A Letter of intent is commonly understood as being pre-contractual documents. The purpose is often to signal the intent of the parties to enter into the actual contract at a later stage. It gives the Parties some assurance that signing up to a “proper” contract is on the horizon, with all the safety, rights and obligations that entails.
In the construction sector a letter of intent is commonly issued by an employer to a contractor/subcontractor to get a project, or a particular aspect of it, up and running. It allows the said contractor/subcontractor to begin carrying out works, order materials or begin design in anticipation of a formal contract being finalised. Often, they contain a limit on the expenditure to which the Employer will be liable and are often prescriptive as to what exactly this sum is to cover.
The actual legal effect of a letter of intent is intrinsically linked to the law surrounding contract formation. To some, a letter of intent appears to be a gentleman’s agreement, not entered into with the intention of being legally binding. Others may seek to rely on letters of intent as binding contracts.
There are no simple rules to govern this matter, and each case must be assessed individually in order to determine its legal effect. Per HH Humphrey Lloyd QC in 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”. A good starting point is to assess the normal requirement for the formation of a contract: offer, acceptance, consideration, and the intention to create legal relations. Case law offers further helpful guidance on the approach of the courts.
AC Controls Ltd v BBC dealt with some of the fundamental considerations when assessing the legality of a letter of intent. Firstly, the judgment of the Technology and Construction Court set out that a letter of intent may give rise to a binding contract if the language used in the letter may be objectively construed to that effect. Furthermore, a letter of intent may give rise to an “if” contract, if Party A states to Party B that it will be paid if certain performances are rendered. This type of contract gives rise to no obligation on the part of Party B, but if B does what it is asked, then A is liable to pay, subject to the limits of the offer.
The judgment also made clear that a contract could come into being without being formally signed if a transaction is fully performed and all obstacles to the formation of a contract are removed in the negotiations and during the performance of the contract.
In this case, the Technology and Construction Court were asked to decide in part whether a contract existed between the parties, having regard to the fact that the protocol agreement issued with the letter of intent was never signed.
The Court took evidence of acceptance from the conduct of Arcadis, who carried out the work irrespective of the fact that there was no signed Protocol Agreement. The Court of Appeal held: “The best evidence that [Arcadis]… had indeed accepted was its conduct in undertaking the work” (Dame Elizabeth Gloster ).
This is a foundational case in which the letter of intent included a ‘subject to contract’ clause; a move which, despite the inclusion of some agreed terms between the parties, seemingly negated the requisite level of intention between the parties, particularly on the employer’s part, to engage in legal relations.
Rather, Lord Clarke held, handing down the judgment of the court, that when a court considers the credibility of a letter of intent as a contract it should objectively interpret the words and conduct of the parties to gauge whether “they intended to create legal relations and had agreed upon all the terms which they regarded or the law requires as essential for the formation of legally binding relations” . This is irrespective of whether certain terms of the letter had not been finalised.
For a letter of intent to function in a practical sense, it is important that it clearly expresses the manner of contract, the terms contained therein, and other relevant particulars. In this case Justice Akenhead J, writing in the context of the letter of intent referencing an amended JCT, held the letter of intent was a simple contract which had: “sufficient certainty: there is a commencement date, requirement to proceed regularly and diligently, the completion date, and overall contract sum and an undertaking to pay reasonable costs in the interim” .
This case is a more sobering example of the need for specificity. Although the Court acknowledged that the letter of intent was a simple contract that obliged Twintec to act “in accordance” with a standard DOM/2 Sub-Contract, the lack of express specificity as to “secondary obligations, such as compliance with indemnity clauses” led Mr Justice Edward-Stuart to conclude that such terms “were not incorporated into the [letter of intent]…as a matter of construction” .
The ramifications of this were that there were “no prospects of showing that the adjudicator was validly appointed under a relevant contractual provision [and so] absent any agreement of the parties to the contrary … any decision that he or she makes will be a nullity” [88-89].
