Letters of Intent…
The Best of Intentions
A letter of intent, or LOI, is a document, that is usually issued by the employer but is also used further down the supply chain from say the contractor to sub-contractor etc. Letters of intent generally demonstrate an interest in entering into a contract for construction works. They are often used where the project is ready to begin, but some elements in the formal contract documentation have yet to be agreed by the parties.
In such situations, a quick start might be advantageous to both parties, and so work may begin under a letter of intent.
Deal or No Deal?
One of the first issues to understand before you begin working under a letter of intent, is whether the letter can be considered to be a binding contract. In order for a contract to exist, it must contain three elements: offer and acceptance, intention, and consideration.
In addition, there should also be certainty over what is being contracted. Lawyer, Sarah Fox describes certainty as ‘the villain’ in the formula. A lack of certainty is often the cause of arguments and ultimately, costly legal bills. Often when folk think they have reached certainty in a contract, they have not.
In many cases, the result of the employer issuing a letter of intent, and the contractor beginning the works will mean a contract has been formed.
Should your letter of intent contain the phrase ‘subject to contract’ it may be the case that no binding contract has been created at all. In these cases, the letter of intent may be making clear that negotiations are still ongoing.
However, just adding the phrase ‘subject to contract’ is not enough to remove the possibility of a contract being entered.
In the case of RTS Flexible Systems Ltd v Molkerei, the courts found the parties had entered into a contract through their actions. This included carrying out the works, making payments, and variations to the works.
Uncertain and Ambiguous
The main risk of working under a letter of intent is uncertainty. What happens once the initial works are completed? What elements are not mentioned in the letter that would normally be defined in the contract?
Negotiating construction contracts may be a lengthy process. With both parties usually eager to get work started, both will want the contract signed as soon as possible. But if work begins under a letter of intent, this urgency can often diminish.
This, in turn, can mean the parties take their foot off the gas in contract negotiations. Ultimately, it may lead to a situation where initial works end. But without a clear scope in the letter of intent, the contractor may just continue working on the project. This may lead to a lack of direction or any contractual certainty as to what they should be doing.
At this point, it will be unclear what the contract terms are. Any work a contractor completes must be paid for, but the price for work will have to be decided retrospectively. If costs cannot be decided by the parties, the courts may need to step in.
Regardless of the outcome, disputes are costly and time-consuming for all involved. Avoiding any ambiguity should be a priority whether you are the employer, contractor or otherwise.
Don’t Miss Out
There are a number of issues which crop up in relation to letters of intent.
The first thing to look out for, before beginning work, is whether the scope of work is clearly defined.
Sometimes the finalisation of the design and specifications is one of the areas holding up the full contract. Or as the negotiations develop, so too can the project plans. This is why it is vital that any works completed under a letter of intent have a clear scope of work. This will ensure that both parties are clear on the requirements, and what work the letter covers.
It is also important to identify some key facts, such as the parties involved, the amounts to be paid, the dates for starting and completing works under the letter, etc. Failure to miss some of these basic elements can lead to costly confusion at a later date. Another point to consider is capping expenditure under a letter of intent. A cap may help to focus the mind of the parties on agreeing the contract.
Mechanisms and Procedures
As letters of intent are often simple documents, there may not be processes and procedures included for activities commonly found on construction projects. For example, this could mean there are no mechanisms for issuing or accepting variations.
Often there is little said about the apportioning of foreseeable risks within the letter of intent. Who would be responsible for any additional costs due to natural disaster, a fire or (as seen in 2020) a pandemic?
Another consideration, is what happens if the full contract is never signed? Can the contractor walk away if terms cannot be agreed? What happens if the employer decides not to award the remainder of the works to the contractor once they have begun?
These are all difficult legal questions. Each one will often require careful examination of the facts, the communications between the parties, and sound legal advice to reach an answer.
A Sense of Entitlement
Due to the laws around ‘unjust enrichment’, if the contractor carries out works, orders materials or provides services that the landowner benefits from, these must be paid for. The amount the contractor can claim should be a ‘reasonable sum’.
However, a letter of intent may contain a cap on expenditure by the contractor. In Diamond Build v Clapham Park Homes, the letter of intent contained a cap on reasonable costs by the contractor (Diamond) of £250,000. Diamond commenced the works, placing orders with suppliers and subcontractors up to around £1.5million.
Before the full contract was signed, the relationship between the parties began to break down. The employer then terminated the works in accordance with the letter of intent. As the full contract was never agreed by the parties, the courts only ordered payment up to the cap despite extra work being undertaken by the contractor.
Is a letter of intent right for your project?
The first question you should ask yourself before beginning work under a letter of intent is why do you need to? What is it that is holding up contract negotiations? What are the advantages in starting the works right away?
The answers to these questions will be different in every circumstance, and you may wish to take advice before issuing or working under a letter of intent.
The Pros
- Get the project started quickly. It is in everyone’s interest for the project to start. A letter of intent can mean work can begin, the contractor can start to get paid, and the project can be finished quicker.
- Make a head start. There may be issues that could hold up the start date if the parties wait for the contract to be signed. These could be ordering materials with a long lead time, obtaining permits, and setting up supply chains and sub-contractors.
The Cons
- Ambiguity. Neither the contractor nor the employer can be certain of their position or the risks they may be exposed to. This in turn can lead to disputes and the need for costly legal advice.
- Contractual negotiations may not be completed at all. There may be no incentive for the parties to conclude the contract negotiations whilst works are ongoing.
- Contract terms may be missing. There is often a lack of terms and procedures. Opening both parties up to the risk of misunderstandings and disputes.
If you are considering issuing a letter of intent, or beginning work under one, it is important to know where you stand. Get good advice and ensure you don’t make mistakes that could expose your business to unnecessary risk.
Whether you need commercial or formal legal advice, Overford and our team of trusted advisors can help you ensure your business avoids unnecessary risks and pitfalls. Get in touch today.
