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Letters of Intent: Do you intend to take the risk?

Topical Issue 649

Letters of Intent: do you intend to take the risk?

Despite a consensus in the industry that letters of intent (LOIs) should generally be avoided, procuring construction works under LOIs remains common practice.

In this article we have set out some of the key risks of proceeding under a LOI as well as providing some practical guidance as to their usage.

What is a LOI?

  • LOIs have no fixed legal definition and can take a number of forms with varying effect.
  • As a general rule, carrying out works pursuant to a LOI will generally constitute a binding contract between the parties (and therefore, in most cases, a construction contract for the purposes of the Housing Grants, Construction and Regeneration Act (1996)).
  • In order to construe what agreement has been struck between the parties, as well as considering the LOI itself, the courts will often consider the wider circumstances, including the parties’ conduct, from which a contractor’s acceptance to contract on terms pursuant to a LOI may be implied.

What are the risks of using a LOI?

The irony with LOIs is that they are often quickly drafted up so that works can commence, with proper consideration as to their effect not always given. However, if sufficient time was available, it would invariably be utilised to finalise the terms of the contract.

Whilst there are obvious practical and commercial advantages to their use, the risks associated with LOIs are often underappreciated.

Some of the common issues with LOIs are summarised below:

  • A LOI can create confusion with parties sometimes unaware as to whether a contract has been formed;
  • LOIs may combine a mixture of binding and non-binding and/or ineffective terms, which can also lead to confusion and disagreement;
  • Unless carefully drafted, a LOI may inadvertently comprise a contract for the entire works, an issue which is compounded by their general unsuitability for such purposes, as detailed below;
  • LOIs generally fail to clearly define the parties’ respective rights and obligations and are often absent important operational provisions (e.g., payment provisions, change mechanisms, progress provisions, dispute resolution provisions etc), thereby increasing the likelihood of disputes; 
  • Unless properly drafted with consideration given to financial caps, amongst other things, employers procuring initial works by way of a LOI may face demands for payments exceeding what they had intended to authorise; 
  • Conversely, LOIs with strict and effective financial caps may place contractors in a precarious position, particularly where the main contract negotiations are delayed and/or there is a risk that the main contract will not be agreed;
  • Commencing works under a LOI may inadvertently relegate the negotiation of the contract to an item of secondary importance, as priorities switch to the delivery of the project;
  • The longer works are undertaken under a LOI (or a series of LOIs) the less likely it becomes that the parties will reach agreement on the terms of the contract.

The key point to emphasise is that LOIs almost always create uncertainty, and uncertainty invariably leads to disputes. 

Some of the recent cases involving LOIs, summarised below, illustrate this point:

Practical guidance on the use of LOIs

Despite their inherent risks, LOIs will continue to be desirable for commercial reasons given their practical advantages.

In the case of Cunningham -v- Collett & Farmer (2006), although commenting that LOIs were “too often used in the construction industry as a way of avoiding, or at least putting off, potentially difficult questions”, the court opined that there were circumstances in which a LOI may be appropriate. Namely, where:

  • Scope and price are agreed;
  • The contract terms (i.e., main contract) are already agreed, or are likely to be agreed;
  • The commencement and completion dates are broadly agreed; and,
  • There are good reasons to commence the works in advance of the main contract being finalised. 

Although, ideally, a LOI should only be considered in such circumstances, in all cases, careful consideration should be given to, at least, the following:

  • Using clear and precise language to specify what is binding and what remains to be agreed between the parties;
  • Including a clearly defined scope for the specific and expressly identified works to be performed pursuant to the LOI;
  • Including a specified duration for the works to be performed pursuant to the LOI;
  • Considering the use of financial limits where appropriate;
  • Including a process for approving additional works and varying any financial limit;
  • Including interim liability clauses;
  • Including clear termination provisions.

In addition to the above, seeking to incorporate draft terms in a LOI requires careful consideration and precise drafting, as illustrated by the case examples above. 

Notwithstanding this guidance, it is critical that expert advice is sought before procuring or agreeing to commence works pursuant to a LOI.

Authors

Sam Beer

sam.beer@hilldickinson.com

David Crone

David.crone@hilldickinson.com

Hill Dickinson LLP

LEGAL NOTICE

The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.

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