UK: The Best Of Intentions: Contract Formation Under Letters Of Intent

In the fast-paced world of construction projects, letters of intent are a common feature of the contractual landscape. So what happens if the formal contract being negotiated is never entered into? We take a brief look at some of the approaches the Courts have taken in light of a recent decision of the Court of Appeal.

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Where a building project is time-critical (as it often is) and contractual negotiations are ongoing, it is common for parties to enter into a letter of intent ("LOI") to enable the Contractor to commence work before the contract proper has been finalised. The form and content of LOIs are as varied as the circumstances in which they may be issued.No doubt it is this variety that led Robert Goff J in British Steel Corp v Cleveland Bridge and Engineering Co Ltd (1984) to observe that there is "no hard and fast answer to the question whether a letter of intent will give rise to a binding agreement: everything must depend on the circumstances of the particular case."

British Steel

British Steel concerned negotiations between British Steel Corp ("BSC") and Cleveland Bridge and Engineering ("CBE") for the sale of steel nodes to be manufactured and delivered by BSC.

  • CBE issued a LOI, which stated the price and proposed contractual terms (in the form of the I.C.E. standard form sub-contract)
  • The LOI requested that BSC proceed with the work "pending the preparation and issuing to you of the official form of sub-contract"
  • Disagreements subsequently arose between the parties in relation to the price and other contractual conditions. In particular, BSC proposed its own standard conditions, which contained a limitation of liability for late delivery (under the I.C.E. conditions, liability was unlimited). Although these disagreements were never resolved, BSC went ahead with production and delivery of the nodes
  • CBE refused to pay for the nodes, instead claiming damages for late delivery

Robert Goff J considered that a LOI could potentially give rise to 2 different types of contract. However, the judge rejected both on the basis that the LOI in question applied "pending a formal sub-contract the terms of which were still in a state of negotiation". (It was no doubt significant that agreement had not yet been reached on a number of terms which, on the facts of the case, were found by the judge to be essential).
Accordingly the Court found that no contract had been concluded and CBE, as the party who had made the request for performance, was obliged to pay BSC a reasonable sum for BSC's performance in accordance with that request. In arriving at this conclusion, the Court appears to have been particularly swayed by the fact that both parties were pedalling their standard conditions, which each took vastly different approaches to liability for delay.

In such circumstances, Robert Goff J held that it was "impossible to predicate what liability (if any)" BSC would have assumed, and it would therefore be "an extraordinary result" for him to find that, in acting on CBE's request that works be carried out before the anticipated formal contract had been finalised, BSC had assumed a level of liability it would never have agreed to under the contract proper.

Trentham

Trentham v Archital Luxfer Ltd (1993) did not concern a LOI, but it is an interesting case on contract formation, as it concerned a fully performed and paid sub-contract

  • Archital was a sub-contractor for the manufacture, supply and installation of windows.
  • Trentham was being pursued under the main contract for delays and defects and sought to recover in turn from its sub-contractors, including Archital.
  • Archital argued that no sub-contract had ever come into existence.
  • The trial judge analysed the facts on the basis of offer and acceptance, and found that it had (all undecided issues being held inessential on the facts).

On appeal, the Court stated that a contract could be concluded by conduct, and that the commercial character of the transaction should be considered. In particular, the Court stated that this was not a contract where there had been a continuing stipulation that a contract would only come into existence if in writing, and that all "obstacles to contract formation" had been removed in the course of the negotiations and performance.

Accordingly, while agreeing with the trial judge's "offer and acceptance" analysis, the Court of Appeal would have been satisfied to hold that a contract (in the circumstances of "this fully executed transaction") had come into existence on the basis of the parties' performance alone.The Court held that this contract impliedly governed pre-contractual performance as well; thus the fact that it had not arisen until the work had been partially executed and paid for was no difficulty.

RTS v Müller

British Steel and Trentham recently came under the microscope in the case of RTS v Müller, which concerned negotiations between the parties in respect of equipment for collating and flow wrapping Müller yoghurt multi-packs.

  • While negotiations were ongoing, RTS commenced work under a LOI with a set expiry date (which was subsequently extended several times)
  • The LOI broadly stated the scope of the project, the price and date for completion, and confirmed Müller's wish to proceed with the project subject to (among other things) a requirement that "the full contractual terms" would be based on Müller's amended form of MF/1 contract and that full terms and specifications would be "finalised, agreed and then signed" within 4 weeks of the date of the LOI
  • Upon expiry of the extended LOI date, the parties had largely agreed the MF/1 conditions, but not the accompanying schedules. Despite this, RTS continued to build and deliver the equipment and was partially paid for it

The trial judge, applying the "commercial" considerations in Trentham, held that, the contract having been largely executed, it would be unrealistic to suppose the parties had not intended to create legal relations. He held that the parties had agreed that RTS would carry out the "agreed work" (which the trial judge held was embodied in a number of documents forming part of the MF/1 schedules) for the "agreed price" (stated in the LOI), and that it was "not essential for them to have agreed the terms and conditions and they did not do so".

The trial judge declined to find that the contract between the parties included the MF/1 conditions on the basis that (1) the LOI and other correspondence indicated that the final MF/1 terms were not to be contractually agreed until signed; (2) the MF/1 conditions and the schedules were meant to operate as a "composite whole" and a number of the schedules had not been agreed; (3) the parties had not adhered to the MF/1 conditions in practice; and (4) clause 48 of the MF/1 conditions prevented the contract from becoming effective until signature and exchange of counterparts.

The Court of Appeal reversed the trial judge's decision, holding that no contract had been concluded after expiry of the LOI. The writing stipulation in clause 48 of the MF/1 was central to this decision. The Court held that the "contract" expressed to be subject to writing in that clause included the schedules, and that the parties' negotiations were conducted on the basis of that stipulation; accordingly the Court applied British Steel (and distinguished Trentham, which had expressly declared itself not to be a case in which the formation of a contract was subject to writing).

A deciding factor in the Court's decision appears to have been the fact that the parties had agreed to a limitation of liability under the MF/1 conditions and that the trial judge, in ignoring this and finding a contract concluded on the basis of conduct alone, had brought about the "extraordinary result" contemplated by British Steel, and "achieved a bargain neither side intended to enter into".

Conclusion

RTS v Müller serves as a timely reminder that the intentions of the parties will be the paramount consideration in the question of contract formation. While it is acknowledged that LOIs play a useful role in many construction projects, the above cases demonstrate the importance of making their effect clear (both in themselves, and as to the contract still being negotiated).

The outcome in RTS v Müller demonstrates that where the Court feels that to find there was a contract concluded by conduct would achieve a bargain at odds with the intentions of the parties, and where there are obstacles to finding the contract under negotiation to apply (for example, the presence of a writing stipulation or failure to agree essential terms), it will be reluctant to find a contract at all. Thus, as ever, these cases remind us of the desirability for parties to reach agreement on essential terms and conditions early in the project, rather than hoping that significant differences (such as each party's take on liability) will resolve themselves during the course of the project.

Reference: RTS Flexible Systems Ltd v Molkerei Alois Műller GmbH & Co KG [2009] EWCA Civ 26

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 06/03/2009.

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