Time and money are the cornerstones of any construction project. However, it is often the case that work on construction projects is started in the absence of any formal contract having been executed in the belief that this will save time and money. Instead, parties use letters of intent in the often mistaken belief that outlining the deal in minimal terms will nevertheless, adequately protect their interests. Letters of intent are meant to be no more than a ‘stop-gap’ as they anticipate the execution of a formal contract within a relatively short period of time. However, as with any stop-gap arrangement, they come with distinct disadvantages and risks.
A letter of intent can have unintended effects or fail to address crucial terms which a party seeks to rely upon at a later stage. The extent to which a letter of intent will be binding, and its actual effect, will depend on its wording and on the understanding of the parties.
A non-binding letter of intent is simply an agreement to agree: an expression by one party of an intention to enter into a contract with another. In British Steel Corporation v Cleveland Bridge & Engineering Co Ltd [1984][1] the Court found that the letter of intent was not a contract because important terms such as price had not been resolved. The absence of a contract in these circumstances meant that the employer could not require the goods to be delivered by a particular date. However, the manufacturer was still entitled to be paid a “reasonable value” for the goods it supplied.
Parties may also seek to protect their position in negotiations by identifying that a document is “subject to contract”. The use of such a phrase can be helpful in rebutting the presumption of contractual intent in commercial situations. If the parties do intend that some parts of the document should be legally binding, then it is advisable that the term “subject to contract” is not used in the label or title of the document, but that the body of the document makes clear which parts of it are intended to be legally binding. However, the words “subject to contract” (or other words which are intended to have a similar effect) are not foolproof and the term may be contradicted by the content of the body of the document, or, the parties may act in such a way as to result in the protection available being waived.
Otherwise, letters of intent act as ‘mini-contracts’ with very limited express terms. Caps on expenditure may be inserted to attempt to control the contractor’s costs. However, the particular wording adopted can have unintended consequences. In Mowlem plc v Stena Line Ports Limited [2004][2], the court held that the contractor, who had continued to work beyond the cap on liability specified in the letter of intent, was not entitled to be paid for this work. The Court refused to imply a term that the contractor would also be paid a reasonable amount for work carried out in excess of that figure. Whereas a term would only be implied as a matter of commercial necessity, it would be contrary to commercial sense if Mowlem could avoid the upper limit on the right to payment by simply continuing with the work and exceeding it. By comparison, in AC Controls v BBC [2002][3], the Court held that the cap on the contractor’s expenditure did not limit the employer’s financial obligation as was intended, rather, it only provided the employer with a right to terminate when the cap was reached. If the employer did not terminate, the contractor was entitled to continue with works in excess of the cap, to be paid on a reasonable basis. Clearly, each case was determined and assessed on its individual facts.
Employers wishing to safeguard their interests have also inserted provisos stipulating that their standard terms will apply. However, in Tesco Stores Limited v Costain Construction Limited [2003][4], the Court held that the letter of intent was binding but failed to incorporate Tesco’s own standard contract terms. As a consequence, the actual obligations upon the Contractor were much less onerous than intended and this exposed Tesco to significant losses.
Perhaps the best example of the type of difficulties that can be created when a party is engaged to carry out works pursuant to a letter of intent is the case of RTS v Muller [2010][5]. This case was ultimately decided in the Supreme Court and it is worth noting that the findings of the courts of first instance, Court of Appeal and Supreme Court all differed as regards the nature of the relationship between the two parties. As Lord Clarke in the Supreme Court so aptly put it, “The moral of the story is to agree first and to start work later.”
Other practical difficulties with letters of intent include; as the works being carried out under a letter of intent progress, the employer is less likely or able to replace the contractor with the consequence that the contractor is often emboldened to reject contractual terms that it would otherwise have accepted had the contract been executed before works commenced; or, in the anticipation of a formal contract being executed, particular fundamental terms (such as health & safety or insurance obligations) are inadequately addressed.
The above examples illustrate some of the risks associated with relying on letters of intent. Without exception, it is best for the parties to invest the time and effort to prepare a formal contract which properly reflects the terms of their agreement, rather then relying upon a letter of intent. Such foresight at the beginning of a project will result in saving the time and money that may otherwise be squandered in disputes arising out of the inevitable uncertainties of letters of intent.
While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.