Letter of Intent - What is it and should I start works upon receipt? page C-Link

Letter of Intent – What’s it for and should I start works upon receipt?

Letter of Intent

As a Quantity Surveyor working for a small main contractor, you’ve been issued a Letter of Intent (LOI) by your client whilst the contract is finalised. Although having not commercially managed a project pre-contract before, you have some queries as to what a Letter of Intent is and its parameters. This C-Link articles aims to provide guidance to your questions.

What is a letter of intent?

  1. As an interim contract on its own terms that will govern the relationship between parties unless and until a formal written contract is executed
  2. As a non-binding statement of the future intention of both parties
  3. As a final contract which is deemed to have incorporated the terms and conditions of the formal written contract

Why Would a Client (or Main Contractor) Issue a Letter of Intent?

Letters of Intent (LOI) are usually issued at a time when it is anticipated the contractor will start to incur costs and overheads. Ideally, the terms and conditions of a contract would be agreed by all stakeholders before any works are performed. The reality is that parties are often under commercial pressure to commence works as soon as possible whilst the contract is fully negotiated.

There are several scenarios in which an LOI is required and often it will simply be due to programme constraints. For example, a main contractor may find certain suppliers have an unusually long lead time. For the intended contract programme to be achieved, an immediate start is required and they therefore decide to issue an LOI with certain caveats. You will find LOI’s are often issued to cover initial design and engineering and capped to certain values.

Structure

  • If the contract is administered by a third party, authorisation from the client acknowledging so
  • Definition of the project
  • Scope of works
  • The intended contract sum, detailing any applicable VAT
  • A cap on expenditure authority, proportional to the works intended to be undertaken under the LOI
  • An expiry date of the LOI, by which time both parties commit to agreeing contract terms
  • Reference to tender documents/intended contract documents
  • Description of the intended form of contract
  • Programme details including site possession date, date on which to proceed works, and completion date
  • Any matters to be resolved prior to contract
  • Clarity that the contract terms will take precedence over the LOI and retrospectively apply to any works carried out
  • Terms and provisions for cancelling the letter and determining the works at any time prior to signing the full contract
  • Statement as to the prevailing governing law
  • Access onto site and its conditions
  • Insurance provisions
  • Dispute resolution procedures
  • Liquidated and Ascertained Damages
  • Retention
  • Expected deliverables

Legal Position

For a Letter of Intent to become a legally binding contract, it must include three items:

  1. Agreement i.e. certainty of key terms;
  2. Intention i.e. a mutual intent to enter in a binding legal contract
  3. Consideration i.e. a price paid for works.

Should there be a scenario where the legality of the Letter of Intent is questioned, a court will look to identify the above.

Interesting Case Law

Ampleforth Abbey Trust vs. Turner & Townsend Project Management – Turner & Townsend were appointed as project managers for several projects at Ampleforth College. Kier Northern was appointed contractor at the advice of the project manager, based on an early start on site instructed via an LOI.

During the project, eight letters of intent were written and issued, with the contract never signed despite being substantially complete.

The contractor was ultimately four months late in completing the works, but as there was no contract in place the settlement reached was not as favourable for Ampleforth as it might have been. Ampleforth therefore began proceedings for professional negligence against Turner & Townsend. The judge awarded damages to Ampleforth on a loss of chance basis as the LOI failed to make provision for liquidated and ascertained damages.

The takeaway being, avoid an over reliance on LOI’s as they do not cover all eventualities that a contract would. It also reduces pressure from the supplier to sign up to more onerous conditions when works are already substantially complete and previously unknown risks are better understood. A benefit to the receiver.

Twintec Ltd v Volkerfitzpatrick Ltd – This was a case that demonstrated the need for a dispute resolution clause when structuring an LOI. The High Court granted the Claimant an injunction to restrain the Respondent from pursuing adjudication on the grounds that the LOI did not incorporate the terms of the proposed contract (DOM/2 sub-contract) that was relied and acted upon for the appointment of an Adjudicator. While this may appear contrary to the Scheme for Construction Contract, the court viewed it from a different angle. Lord Justice Edwards-Stuart held that the validity of the Adjudicator’s appointment “goes to the heart of his jurisdiction” and unless appointed under the correct contractual procedure, the nomination and appointment will be invalid.

