In this article, Commercial Manager Thomas Wilkinson considers the issues surrounding letters of intent and provides practical advice.
Time and time again we hear of disputes that arise as a result of using letters of intent in the absence of formal contracts. The question is, why are letters of intent still all too often used when it is widely known within the construction industry of their inherent risk?
This publication is not to go into the intricate detail about what a letter of intent is or the case law that governs them, this is already widely documented. It instead will look to understand why letters of intent are still used, whether this is justifiable and, when justified, some sensible precautions that could be made to resolve the all too familiar disputes that typically follow.
A Brief Overview of Letters of Intent
From the very outset of a project all parties commence with the best intentions. They plan and prepare for the works to be procured in the usual manner, through contracts and subcontracts. Then comes the dreaded erosion of time. This could be for a variety of reasons, but which inevitably compress the procurement process so as not to impact the on-site delivery programme. This now doesn’t afford the procuring party the necessary time to procure, negotiate and award the works, particularly on packages that are first to be undertaken in the programme[1].
This is then when letters of intent are utilized as an acceptable method of awarding work in advance of agreeing the formal contract.
Letters of intent come in many different shapes and sizes. There is no industry standard in the same way there is for standard forms of contract. This means the level of detail can be vastly different and the allocation of risk can be substantially different from the formal contract that is still in negotiation. In many instances each party’s interpretation of the provisions in the letter of intent differs, which leads to disputes as the works progresses.
These disputes are wide and varied and cover areas such as the scope of works, the agreed price[2], the contract dates, the terms[3] and payment provisions[4].
A final problem with letters of intent is that often work to agree the contract loses all momentum once works start on site and the letter of intent is in place. No one wants to deal with complicated negotiations on the formal contract. Instead focus is now on delivering the project and getting on with the job. There may be occasional email exchanges about the contract, but often nothing gets signed. This leads to another dispute: which terms govern the works? Has a contract been agreed or does the letter of intent still stand? This can be a messy and complex area.
The Alternatives to Letters of Intent
Now that we know briefly why letters of intent are used and their pitfalls, it is time to consider what alternative options are available to the parties:
- Just agree the contract. If the parties are going to the trouble of drafting and agreeing a standalone letter of intent prior to the formal contract, then why can’t the formal contract just be finalized? This might take a little more time to agree but in the long run is by far the best approach.
- Split the contract. A letter of intent may be required to start the enabling works or procure long lead items. If this is the case, then why can’t the contract be split in two? Whereby agreeing a contract for the early start activities, with a following contract agreed for the later works[5]. In my view it is significantly safer to limit the scope of works rather than place a financial cap on works which can be carried out under the letter of intent. The latter opens the door to a risk that if no final contract is signed, the parties could be deemed to have waived the financial cap and all works deemed to be carried out under the letter of intent. A limited scope also means both parties have a reason to continue negotiating as works progress, retaining the sense of momentum discussed above.
- Consider a different form of contract. The parties may be unable to agree a formal contract because the contract price is not yet finalized under a lump sum agreement. Why not consider awarding under a different measurement basis, for example remeasureable or cost reimbursable. This would adjust the contract risk profile to suit the level of detail available[6].
It should also be noted that the contracting party can refuse to work under a letter of intent arrangement and insist on having a formal contract in place. There are a lot of contractors and subcontractors that refuse to operate under these types of arrangements, full stop. They perceive the uncertainty to be too much of a risk. Obviously, this is a judgement call for each party to make and may result in lost opportunities, however it mitigates risks and provides greater certainty to the parties’ order book.
Conclusion
It is widely agreed within the construction industry that letters of intent should be avoided wherever possible. The Royal Institution of Chartered Surveyors[7] advises not to use letters of intent wherever possible and instead complete the formal contract:
“Operating under a letter of intent only delays dealing with the key issues between the parties, which need to be agreed for there to be a formal contract. Completing the formal contract and avoiding letters of intent is a good conflict avoidance strategy.”
This same viewpoint was echoed in the Supreme Court by Lord Clarke during the case of RTS v Muller[8]:
“The moral of the story is to agree first and to start work later.”
Ultimately construction projects will experience delay and time pressures. Some contracts may be complex and difficult to agree. It is the responsibility of the parties to make a concerted effort and try and work through these issues and agree the formal contract where possible. If this is not possible there are alternatives, as discussed above, that can be explored and considered prior to choosing to use a letter of intent.
If the parties are still determined to commence works under a letter of intent, then the parties need to give careful consideration to the likes of:
- The scope of work, including relevant specification and drawings.
- The financial mechanisms, including the price, associated cap, how the value of works is to be assessed and the payment process.
- Commencement and completion dates and any other key dates.
- The terms and conditions, preferably referencing those from a standard form of contract.
- Liabilities and any limitations.
- The parties conduct while working under a letter of intent. The parties actions can be a deciding factor on the terms of engagement, not just the letter of intent terms.
This is by no way an extensive list, merely a summary of key provisions. The majority of provisions should be captured under the terms and conditions of a standard form of contract. There are also templates available for consideration, from places such as The City of London Law Society[9].
However, if you so chose to progress works under a letter of intent, be warned, there is a long list of case law from projects that have come and gone where letters of intent were used, and which failed to achieve their intended objective. You have been warned.
We are actively recruiting. If you are interested in discussing opportunities to join ALA, please email [email protected] or look at our Current Vacancies.
Interested in finding out more about ALA?
Click here to see our latest news and updates, or follow us on LinkedIn.
[1] Justice Edwards-Stuart notably described the contract as a “triumph of form of substance” in Anglian Water Services v Laing O’Rourke Utilities Ltd [2010] EWHC 1529 (TCC)
[2] Housing Grants, Construction and Regeneration Act 1996, s108.
[1] Now this is not saying that all projects that utilize letters of intent follow this exact scenario, just it is typically time constraints that dictate the requirements to use a letter of intent in the first place.
[2] Mowlem Plc (t/a Mowlem Marine) v Stena Line Ports Ltd [2004] EWHC 2206
[3] Arcadis Consulting (UK) Ltd v AMEC (BCS) Ltd [2018] EWCA 2222
[4] OD Developments v Oak Dry Lining Ltd [2020] EWHC 2854
[5] Additional wording would be required in the contract for this option if both contracts then required subsuming into the one formal contract from a liability perspective.
[6] Consideration would need to be given to the pros and cons of each option and weighed up against the risks of using a letter of intent.
[7] The Royal Institute of Chartered Surveyors, RICS Professional Guidance, UK, Conflict avoidance and dispute resolution in construction – 1st edition, guidance note, p9.
[8] RTS Flexible Systems Ltd v Molkerei Alois Muller Gmbh & Company KG (UK Production) [2010] UKSC 14
[9] See The City of London Law Society Standard Form Letter of Intent