REUTERS | Lisi Niesner

Letters of intent: often used and often problematic

In the construction industry, more than any other industry, there is a tendency for works to be carried out on the basis of unsigned contracts and letters of intent. While there are often legitimate commercial pressures to start work before all the contractual terms have been agreed, two recent cases have highlighted the risks in not getting this right:

  • Haden Young Limited v Laing O’Rourke Midlands Limited highlights the risk to an employer (or a contractor engaging a sub-contractor). In this case, the parties failed to agree all the terms of the contract, the court held that there was no contract and Haden Young successfully claimed payment on a quantum meruit basis.
  • Diamond Build Limited v Clapham Park Homes Limited highlights the risk to a contractor. In this case, the parties proceeded on the basis of a letter of intent and never agreed a formal building contract. The letter of intent included a cap on the amount payable by the employer. The court enforced that cap even though the contractor had exceeded it by some margin.

Here are some practical tips for avoiding these problems:

Scope of the letter of intent. If you have to start work on the basis of a letter of intent, make sure that the scope of the letter of intent is clearly defined. This can be by reference to the work to be carried out under it, the period of validity of the letter of intent and/or amounts to be expended under it. In particular:

  • Contractors: do not continue work and incur costs above any financial limits stated in the letter of intent without ensuring your right to payment for those costs (for example, by agreeing a further letter of intent or signing a formal construction contract).
  • Employers: do not instruct work, or permit work to continue, under a letter of intent that has expired. You run the risk that the contractor will be entitled to payment on a quantum meruit basis for this work and a reasonable time in which to complete the work.

Intention to create a contract. Make sure that it is clear whether the letter of intent is intended to create a contract. If it does create a contract, make sure that you are certain what matters remain to be resolved for a formal construction contract to be entered into.

Risk management. Consider putting in place internal risk management policies to prevent a project being continued and/or completed where the underlying contract documentation has not been agreed. This may involve diarising key dates and (at least) weekly cost updates.

Agree a formal construction contract. Do not regard a letter of intent as a substitute for a properly drafted construction contract. It is unlikely to contain terms that are adequate for your protection and may leave many important issues unresolved. You may also find that you do not have the contractual remedies that you thought you had, when things go wrong.

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