Wilson Smithett & Cape (Sugar) Ltd v Bangladesh Sugar & Foods Industries Corporation – The defendant, acting on behalf of Bangladesh Government, issued a tender for the sale of 10,000 tons of sugar cane. The plaintiffs were the second lowest bidder. The defendant upon instruction from their client decided to order an additional 10,000 tons and placed it with the second lowest tenderer (i.e. the plaintiffs) if they were agreeable to matching the successful tenderer’s bid.

Negotiations were conducted between the plaintiffs and the defendant. The plaintiffs sent a letter of offer to the defendant, which was to remain open until 2pm local Dacca time on 12 June 1981. The same day the defendants issued a letter of intent, which stated:

“We are pleased to issue this letter of intent to you for the supply of the following materials … all other terms and conditions as per your … offer dated June 12th June 1981‘. Including a performance bond to be set up within one week, which the plaintiff complied with.”

The defendants decided not to proceed with their purchase and contended that their letter of 12 June was nothing more than an expression of a future intent to enter into a contract.

It was held by the court that while the term ‘letter of intent’ was used, it was nevertheless intended to have a contractual significance and effect; accordingly there was a binding contract between the parties.

Hall & Tawse South Ltd v Ivory Gate Ltd – This particular case law sought to distinguish a letter of intent from a provisional contract. Judge Thornton QC described the comparison in the following terms:

“A letter of intent is usually a unilateral assurance intended to have contractual effect if acted upon, whereby reasonable expenditure reasonably incurred in reliance upon such a letter will be reimbursed. Such a letter places no obligation upon the recipient to act upon it and there is usually no obligation to continue with the work or to undertake any defined parcel of work, the recipient being free to stop work at any time.

The effect of such a letter is to promise reasonable reimbursement if the recipient does act upon it. However, the letter in question (in the particular case) … is one which imposes obligations on both parties. It requires the plaintiff to commence the works, being a defined package of work and contract administration. The plaintiff had an option of whether to start or not but, having started, the plaintiff was under an obligation to continue with the works and not to stop, unless the defendant determined the works in accordance with provisions set out in the letter. Therefore, it was judged for the letter to be the ‘provisional contract.’”

Dangers & Scenarios

We can look to case law to illustrate the dangers of a Letter of Intent, summarised as follows:

  • Over reliance: a tendency to use the LOI as the governing document between parties. Apathy, strategic or otherwise, may result in the LOI being continually extended
  • Not enough detail: the structure of the LOI should be substantial, utilising many of the documents and conditions that will be incorporated into the subcontract. A prevalent danger is not including for important terms such LADs
  • Actioning: Commencement of works under the LOI can be a risk for both parties, therefore clarity on scope of works, segmentation of each package of work (i.e. design, procurement etc), associated values, deliverables, and timescales is vital. As a supplier you do not want to be in a position where works have been done and not paid for.

There are many scenarios where implementing a Letter of Intent is useful and commencement of works would be fine. For example, a certain material could be on an extended lead time and as a result, design and engineering need to commence urgently. Material on a 20-week lead time is needed on site for week 40, with 5 weeks for design. The contract wording is still being agreed and it is expected to take a further 4 weeks. Therefore, the decision is made to issue an LOI to commence design with the view the contract will be concluded and supersede the LOI. Within the LOI timescales, required deliverables, value and other terms are expressly stated. Both parties are satisfied as each gain to the overall benefit of the project.

There is no limit on what element of works can be started under an LOI, however it is advisable the structure of an LOI is followed and that a contract is agreed and executed prior to works starting on site. The implications of not doing so is exemplified in case law.

Conclusion

Letters of Intent are issued at a time when a contract has not been agreed and executed, but it is anticipated the contractor will incur costs and overheads related to the project. Such costs and overheads will occur at the on-set of a project, in design and engineering. Each letter of intent must be drafted based on the specific context. With it being important that it is not used as a contract substitute but as a stopgap until the full terms and conditions of the contract are agreed.

For LOIs to be a legally binding agreement, intention and consideration are required which you must consider based on your intention/context. Keeping to a structure and including as much contract detail as possible is recommended to minimise risk in the unfortunate case of dispute. Overall, Letters of Intent are a useful tool in alleviating the commercial pressures that project teams will often face if administered correctly.

Manny Singh