Letters of intent are common in the construction industry. They can demonstrate a commitment to a project. A contractor or subcontractor is often under immense pressure to procure materials, carry out design work, or even start the works themselves. In these circumstances, a letter of intent may be useful.
If the parties are bound by the letter of intent and no formal contract is ever eventually agreed by the parties this could mean that the parties have entered into a simple contract that is unsuitable for the project.
There are two main forms of letter of intent: those that form a binding contract and those that do not. Where there is no binding contract it produces uncertainty around payment, time to complete the works, site access, control over materials and relationships with third parties. Where there is a binding contract it produces more certainty.
THE ISSUES TO CONSIDER FOR A BINDING CONTRACT
The letter of intent must include the following to make a binding contract:
the letter must be signed and record the agreement of both the parties.
the letter must provide for consideration.
the letter must clearly show that the parties intend to enter into a binding contract and the terms of the contract are clear.
The parties must also be clear what they want to achieve with the letter of intent. For example:
the employer may only want the contractor to do a limited amount of work e.g. to start site preparation or enabling works prior to entering into a formal contract.
the contractor may agree to commence works without agreeing to complete all of the works.
usually, the employer or the contractor can call a halt to the works at any time.
there is usually an obligation on the employer to pay for the works the contractor carries out on a cost reimbursable basis (which is usually subject to a cap). This type of contractual arrangement is referred to as an “if” contract. See British Steel Corp. v Cleveland Bridge & Engineering Co Ltd. 1984.
the parties may believe that they can finalise the formal contract within a certain time scale and may only want a letter of intent to cover works undertaken up to that point in time.
the parties may intend to enter into a contract based on a particular standard form, but wish to have a simpler arrangement in place until the standard form is agreed and in place.
the employer may only have limited funds and therefore does not want payments to the contractor to exceed that sum.
A letter of intent can offer a large amount of flexibility in the contractual arrangements in the early stages of a project. However, the parties may struggle to agree a binding contract.
Care needs to be taken when drafting the terms of a letter of intent. There are key provisions that need to be addressed. A letter of intent should set out:
the scope of works;
the payment terms and any cap on payment;
the terms and conditions applying;
the quality of the work and timing of the work;
any insurances to be maintained;
a dispute resolution clause that complies with the Housing Grants, Construction and Regeneration Act 19996 ( the Construction Act);
a copyright licence, if required;
how the letter of intent will come to an end, including what happens if the parties enter into a formal contract;
deal with governing law and third parties
SCOPE OF WORKS
The letter of intent should state what the scope of works is. For example:
that the employer wants the contractor to only purchase long lead items;
that the employer wants the contractor to carry out design work only;
that the employer authorises and instructs the contractor to proceed with certain defined works or that the employer instructs the contractor to commence the whole of the works.
PAYMENT PROVISIONS AND CAPS ON PAYMENT
certainty as to payment is crucial. The letter of intent may state that the employer is to pay the contractor on a cost reimbursable basis or a cost plus basis.
the employer may cap its liability to a maximum sum. This can act as an incentive to the parties to finalise the formal contract documentation before the cap expires. Payment will be limited to the agreed cap, even if the contractor carries out work in excess of that cap.
if a letter of intent is a “construction contract” under section 104 of the Construction Act 1996, it will be caught by the Construction Act’s payment provisions. Unless the parties want to rely on the Scheme for Construction Contracts ( England and Wales) Regulations 1998 (“ the Scheme”), a letter of intent must provide an adequate mechanism for payment, with due dates and final dates for payment, and time limits for notices as required by the Construction Act 1996.
TERMS AND CONDITIONS
A letter of intent should specify what terms and conditions apply to the works that are defined in the letter of intent. These could be:
the terms and conditions as set out in the letter of intent.
the terms and conditions of the formal contract which the parties are hoping to enter into (provided they are consistent with the terms and conditions of the letter of intent). For example, the JCT Standard Building Contract, 2016 Edition (SBC 2016).
a mixture of terms and conditions, for example, the payment provisions of the SBC 2016 and the terms and conditions set out in the letter of intent.
If the parties intend to incorporate some or all of the terms of a standard form contract into the letter of intent, they must do so clearly and expressly.
