In this question, I will aim to critically discuss the legal issues arising out of the use of Letters of Intent and their application within the construction industry. I will aim to put forward a balanced view, highlighting both the positive and negatives of Letters of Intent.
When looking at Letters of Intent within the Construction Industry we need to understand what a construction contract is. In Modern Engineering (Bristol) Ltd v .Gilbert-Ash Northern 1974 AC 689, Lord Diplock at 717B described a building contract as Adriaanse 2017
“An entire contract for the sale of goods and work and labour for a lump sum price payable by instalments as the goods are delivered and the work done. Decisions have to be made from time to time about such essential matters as the making of variation orders, the expenditure of provisional and prime cost sums and extension of time for the carrying out of the work under the contract.”
The nature of the construction industry is that its projects are often constrained by time, this aspect of the construction industry is not conducive to the fact that they are often very complex with multiple parties involved which means that often contracts take a lot of time and resources to finalise. This creates a situation whereby the design/delivery teams are on hold until the details of the contract are agreed which can take months, should any disputes over the details arise and our contract engagement programme slips it will invariably push our design and delivery programmes but as we discussed above time (usually the completion date) is a major constraint and often an essential term in the contract. Therefore, we need a mechanism that can be used to show the clients intent to enter the contract and expedite the works to ensure timeous delivery, we thus use letters of intent, letters of Intent are an interim mechanism to ensure work starts whilst the details of the contract are finalised, this is not a substitute for formal contract and I would always recommend that anyone considering the use of LOI’s is 100% sure they are the correct mechanism to use and are very confident that a formal contract is in advance stages of negotiation.
There is a tendency in the construction industry to attempt to use letter of intents as contracts, as a letter of intent attempts to do two things Adriaanse 2017:
1. Persuade the other party to begin work straight away.
2. Cap any payment under the agreement.
This undermines the argument for treating a Letter of Intent as a contract.
A letter of intent is used to express an intention to enter into a contract at a future date. However, as Lord Denning observed in Courtney & Fairburn, the law does not recognise a contract to negotiate, i.e., an intention to enter into a contract. He argued that a LOI is purely a term of convenience and is unlike expressions such as “subject to contract” and “without prejudice” which have defined legal meaning in contrast Letters of Intent have no substantive legal meaning.
No substantive legal meaning? How can we then use something that has potentially massive commercial ramifications if we don’t have a substantive legal meaning for it?.Here in lies the complexity of the adjudication of cases that involve letters of Intent, it is therefore not the mechanism itself that is the key factor but rather the details contained within the letter that allow us to adjudicate such issues.
We don’t live in a utopian world where all parties are always in agreement with every detail of a contract, allowing contract engagement to occur seamlessly (particularly in the construction industry) but rather an over complicated and congested one that means multiple parties are often at odds over contractual details meaning months and months of negotiation.
This is where a Letter of intent comes into its own and allows us to engage with suppliers/contractors and expedite work prior to a formal contract being agreed, this is with the understanding that there is an “intent” to enter into a contract in the future. If this is done at the very advanced stages of contract engagement and is used merely as an interim solution whilst the contract is being finalised it can be a very efficient tool from a commercial stand point allowing us to continue the works and maintain the construction programme whilst adjusting the contract engagement programme which inherently has more flex.
Windward suggests that there are 4 categories of Letters of Intent Adriaanse 2017:
(a) an expression of intention to enter into a contract at a future date which does not give rise to any legal obligation.
(b) an expression of intention to enter into a contract at a future date which does not give rise to any legal obligation but does not exclude other claims to payment.
(c) the creation of a conditional obligation which will be subsumed by a wider contractual obligation when the formal contracts are executed.
(d) A legally binding contract in that the LOI is an offer capable of being accepted.
Where the use of a Letter of Intent is most successful is where the essential terms are agreed upon this falls into part (c) of the 4 categories mentioned above. Generally, if this happens a dispute is unlikely and the works carried out under the Letter of Intent will be subsumed into the wider formal contract. Essential terms in construction can be but not limited to the price (or at a very minimum a method to ascertain price), delivery date (programme) and specifications. In Courtney & Fairburn Ltd v. Tolaini Brothers (Hotel) Ltd 1975 one party claimed that a contract existed between the two parties, however the court ruled that there was no binding contract between the two parties because:
1) An agreement to negotiate was no substitute for an agreement as to price. If there was no agreement as to price, and no agreed method for ascertaining the price (except by negotiations between the parties), there was no binding contract.
2) A ‘contract to negotiate’ was too vague to be a contract in law.
An argument exists that the disadvantages of a Letter of Intent or why they fail lies intrinsically linked to the wording Adriaanse 2017. Problems historically have also arisen when parties have issued a Letter of Intent and have then been unable to reach an agreement as per British Steel v. Cleveland Bridge & Engineering Co. Ltd (1981) or in ERDG Group Ltd v. Brunel University 2006 where the final documentation was never completed. In British Steel Corporation v. Cleveland Bridge & Engineering Co. Ltd (1981), Goff concluded that there are 2 forms of contracts that can arise from the use of Letters of Intent:
1) Bilateral (Executory) – each party assumes reciprocal obligations to the other (Turriff Construction Ltd v Regalia Knitting Mills Ltd (1971) 202 EG 169.)
2) Unilateral (“if” contract) A requests B to carry out a certain performance and promises B that, if he does so, he will receive a certain performance in return.
The defendant in this case was carrying out works in Saudi Arabia that required steel nodes that were supplied by the plaintiff. In this case no formal contract was ever signed due to the parties not being able to reach an agreement on the sequence of the delivery nodes. Goff, ruled that neither a bilateral or a unilateral contract had been entered into and that by way of a quasi contract the plaintiff was able to recover on a quantum meruit for work done pursuant to the direction contained with the Letter of Intent.
In conclusion, having reviewed the cases I firmly believe that the use of letters of Intent in the right circumstances can be very advantageous in real world situations allowing projects to expedite commencement of the work whilst the details of the contract are being finalised. Having said that I believe that where British Steel v. Cleveland Bridge & Engineering Co. Ltd (1981) and ……… went wrong was that the essential details of the contract had not been agreed and did not form part of the Letter of Intent, this led to the inevitable situation of dispute and litigation. As a minimum all Letters of Intent should follow the guidelines set by HHJ Humphrey QC in ERDC Group LTD:
1) There must always be clarity of the scope of work to be undertaken.
3) Time-frame for works to be undertaken and completed
As long as the express terms are clear and there is no ambiguity there is no reason why a Letter of Intent should not be used when trying to expedite work, however it should not be used as a replacement for a formal contract.