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A sheep in wolf's clothing?

1 January 2014

Following decisions such as Ampleforth Abbey Trust v Turner & Townsend Project Management Limited [2012], some in the construction industry have suggested that no work should be carried out under letters of intent ("LOIs"), regardless of how desperate the employer is to proceed. However, if lawyers advised clients never to commence work unless the building contract was signed, wouldnt the profession be demonised for being impractical? We set out a sensible basis on which LOIs can be used.

What are the risks?

It is true that in a perfect world, the safest way to approach contracting would be to sign a properly documented building contract before work commences. The practical and legal risks of working under a LOI are well documented:

  • Employers risk the balance of power in negotiations shifting to the contractor. A contractor may wish to revisit pricing, either because he discovers risks he had not priced for, or because of underbidding at tender stage (all too common at a time when "suicide bidding" will still win work). Whilst this may cause funding problems for the employer, he might still concede the point(s) on the basis that it will cost too much to employ a replacement contractor, particularly where (repeat) mobilisation costs are high.
  • Contractors may discover that their costs in providing the works exceed the financial cap in the LOI; in this event, should they stop work and prejudice their relations with the employer or continue to work at their own risk?

However, if your development simply must finish on time (e.g., student accommodation schemes), then long-lead order items and ever shortening programme windows can make it impractical to delay works from the outset in order to finalise every minor contract detail. It is for this reason that many feel they have no choice but to procure materials and prepare designs under a LOI. In this event, it is important to recognise and manage your risk. We set out some advice below.

Tips for use

Do you in fact require a LOI? It is not always appropriate or necessary - in which case dont use one.

Always enter into the main contract as quickly as possible - a short LOI is not designed to, and cannot, provide the same level of protection. A well drafted LOI should leave both parties incentivised to do so within a clearly defined timescale, so restrict work under the LOI with low financial caps and a tight timetable for contract signature.

Always tailor your LOI to the project.

Employers and their advisors should:

  • so far as possible, incorporate the main contract terms into the LOI, remembering that it can be difficult to rely solely on the contract payment terms without amendments;
  • allow generous termination provisions and detailed provisions exempting any claims for loss of expectation etc in the event that the main contract is never progressed;
  • consider how losses or delays may be compensated (do you need a general indemnity for losses or delays or any guarantees / bonds?);
  • ensure the LOI is sufficiently robust to stand alone and protect the employer in the absence of a main contract (remembering always to work towards completion of the main contract); and
  • choose their draftsperson carefully.

Advisors should note the comments in Ampleforth that they are "coordinator and guardian of the clients interests" and that "efforts to finalise the contractual arrangements [are] of central importance … The execution of a contract is to be seen not as a mere aspiration but rather as fundamental".

Avoid using successive LOIs, which each extend the works and sums due.

Finally, remember that the term "letter of intent" does not have any precise meaning. The effect of any document will depend on its specific terms - including the possibility that it has no effect at all. This article was first published in The Structual Engineer

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