UK: Letters Of Intent: Overcoming The Pitfalls

No matter how forcefully lawyers may counsel against them, letters of intent have an established position in the commercial and administrative landscape of the construction industry in the United Kingdom. There is, to a certain extent, good reason for their use. In the real world where deals are struck and offices, schools, hospitals and homes, etc. are built, factors such as materials shortages, stakeholder expectations and aggressive programmes can trigger a need to "get on with the job" long before contract negotiations have come to an end and the lawyers have finished playing with words.

Authorising activities under a Letter of Intent ("LOI") has practical advantages for employers and contractors alike. An LOI can, as previously suggested, alleviate programme constraints by enabling certain activities to be progressed pre-contract, such as:

  • off-site pre-construction activities;

  • the instruction of subcontractors/suppliers e.g. for prefabricated items, steelwork, etc.; and/or

  • the instruction of site remediation (in advance of full planning permission), enabling works and other (limited) on-site activities.

Open-ended commitments are, however, extremely unwise, both legally and commercially. Work should not be allowed to continue in perpetuity under an LOI as it is no substitute for formal contract terms, and will not (unless carefully drafted and administered) afford the parties a satisfactory degree of protection. The purpose of this paper is to highlight many of the common problems with the drafting and general use of LOIs and offer some practical advice to those using LOIs on a regular basis.

If an LOI must be issued, there are several ways in which the parties can ensure that the document is legally binding. A binding LOI has essentially three fundamental elements: (a) intention to enter into a binding agreement; (b) certainty of terms and of dealings; and (c) consideration.

Identity and intention of the parties: it would seem self-evident that the parties must be known to each other and have reached a consensus as to the purpose of the correspondence between them. Yet even these basic principles appear to present a challenge for certain parties engaged in activities pre-contract. Care should always be taken to ensure that each party understands the purpose of the proposed LOI and that each party intends it to be binding until superseded by a formal contract (subject to agreement of satisfactory terms).

LOIs are frequently issued by surveyors and project managers on behalf of their clients for expediency; however, this practice is best avoided whenever practicable. A contractor would not accept a JCT contract executed by any party other than the contractor's ultimate employer; therefore the same discipline should apply to the signature and issue of a LOI.

In addition to failing to accurately reflect the intentions of the parties, poor drafting can lead to a variety of other problems:

Scope/duration unclear: As lawyers we are frequently asked to review LOIs expressed to authorise the contractor or consultant to proceed with the whole of the works or services for an indefinite period and either for full value or an unconfirmed sum. On such terms, there is very little incentive for the contractor or consultant concerned to cooperate with the employer so as to conclude a formal contract.

Uncertain status of adjudication: The questionable status of LOIs as creatures of contract can also cause procedural problems when disputes arise during the course of authorised works. Bennett v Inviron1 was an application to enforce an adjudicator's award. The dispute involved work undertaken by Bennett under an LOI with Inviron during the course of electrical installations at a project in Wimbledon. Bennett referred the matter to adjudication in 2005. Inviron asserted that the adjudicator had no jurisdiction as there was no binding contract between the parties necessary to comply with s.107 of the Housing Grants Construction & Regeneration Act 1986.

The adjudicator agreed and declined to make any determination, therefore Bennett referred the matter to a second adjudicator. That adjudicator concluded that he did in fact have jurisdiction and found in favour of Bennett, but Inviron refused to pay. Inviron raised several jurisdictional challenges, including the submission that as there was no contract (simply an LOI), any remedy that Bennett might have was restitutionary and so outside the scope of s.107 of the Act.

In considering the adjudicator's award, the court had regard to various matters of fact: whilst the terms of Inviron's own contract and the proposed form of subcontract with Bennett were mentioned, the LOI was clearly identified as an LOI and headed "subject to contract"; the letter also referred to a meeting between the parties but did not elaborate as to the significance of the meeting or the terms agreed at it; and although a price for Bennett's work was confirmed, subsequent valuations well exceeded that price and the scope of work was varied.

Wilcox J concluded that the parties did not intend that the LOI should have contractual effect, as express and material terms were not specifically recorded in it or incorporated by reference in a manner satisfying s.107. Therefore even if the LOI had not been subject to contract the agreement between the parties as evidenced by the letter had to comply with the Act. The adjudicator had no jurisdiction and Bennett's application for summary judgment was dismissed.

Contractual uncertainty was again an impediment to proper interpretation and thus a bar to adjudication. In other cases, however, the courts have found enough in the terms of agreement and in the conduct of the parties to conclude that the adjudicator did have the necessary jurisdiction to reach a decision on an LOI, therefore the factual background to a dispute under an LOI assumes greater importance for the party wishing to rely on adjudication as a means of dispute resolution.

Instruction not renewed following expiry or renewal letter not accepted: In ERDC v Brunel,2 the ERDC was engaged to construct new sports facilities for Brunel's Uxbridge campus. ERDC had submitted a tender based on a JCT Standard Form of Contract with Contractor's Design (1998 Edition). It was decided that the parties would defer formal contract execution until full planning permission for the project was obtained, and that pending the planning decision, ERDC would progress the works under an LOI.

