United States: The Concluded Bargain: Near Enough Good Enough?

Last Updated: April 16 2013
Article by Scott A. Stiegler

A letter of intent can undoubtedly be used effectively to quickly kick off a project or as a temporary solution pending the parties' agreement on the formal agreement. In the right circumstances, and if used appropriately, a letter of intent can set the foundation for a good working relationship between the parties.

It is, unfortunately, a common occurrence that a letter of intent tends to create more problems than it resolves. All too frequently after the signing of a letter of intent, the parties neglect to formalize the main agreement and simply rely on the letter of intent. It is also a known practice, especially for engagements with low fee values, that letters of intent are used to circumvent the difficulties that typically arise in commercial negotiations given the number and complexity of issues in both standard and bespoke forms of contracts.

A "near enough is good enough" approach can create a multitude of both practical and legal risks for both an employer and a contractor, including such matters as the binding nature of any letter of intent, the sufficiency of its terms pending a formal agreement, certainty in the parties' rights and obligations, and whether the parties have, in fact, reached a finally concluded bargain.

A recent decision of the Technology and Construction Court in the United Kingdon has again highlighted the difficulties that can be placed on contracting parties when seeking to rely on the terms of an agreement, which, in fact, had not been finally concluded between the parties.

The Case

The Court was asked to consider an application by the Defendant in the action, Balfour Beatty Engineering Services (HY) Limited (Balfour Beatty), to stay an action brought by the Claimant, Merit Process Engineering Ltd (Merit) pursuant to CPR 62.3(2) and section 9 of the Arbitration Act 1996.1 The case highlights what could be described as a typical subcontract negotiation.

It is, unfortunately, a common occurrence that a letter of intent tends to create more problems than it resolves.

The claim brought by Merit related to three separate contracts made with Balfour Beatty. Balfour Beatty sought to argue that the proceedings should be stayed on the basis of agreed arbitration provisions in each of the three contracts. While Balfour Beatty succeeded in its argument on two of the three contracts, it failed in relation to a contract referred to in the case as the "main installation package" contract.

In not unusual circumstances, the parties entered into a letter of intent pending the agreement of a formal subcontract. The Court analysed in detail the negotiations between the parties on the main installation package, which focused on the letter of intent and various correspondence that was exchanged between the parties during the negotiations. These negotiations focused on the agreement on the contract price and whether or not a "main contractor's discount" was included in the finally agreed sum. The discount, representing 2.5 percent of the contract price, was expressed by Justice Edwards-Stuart to not be a de minimis amount when it was within the Court's knowledge that margins on contracts such as those in dispute could be as low as 2-3 percent. In addition to the various emails and telephone conversations that were analysed, there were no less than 3 separate forms of agreement that were exchanged. Interestingly, the negotiations between the parties lay silent for nearly a year between what was perceived to be agreement on the issue of the contractor's discount and the provision by Balfour Beatty of a fully engrossed formal contract, upon which, the debate was reopened.

Do We Have an Agreement?

While the UK Courts do not expect that commercial documents be drafted with strict legal precision, the Courts are nevertheless highly reluctant to write the parties' contract for them. However, there is a range within which contractual certainty operates and whether or not a contract is binding will be viewed objectively by the Courts and will ultimately come down to the particular facts and circumstances of the case.

The humble letter of intent may often be construed as merely an intention to create legal relations at some point in the future. Provisions which anticipate future negotiation of a contract will not usually be considered as enforceable by the Courts.

The question is, however, somewhat more difficult when the parties have agreed some terms but have left others for agreement at a later point in time. There is judicial authority2 to support the proposition that if the parties have shown an intention to be contractually committed, albeit while deferring discussion of some aspect or aspects of the deal, then the Court will recognize a contract unless what remains outstanding is not merely important, but essential in the sense that without it, the contract is too uncertain or incomplete to be enforced. Quite clearly, the more important the term is, the more unlikely the Court will find a binding contract.3

It was this point that was considered by the Court in the Merit decision. Balfour Beatty contended that there was agreement on the key terms and that the remaining dispute related only to the main contractor's discount. This position did not preclude the conclusion that a contract had been formed. However, Merit argued that no contract had been formed as there was a dispute over the contract price, an obvious key term of the contract. In the circumstances of the case, the price needed either to be fixed or some mechanism agreed for fixing it. As neither existed, the Court determined that no agreement had been reached and as such, there was no enforceable arbitration clause.

Contractual Negotiation - The Letter of Intent

Contractors, consultants and the like are too frequently put in a position, whether by the employer's actions or by their own actions, whereby they are asked to commence works before the contract negotiations have been concluded (or in some cases before the form of contract is even decided, as in the above case) on the promise that "the paperwork will follow." It is this approach which is most troublesome to any in-house lawyer, commercial advisor and even a company's insurer.

