Practical Law

An employer, such as a property developer, may need to involve a contractor in a project before it is ready to sign a building contract. This is sometimes generically known as early contractor involvement (ECI), and can take place on a formal or informal basis. Two common types of agreement between an employer and a contractor in these circumstances are a letter of intent and a pre-construction services agreement (PCSA). (Occasionally, a PCSA is known by the even shorter acronym: PCA, for pre-construction agreement.)

What is a letter of intent?

As we say in our practice note, because parties may want to start work quickly, they may:

“… [still] be concluding contract negotiations when they need to start to procure materials, commence site preparations or even start the works. In these circumstances, they may turn to letters of intent.”

A well-drafted letter of intent gives both the employer and the contractor a legal framework in which the contractor can start (and be paid for) work. Additionally, the employer typically only agrees to pay for that work up to a given sum, pending final agreement of the building contract.

Although a letter of intent is perhaps most commonly used when the parties know what is to be built, it can be used in other situations. For example, to demolish an existing building while the contractor finalises its design for the proposed new project.

However, letters of intent sometimes drag on, in circumstances where the final terms of contract may not be clear. In the words of Lord Clarke (RTS Flexible Systems v Molkerei Alois Muller), parties should be wary of the:

“…perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story to is to agree first and to start work later.”

What is a PCSA?

A pre-construction services agreement is a contract for use in a two-stage tendering procedure. Two stage tendering is more commonly used in larger or more complex projects and involves the employer tendering the project on the basis of an incomplete design, price and programme prepared by the employer’s professional team. One contractor is then chosen to work with the employer based on its proposal for the (pre-construction) second stage of the tender.

During the first stage, the parties enter into a PCSA, with the contractor advising the employer on the buildability of the design, the final cost estimate and other pre-construction services. Only once this is done does the employer engage the contractor for the construction stage under a construction stage contract (often based on a standard form contract, such as a JCT or NEC3 form).

What’s the difference between a letter of intent and a PCSA?

One way of viewing the key difference between a PCSA and a letter of intent is the parties’ (or perhaps the employer’s) purpose:

• The employer’s purpose in entering into a letter of intent is usually to sign a formal building contract for a given package of works, as soon as the parties can agree final terms. While the price and some final design details may be under negotiation, the nature of the works will usually be broadly settled. In one sense, the employer may be thinking to itself that it just wants to “get on with it”.
• In contrast, the employer using a PCSA will usually genuinely want the contractor’s input on buildability, programming, project management, the division of works into appropriate sub-contract packages, even on overall final designs. The typical employer in those circumstances may also be wanting to “get on with it”, but not until it has the benefit of the contractor’s input and advice.

Looking at things from a contractor’s perspective draws this distinction into focus: under a letter of intent a contractor simply carries out its role under the building contract in advance of that contract being finalised; under a PCSA a contractor provides services outside the scope of a typical building contract – the contractor is advising the employer as part of the procurement process.

Does the difference matter?

There are some key practical similarities for an employer using a letter of intent or a PCSA. For example, in both circumstances, the employer will be building up a certain momentum with the contractor. If it becomes difficult to agree the final terms of the building contract, or if the contractor’s vision for a project under a PCSA does not seem to fit with the employer’s vision, there will already be a lot of water under the bridge. In those circumstances, it is difficult in practice for the employer to go ahead with the project without the incumbent contractor.

Having said that, it is much less likely that an employer on a major project will get the best out of a sophisticated contractor if it does not give the contractor an opportunity to input into the project. In the right circumstances, a PCSA can bring focus, new ideas, design improvements and costs savings, and can be the start of a strong working relationship. A letter of intent alone is not nearly so likely to achieve that.

Is using a letter of intent a backward step?

Given what many describe as the obvious advantages of a PCSA, it is possible to think that using a letter of intent is always a negative step. Certainly, reaching for a letter of intent as a knee-jerk reaction is not good practice. However, the parties to a letter of intent may have good reasons for their choice, for example:

• A PCSA may only be appropriate where time and costs allow. On a smaller or more simple project the additional costs may not cover any savings made.
• Using a letter of intent for a specific purpose can help the parties. For example, if the contractor can begin a particular phase of works, for an agreed price, while negotiations continue on the next stage of the works, a letter of intent might be best. (However, there is nothing to stop certain works commencing under a PCSA.)
• If the parties have worked together before, the letter may simply give them the short window they need to conclude negotiations.

The future

PCSAs have their advantages, and letters of intent may be over-used in practice, but both are likely to continue to have a place in future construction and engineering projects.