Requests for payment were issued as if the JCT terms applied, using the rates and prices in the original tender. Several LOIs were issued during the course of the works but the contract was still not executed when the last renewal letter expired. ERDC nevertheless continued to work without the benefit of a supplemental letter for a further six months. When the contract documents were finally presented for execution ERDC refused to sign them. The contractor indicated that it would only continue to work for Brunel on the basis that a quantum meruit valuation would apply.

When the case came before the court, LLoyd J had no difficulty in finding that there was a clear intention to create legal relations, and the work and programme requirements were sufficiently described to avoid uncertainty. Lloyd J therefore concluded that all work carried out pursuant to the LOIs had been carried out under the contract contemplated by the last letter and so was to be treated as valued in accordance with its terms and not on a quantum meruit basis.

ERDC was, however, entitled to be paid on a quantum meruit basis for the work carried our after the date of expiry of the last letter. Nevertheless, since the conditions under which the later work was carried out did not differ materially from the conditions under which the rest of the work was carried out, the later work would be valued on the basis of ERDC's contract rates and not on a cost plus profit basis.

Monetary limits exceeded: Financial thresholds may be exceeded in a number of ways. Most commonly, authorised expenditure is exceeded and goes unchecked when a limited LOI expires and is not renewed, or agreement as to renewal cannot be reached. Similarly, an employer's maximum aggregate liability cap, which was in all probability hard won in negotiations, may be waived by conduct if the employer continues to pay out sums in excess of the cap, whether or not the general authority conferred by the LOI has expired.

In the Buckingham case, much of the work carried out by AWS was not included within the two lump sum items referred to in the letter of intent and certainly not the work carried out in the two contested valuations. The court nevertheless found that, as it was work that the supervising officer had authorised on behalf of the defendant, AWS was entitled to be paid in accordance with the terms of the proposed contract. Employers should, accordingly, always have an eye to the budget and be wary of issuing or permitting the issue of instruction to a party under an LOI which pushes the boundaries of the sums authorised under it.

Terms insufficient for on-site activities: A common pitfall for many employers is the use of LOIs intended only for off-site activities in a physical works context. The complexity of on-site activities from a liability perspective means that the parties are best advised to confine activities under an LOI to off-site works and/or services wherever possible. It can be helpful to use express terms to prohibit on-site activities so that the parties are compelled to vary the scope of the instruction formally before on-site works can commence.

LOIs authorising on-site activities are very different documents from those serving a more limited purpose. A limited letter will therefore be deficient in a number of fundamental ways if relevant terms of the proposed contract are not incorporated by reference and the LOI is silent on matters such as:

  • works insurance and insurance for public/third-party property liability;

  • indemnities for personal injury and/or death;

  • site establishment and health and safety requirements such as CDM Regulations compliance;<

  • nuisance trespass in relation to adjoining owners and occupiers;

  • (where appropriate) a duty of reasonable skill and care of a competent designer and professional indemnity insurance requirements;

  • subcontracting arrangements (including a right for the employer to take over a subcontract or supply contract in the event of termination of the instruction).

Conclusions

The practical issues surrounding and the judicial opinion flowing from disputes generated or exacerbated by the use of LOIs clearly demonstrate that LOIs are documents requiring serious consideration and, as such, should not be entered into lightly. Parties are best advised to put formal contract negotiations first so that the contract is not treated as an afterthought and, where possible, to seek other means of managing their commercial arrangements, such as placing smaller more limited contracts for early works if there are particular pressures to begin work in advance of agreeing the main contract. Where the parties have no alternative but to proceed on the basis of an LOI, its terms demand equivalent time and attention as formal contract terms (particularly where on-site activities are being authorised).

Avoid ambiguity, as neither party may benefit from it in the long term if the LOI is tested in an adjudication or in court proceedings. Have a positive eye to the future and to the successful conclusion of contract negotiations by including a clear statement in the LOI that the terms of the contract will take precedence and have retrospective effect. Finally, make sure that you do your housekeeping a well-drafted LOI is only as good as those who manage it. Ensure that renewal dates are documented, reviewed and met, and that authorised expenditure is not exceeded, if there is really no alternative but to issue a supplemental LOI. The terms of any supplemental letter should be discussed well in advance of the expiry of the earlier LOI so neither party is facing a "showdown" over the drafting which might lead to a legal vacuum where an instruction has expired and there is no contract in its place.

Footnotes

1. Bennett (Electrical) Services Limited v Inviron Limited [2007] EWHC 49 (TCC) Judge David Wilcox

2. ERDC Group Limited v Brunel University [2006] EWHC 687 (TCC) Judge Humphrey LLoyd

To see further articles on matters relating to construction, engineering and energy projects, please visit www.fenwickelliott.co.uk.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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