Inevitably, the viability of agreeing to proceed without a formal contract in place comes down to the sophistication and awareness of the contracting parties as well as a service provider's appetite for risk in what could turn out to be an uncertain contracting arrangement.

Where works or services are being performed by a party prior to the agreement of a formal agreement and a letter of intent is contemplated, it is critical that the parties take the time to carefully consider the terms to be included in the letter of intent. Critically, the letter of intent should be sufficiently clear and should preferably expressly state that it creates legally binding obligations on the parties. Language such as "subject to contract" should obviously be avoided. Simple steps such as correct entity details and having it signed by both parties are also important to ensure the letter of intent meets all the fundamental principles of a binding agreement.

In its simplest form, a binding letter of intent should make provision for such basic matters as:

  • a clearly defined scope of work;
  • general performance requirements (i.e. standard of care);
  • payment terms or mechanisms and a fee limit;
  • basic program requirements and a longstop date;
  • dispute and termination procedures, including circumstances when the letter of intent will end; and
  • governing law and other boilerplate clauses.

Inevitably, the viability of agreeing to proceed without a formal contract in place comes down to the sophistication and awareness of the contracting parties as well as a service provider's appetite for risk in what could turn out to be an uncertain contracting arrangement.

Depending on the scope of works and the requirements of the parties, it may also be appropriate to include basis insurance requirements, intellectual property and confidentiality obligations and perhaps even a documented process as to how the parties are to approach the negotiation of the formal contract. From a contractor's perspective, an express limitation on liability would also be desirable along with a release from liability for consequential losses, should the parties not be able to reach agreement on the terms of the formal agreement.

Liability Issues

While the letter of intent will, in most instances, prescribe a basic contract framework, it is unlikely to deal with all requirements that would be typically described in a complete construction or consultancy agreement. For example, letters of intent rarely describe detailed variation procedures, programming and extension of time procedures, detailed performance obligations or requirements, reporting requirements, force majeure events, liquidated damages regimes or liability and indemnity requirements.

The precision of the description of the scope of works is not only critical to determining the parties obligations and for pricing purposes, it is also fundamental to the consideration of variations. As detailed variation mechanisms are not typically addressed in letters of intent, parties must be careful not to wander outside the scope of services being provided given the obvious risks with costs, time and potential liabilities (and caps thereon).

It is, however, not always a legal solution that will effectively manage risk. Such practical measures like withholding all or key deliverables or limiting payment amounts, will work to incentivize the parties to negotiate and conclude the formal contract. It is also very useful to prescribe a framework for the negotiation of the proposed agreement including establishing relevant negotiating representatives of the parties, proposed base agreement documents and the timeframe within which the parties will negotiate the proposed agreement.

Express deadlines are a useful incentive, however, the usefulness of such a deadline will be influenced by, amongst other factors; the strength of the respective parties bargaining positions, the availability of other suitable alternatives in the market and the service providers willingness to walk away from the project should agreement not be reached between the parties. In more uncertain economic times, it is considered that this last point will have a significant impact on the parties negotiating position.

While the letter of intent will, in most instances, prescribe a basic contract framework, it is unlikely to deal with all requirements that would be typically described in a complete construction or consultancy agreement.

Concluding the Bargain

It is an unfortunate fact of the construction industry that the parties may in some instances never reach agreement on a formal contract despite the physical works being completed and the contractor or consultant being paid. This is particularly so for engagements with low fee values. While at the time of completion of the works, this may not present a significant issue, it may nevertheless cause problems if, for example, a defect arises in the works. A rather serious example of the consequences of failing to conclude an agreement can be seen in BHP Coal Pty Ltd. v.O&K Orenstein & Koppel AG.4 This case revolved around, in particular, the failure to appropriately inspect a bucketwheel excavator at a mine site in Central Queensland which subsequently collapsed.

While the fee for the engagement was only in the order of AUD 27,000, the liability that attracted to one of the defendants was in the order of AUD 53,000,000 (an amount nearly 2,000 times the original fee). Clearly in this case, near enough was not good enough.

Footnotes

1 Merit Process Engineering Ltd. v. Balfour Beatty Engineering Services (HY) Limited, [2012] EWHC 1376 (TCC).

2 See Bear Stearns Bank Plc v. Forum Global Equity Ltd, [2007] EWHC 1576 (Comm).

3 See Pagnan SpA v. Feed Products Ltd., [1987] 2 Lloyd's Rep 601.

4 [2008] QSC 141.

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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