fully reflect their intentions. They will then need to determine whether that contract supersedes the Letter of Intent in respect of its scope of works. Parties can avoid this scenario by making clear that all their discussions are in contemplation of and subject to the agreement of a contract.

Conclusions

Letters of Intent, if used properly, can be a useful solution to a common problem where parties are still concluding contract negotiations but works are required to start. However, failure to make the terms clear can lead to uncertainty and expose both parties to risk. The difficulty in identifying what the terms are between the parties will often be fertile ground for dispute in matters such as payment and the rectification of defects, which are typically dealt with much more clearly in a formally agreed contract.

For more information about Letters of Intent, or if you would like assistance with the preparation of any construction contract documents, feel free to contact our David Rintoul at drintoul@clarkslegal.com.