Letters of Intent

David Daly, Director at HD Construction Solutions

Introduction

Letters of intent (“LOIs”) are widely used in the construction industry but are often misunderstood and often the cause of disputes. LOIs are intended to allow work to proceed on site whilst giving both parties some legal protection, typically before negotiations for the finalised construction contract are completed. They are usually contracts in their own right, containing all the usual requirements such as offer and acceptance, consideration, intention to create legal relations etc. Note however they are intended to be interim and not final. Whilst that sounds all fine in theory, the reality is often much more complicated.

The law

It is also important to note that there is no defined format for LOIs as was summarised in the case of ERDC Group v Brunel University (2006) EWHC 687 (TCC): “Letters of intent come in all sorts of forms … there can therefore be no prior assumptions” [27].

It is also essential that if the parties intend for an LOI to be binding, it is important to state this clearly and unequivocally so that enforceable contractual obligations on either party arise. If not and the LOI is found to be non-binding, ambiguity as to the parties’ respective obligations can arise such as remuneration for work done, which is likely to be assessed on a ‘fair and reasonable’ basis, which itself comes with inherent uncertainty. Similarly, if there is no binding completion or expiry date in the LOI, then what date are the parties working to?

Ensuring a smooth transition from LOI to an executed contract is also important so that the terms of a LOI will be superseded by that of the formal contract as was held in Twintec Ltd v Volkerfitzpatrick [2014] EWHC 10 (TCC): “It has been well established for some fifty years that, all other things being equal, where two parties enter into an agreement to carry out work in anticipation that they will in future enter into a formal contract in respect of that work, if that formal contract is subsequently entered into it there may well be an implied term that the contract will govern the parties’ relationship retrospectively.” [18]

LOI problems

Examples include:

• Disagreement

What occurs if the works are commenced under a LOI but negotiations to conclude the formal contract end up in a stalemate?

Provided the terms of the LOI have not been varied, then a contractor may choose to limit its works to that provided for in the LOI and leave site when that point is reached. What then for the employer? It is likely in that scenario that the employer would be left at square one and would need to re-tender the works. Given what has happened in the market over the last 18 months with cost escalation across the board and interest rate rises, the absence of a fixed price lump sum would leave an employer greatly exposed to increased construction and funding costs.

• LOI management

LOIs can often grow legs of their own if not managed closely and be varied by conduct and/or correspondence. A typical example where this occurs is where time or expenditure limits are provided for in the LOI but are exceeded without the LOI being amended. It is not uncommon to see projects executed through to practical completion on extended/amended LOIs without a formal contract ever being concluded. Where disputes do not arise that is all well and good but where parties cannot agree final terms of contract, all sorts of problems can arise during the works.

What should an LOI contain?

LOIs should provide for (amongst other things) the following:

• A defined scope of works

• A contract sum, or more commonly in LOIs, a defined limit on expenditure

• Compliant payment terms

• A commencement, completion and/or expiry dates

• Insurance requirements

• The governing law

• A dispute resolution mechanism

• A pathway for integration into the executed contract

Conclusion

Where LOIs cannot be avoided, it is imperative that its provisions and limitations are closely monitored and revised when necessary. When drafting LOIs, set out the terms of the LOI clearly and ensure they are free from ambiguity and ensure that any revisions are made in good time. Ultimately, replace the LOI with a formally executed written contact as soon as possible and ensure that that contract supersedes the LOI in full.