The use of LOIs as the basis for construction projects has mushroomed in the Gulf in rent years. However the practice carries a significant risk to the parties involved, who may end-up finding themselves in a legal predicament. Heba Osman, Partner, Fenwick Elliott LLP, writes.
In many countries in the Gulf region, construction projects start with a hand shake followed by the issuance of a Letter of Intent (usually referred to as LOI) setting out some basic information about the project, the parties, type of works, payment, project duration and other terms.
Typically, the LOI gets issued, along with a notice to commence the construction works, by the client and countersigned by the contractor to allow the project to start. The parties usually anticipate that a more detailed and final contract will be signed at a later stage. However in many instances a final contract does not get signed.
This might be due to the parties' inability to reach an agreement on the final contract terms, or not having enough time to finalise the negotiations, or simply because the parties forgot.
Whatever the reason, it is undeniable that using LOIs to commence construction projects has mushroomed in the Gulf region, particularly prior to the global financial crisis, and has significantly assisted parties to start projects a lot faster than if they had to wait for final contract negotiations to be completed.
This practice, however, carries a significant risk to the parties who may end-up finding themselves in the unenviable position of not knowing their rights or obligations and trying to second-guess these rights through the ambits of the applicable law. This is, of course, in addition to the question of whether an LOI is binding or not in itself. In short, an LOI without the signing of a final agreement is pretty much similar to playing football in a major tournament without rules: the outcome of the game would then be determined based on the power of the players, not the rules.
The question of whether the LOI is a binding contract or simply a promise to contract appears to be quite theoretical and of little value to many non-lawyers. In the legal realm this is not the case, as the answer to this question will determine the rules of play and the type of remedies and/or damages available to the party relying on the LOI.
In many jurisdictions around the world, LOIs are not considered binding agreements. In the UAE, Qatar and many other civil law jurisdictions, whether or not the LOI will be considered binding is based on the terms of the LOI itself and what is contained in the LOI. In order to determine whether an LOI is binding or not, one must turn to the provisions of the relevant law in each country and the requirements that the law sets for a document to be considered a binding contract.
The position in the UAE and Qatar
The UAE Civil Code does not specifically deal with LOIs nor does it contain any reference to LOIs. However, the Code determines that a contract is binding if it contains the parties' agreement on the essential terms of the obligation that this contract covers as well as the parties' agreement on other terms that the parties consider essential.
The UAE Civil Code also allows the parties to stipulate in the LOI that further conditions will be agreed at a later date and to state that the LOI would not be binding if these terms are not agreed. Consequently, an LOI will be binding if it contains the essential terms and does not contain a provision invalidating it if an agreement on remaining terms is not reached. The logical question now becomes: what are these essential terms exactly?
These essential terms, from a legal perspective, can be summarised in the following points:
- For any contract to be binding, there must be an acceptance matching the offer. LOIs are no exception if they were to be considered binding. Therefore, the LOI must show that there is an acceptance matching the offer. In simpler terms, the LOI terms must be accepted as they are rather than with amendments. Or if there are amendments, then these amendments must be accepted too. This is a general requirement for all contracts to be binding and must be satisfied for the LOI to be considered binding.
- For construction contracts to be valid, the UAE Civil Code requires that construction contracts contain details of the project, its type, amount of works, how the works will be done, time for completion and price . Accordingly, and as the LOI is essentially a construction contract, it is essential that, at the very least, the LOI deals with all these points otherwise the LOI could be considered non-binding.
- Other provisions that the parties consider essential. The conditions, of course, would differ from one project to another and would be determined by reference to correspondence exchanged between the parties prior to the signing of the LOI. In the writer's view, these types of essential terms dictated by how the parties view them impose the biggest problem in determining whether the LOI is binding or not due to the amount of correspondence usually exchanged between the parties from tender stage until the signing of the LOI. The Qatari Civil Code adopts a similar position to the UAE and requires that a contract contains all of the essential elements in order to be binding. If that contract (or LOI for that matter) leaves certain elements for agreement at a later date but does not stipulate that the contract would not be binding unless agreement is reached on these elements, then the contract will be binding. This is essentially the same position as set out above in respect of the UAE law. Therefore, all that has been said in respect of the UAE remains valid for Qatar.
How to ensure that the LOI is binding?
While legal practitioners would generally advise against using LOIs because of the significant risk they carry, there are some points that the parties should consider incorporating into their LOI if they insist on using it. While not an exhaustive checklist, including the above list of points in an LOI is quite likely to reduce risk in the event that no final contract is signed.
LOIs can be a very useful tool for the fast-paced construction industry allowing projects to progress as fast as possible. However, any contract that is not fully prepared or negotiated will expose its parties to a risk that eventually translates into a loss of money of some sort. In a perfect world parties should not use LOIs, but since it has somehow become the norm in the construction industry, parties are cautioned to ensure that the LOI they are signing covers as many of the possible terms that govern their contractual relationship in the event that no final agreement is signed. In other words, when agreeing an LOI parties should sign it with the mindset that it might be the only document governing their respective rights and obligations in case of a dispute.
Checklist for a Letter of Intent
- Full details of the project and the parties (including ensuring that the parties named on the LOIs would be the parties of the intended final contract);
- Exact scope of works to be carried out by the contractor;
- Duration of the works;
- Contract price and payment method;
- Other major and essential terms of the contract such as sub-contracting, insurance, bonds,defects liability period ... etc.
- A termination provision;
- A provision regarding applicable law and dispute resolution method;
- A list of terms that are yet to be agreed between the parties;
- A reference to a standard form of contract or a specific contractual document to be adopted in case the final agreement is not reached or signed;
- A statement that the LOI is binding until the date of signing the final agreement.
International Quarterly is produced quartely by Fenwick Elliott LLP, the leading specialist construction law firm in the UK, working with clients in the building, engineering and energy sectors throughout the world.
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