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Letters of intent - a sheep in wolf's clothing?

17 June 2013

Letters of intent have had a tumultuous history. Indeed, following the decisions of Ampleforth Abbey Trust v Turner & Townsend Project Management Limited (2012) and Shaker v Vistajet Group Holdings SA (2012), some in the construction industry have gone so far as to suggest that no work should be carried out under these documents, regardless of how desperate the employer is to proceed.

It is true that in a perfect world, the safest way to approach contracting is to sign a properly documented building contract before work commences. However, if you are working on one of the many developments with an immovable completion date, is it really practical for an employer to delay work in order to finalise contract details such as pricing? Long-lead order items and ever shorter programme windows (not least because of funding release timescales) force many employers and contractors into using letters of intent. In this article, we consider whether the doomsayers are right or if there is a sensible basis on which letters of intent can be used.

A reminder: what is a letter of intent?

Given how often the terms are used in the industry, it can be easy to forget that the phrases letter of intent and memorandum of understanding do not have any precise meaning. The effect of any document will depend on the terms set out (including the possibility that the document has no effect at all). In this article, we have used the term letter of intent to refer to all such documents.

What are the risks?

The practical and legal risks of working under a letter of intent are well documented. An employer risks allowing the balance of power in negotiations to shift to the contractor after allowing them to start work, with contractors seeking to renegotiate elements of the overarching contract which had already been agreed. This may seem reasonable in the circumstances to the contractor (perhaps because during his initial work he has discovered risks beyond which he had priced for), but for the employer, this may be a risk they considered was allocated to the contractor and for which they had not allocated funding. This may also be the result of inadequately detailed pricing at tender stage by the contractor, which is all too common at a time when tendering prices are increasing, margins are shrinking and suicide bidding will still win work. In such circumstances, the employer may well concede the point(s), on the basis that it will cost too much to employ a replacement contractor, particularly where mobilisation costs are high and will need to be repeated for any replacement contractor. An employer also risks, as in the Ampleforth case, the contractor getting his feet under the table and the formal contract never being signed. A contractor risks discovering that its costs in providing the authorised works and activities exceed the financial cap in the letter, giving it the difficult decision of whether to stop work and prejudice its relations with the employer or continue to work at its own risk.

However it is important to remember that there are also practical risks in refusing to enter into pre-contractual documents. Many developments simply must finish on time (educational and student accommodation schemes, as in the Ampleforth case, being a classic example). If the parties have not yet agreed every element of their contract, if they are say, finalising pricing, is it right to delay the timetable from the outset, when materials could be procured or designs prepared on an agreed basis? If lawyers advised clients never to utilise letters of intent and instead only pay and allow the contractor to commence when the building contract has been signed, would we instead be reading a raft of articles demonising the legal profession and their inability to be pragmatic and practical and so complicating and delaying projects? Would projects cease to get off the ground purely because contractual matters, final designs and/or prices are being finalised and long-lead orders cannot be placed? Letters of intent are, as acknowledged by certain members of the judiciary, necessary evils and we set out some advice regarding their use below.

Tips for use

Always enter into the main contract as quickly as possible, not least because a two or three page a letter of intent is not designed to, and cannot, provide either party with the same level of protection as a full building contract.

Consider carefully what terms you want the letter to have. Depending on its terms, a letter of intent may (1) not bind the parties at all; (2) form an interim contract on its own terms, governing the relationship between the parties unless and until a formal written contract is executed; or (3) be a final contract which, despite there having been no formal execution, is deemed to have incorporated the terms and conditions of the formal written contract that the parties intended.

This is not straightforward, so parties may wish to consider carefully whether to take legal advice when advising on and drafting letters of intent.

Project managers, quantity surveyors, lawyers and other professional advisors should exercise caution in recommending the use of letters of intent and make sure that they consider the service/work which is to be done under the letter and whether the use of the letter is really suitable and necessary (as mentioned above, letting a contractor onto the site may increase the employers risks).

A well drafted letter of intent should leave both parties incentivised to enter into the main building contract within a clearly defined timescale. To achieve this, utilise:

  • low financial caps on the value of the works that can be carried out and materials that can be ordered; and
  • a tight timetable for contract signature, limiting the time for performance under the letter.

Employers and their advisors should:

  • consider carefully whether the situation in fact requires a letter of intent
  • so far as possible, incorporate the main contract terms, remembering that it can be difficult to rely solely on the contract payment terms without additional amendments or the inclusion of detailed additional information
  • allow generous termination provisions together with 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
  • tailor the letter to address any project-specific requirements
  • in any event ensure the terms of the letter are robust enough to stand alone and protect the employer in the absence of a main contract (remembering always to work towards completion of the main contract)
  • choose your draftsperson carefully.

Advisors should:

  • avoid the risk of in any way affecting or damaging the Employers position through the use of a letter of intent
  • 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 …"
  • ensure that they carefully consider the most appropriate contractual framework for the circumstances and advise their clients of the associated risks.

Drafts people and users generally should:

  • wherever possible, avoid using successive letters of intent, each one extending the works and sums due
  • ensure that letters of intent encapsulate all key terms that would be required were the letter in fact the main contract
  • not forget to consider whether liquidated damages should be reserved, or alternatively, a general indemnity for losses or delays and when any guarantees and bonds may be needed.

In summary

Unless the construction markets approach to contracting changes radically, letters of intent will continue to be necessary evils in the sector and advisors and employers should not shy away from using them where there is a genuine need.

If you would like to further information on the drafting of or advice on a letter of intent please contact Tim Claremont and Claire Atkins.

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The content on this page is provided for the purposes of general interest and information. It contains only brief summaries of aspects of the subject matter and does not provide comprehensive statements of the law. It does not constitute legal advice and does not provide a substitute for it.

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