This case should illustrate that it is wise to be as specific as possible in the particulars of the letter of intent. Ultimately, if the letter of intent is a contract under section 104 of the Housing Grants, Construction and Regeneration Act 1996 (Construction Act 1996), for best practice, parties should endeavour to refer fully to the specifications and timescale that will apply to the works, the cap on liability and the form of payment in accordance with the Construction Act 1996.
In this case, a letter of intent contained terms allowing disputes to be referred to Adjudication, and that it was intended the parties would enter into a JCT subcontract at a later date. When a payment dispute was referred to adjudication, the adjudicator decided that the JCT standard form was incorporated into the contract between the parties, including its payment terms. This resulting in a decision that Oak Dry Lining were due Oak was due £431,000.
When OD Developments issued Part 8 declaratory relief proceedings, which were countered by Part 7 enforcement proceedings issued by Oak, the judge decided that the appointment of an adjudicator under the letter of intent was valid. It was ruled that the terms of the letter of intent stood on their own. However, the terms of the JCT could not be read into the letter of intent if they hadn’t actually been executed, in which case the letter of intent would have been supplanted by the JCT. As this had not occurred, the decision of the adjudicator was outside of his jurisdiction, and his decision was ruled unenforceable.
Spartafield, a developer, and Penten Group, a contractor, had agreed on a letter of intent, which was due to be replaced by a JCT contract later. However, the form of contract was identified as the JCT ICD in the tender documentation and letter of intent. The letter of intent covered the full value of the works, essentially regulating the parties’ dealings for so long as they both agreed that Penten should proceed with the works, or until replaced by a new contract. Penten were reluctant to sign the replacement contract due to dissatisfaction over collateral warranties but did otherwise perform the project under the terms and conditions of the JCT ICD.
Penten later wished to withdraw from the project, relying on the letter of intent. Spartafield argued that the JCT ICD contract was in play, and therefore Penten could not withdraw lawfully, and were not entitled to payment that had not been certified under the JCT ICD.
The Technology and Construction Court decided that, as it is normal for parties to conclude a contract without signing it, and as the letter of intent had not imposed a condition that the replacement contract had to be formally executed, there was no commercial reason or agreement for formal execution of the contract to be a pre-condition for its enforceability. Penten were therefore not legally entitled to withdraw, as it had already entered into the JCT ICD, which supplanted the letter of intent.
In short, a letter of intent can be a binding contract if the requisite elements for the creation of a contract are in place. Generally, it is considered that there is a presumption of an intention to be legally bound in case of business and commercial agreements, but sometimes this presumption of an intention to create a legal relation can be displaced by inserting an ‘honour clause’: the offeree does not intend for it to be legally binding, and the agreement should be taken as a matter of honour or as a ‘gentleman’s agreement’.
Regardless, practitioners and parties looking to engage in legal relations should continue to finalise a contract which contains the necessary amount of clarity and security and balances the commercial risk and commercial aims of both employer and contractor (or contractor and sub-contractor). A letter of intent can be a contract, but this does not mean it should be a permanent contract.
“They do not protect, and are not intended to protect, the employer’s interests in the same manner as would the formal contract; that is why their “classic” use is for restricted purposes.” (Ampleforth Abbey Trust v Turner and Townsend Project Management Ltd  EWHC 2137 (TCC) Keyser QC HHJ ).
Or, if you want to avoid the risk and uncertainty altogether, you could revisit Lord Clarke in RTS v Muller where he noted, apparently oblivious to the nature of the construction industry, that:
“The different decisions in the Courts below and the argument in this Court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story is to argue first and to start work later.”
Should you need any advice on letter of intent, please do not hesitate to contact us.
Quigg Golden are experts in the preparation and evaluation of all aspects of construction claims including claims for extensions of time, prolongation cost, disruption cost, acceleration cost or recovery of disputed variations. Our team, many dual qualified, can analyse the contractual, technical and financial position of any claim. We are experienced in advising on such claims under all standard forms including NEC, PWC, JCT and FIDIC.
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