In Arcadis Consulting (UK) Ltd v AMEC (BSC) Ltd 2016, Coulson J (as he then was) found that the reference in the letter of intent to “terms and conditions… that we are currently working under” did not refer to, or incorporate, any of the three sets of competing terms and conditions because none of them had been agreed. As a result, the court concluded that the letter of intent did not incorporate a cap on liability even though some sort of limit on liability was referred to in each of the three competing versions.
The Court of Appeal overturned this decision. The court held that the first set of terms and conditions had in fact been agreed by the parties (“the November Terms”), although they related to a different project between the same parties, and were incorporated by reference into the parties’ letter of intent.
The court held that it did include a term limiting Arcadis’ liability. The court also concluded that the November Terms were not superseded by the subsequent two sets of terms and conditions because these were never agreed. The court commented that Coulson J’s conclusion that Arcadis had assumed an unlimited liability for its contractual performance under the letter of intent was an “extraordinary result”.
QUALITY AND TIME
A letter of intent should:
make reference to specifications or standards that will apply to the works.
include a timescale for the carrying out of the works and provide for what will happen if the date is not met.
The employer may need the contractor to confirm that it will maintain public liability insurance throughout the duration of the letter of intent. This should be made an express term in the letter of intent or incorporated into the letter by reference.
DISPUTE RESOLUTION AND APPLICABILITY OF THE CONSTRUCTION ACT 1996
If the Construction Act 1996 applies, a letter of intent should provide for adjudication, unless the parties are content with the provisions of the Scheme.
ENDING THE LETTER OF INTENT ARRANGEMENT
The parties should always set out how they may bring a letter of intent arrangement to end. This makes for certainty. In particular, the parties should record that:
once the formal contract documents have been executed, the terms and conditions of that contract will supersede the terms and conditions of a letter of intent.
any works carried out or payments made under the letter of intent will be treated as carried out or made under the formal contract.
the formal contract is retrospective to the start of the works that were governed by the letter of intent.
the formal contract is an entire agreement with regard to the works.
One advantage of a letter of intent is that it allows the parties to undertake specific works without the obligation to complete the whole of the works.
If the employer is dissatisfied with the contractor, or if the contractor no longer wishes to carry out the works, either party can end the arrangement quite simply without the wide-ranging consequences that might apply if the parties had signed a formal contract.
The termination provision should address:
how notice is to be given.
how much the contractor will be paid. Usually it will be reasonable costs incurred to the date of the termination.
whether any loss of profit will be paid to the contractor.
the protocol for leaving the site, releasing documents to the employer and providing for the employer to take over sub-contracts that the contractor entered into before termination.
how will any claims be dealt with.
EXPIRY OF THE LETTER OF INTENT
A letter of intent may provide for the letter to expire. Parties should ensure that:
no further work is carried out after the expiry date.
if the letter is extended, the extension is recorded in writing.
If appropriate, a formal contract is signed or executed on or before the expiry date.
GOVERNING LAW AND THIRD PARTIES
A letter of intent should state what governing law applies and make specific reference to whether rights are excluded for the purpose of the Contracts (Rights of Third Parties) Act 1999.
Any uncertainty about the effect of a letter of intent may result in a court to taking a view on the terms of the letter and this uncertainty would be unsatisfactory to both parties.
Best practice will always be to agree terms and conditions and sign a contract first before commencing any work. However, this is not always possible.
If you fail to make the terms and conditions in your letter of intent clear then this will lead to uncertainty and expose the parties to risk.
Two key areas are how the contractor or subcontractor will be paid and how does the letter of intent come to an end. Careful drafting is needed.
Please contact our Michael Janney or Jonathan Waters if any assistance is needed with the preparation of any letters of intent or any other construction contract documentation.
IF YOU HAVE ANY QUESTIONS PLEASE DO NOT HESITATE TO GET IN TOUCH
Michael has over 36 years’ experience of acting in major contentious construction and engineering cases in the UK and internationally. He acts for employers, developers, main contractors, specialist subcontractors, NHS Trusts, education establishments, care home companies and housing associations. You can email him at [email protected]
This article is written to raise awareness of the issues it discusses and it may not be updated after it is first written, even if the law changes. It is not intended to be legal advice and cannot be relied on as such. Helix Law is not responsible or liable for any action taken or not taken as a result of this article. If you think the matters set out affect you and you wish to apply them to your particular circumstances then we are happy to give you free initial telephone advice.