When might a letter of intent be appropriate?

The case: Cunningham and Others -vs- Collett and Farmer, TCC, 13 July 2006.

The issue: Whether it was negligent to allow the issue of a letter of intent.

The implication: If certain preconditions are satisfied, a letter of intent can be a useful aid to an early start on site.

When might a letter of intent be appropriate?

One of the most commonly recurring themes of the articles written in this column over the past 10 years has been the remarkable ability of contractors and their clients to find themselves in a position where one party alleges that major construction works have been undertaken without the benefit of a formal construction contract.

The most common reason for this occurring is when works have commenced in accordance with a letter of intent issued by the client, but the parties have not subsequently concluded formal contact documentation. Sometimes this is simply because they have overlooked the need to do so, while on other occasions difficulties have arisen when the parties have tried to conclude the precise terms of the contract.

At its purest, a letter of intent is simply that a non binding statement of the client's intentions. It might be issued to reassure a contractor that it is likely to be favoured with the award of a contract and possibly comfort it sufficiently to remain committed to the client and the project while the necessary formalities are carried out. Sometimes, encouraged by such letters of intent, contractors are also willing to undertake limited preparatory activities - but this would be essentially at their own risk.

More commonly, the letter of intent also invites the contractor to undertake works in connection with the project and offers to pay the contractor for those works on a stated basis should a formal contract not be entered into.

The works to be undertaken in accordance with the letter of intent may be expressly limited to specified activities, or a limit upon the client's total financial commitment under the letter of intent may be imposed. Letters of intent in this form are essentially an offer which, if accepted by the contractor, gives rise to a contract in accordance with the terms of the letter.

Formal planning

In an ideal world, letters of intent will never be necessary, as clients would always take care to ensure that the scope of works, price, period and contract terms have all been agreed before committing themselves to proceed with a project.

Unfortunately, this ideal situation does not always occur in practice and it is common for parties to reach agreement upon the main points, while leaving the 'small print' to be resolved at some later date.

Typically, this situation may arise where the tender was more than expected, leading to various savings being negotiated to bring the scheme back within budget.

In such circumstances, the parties may be happy that they know what has been agreed, but recognise that a period of time will be required to make the necessary amendments to the contract documents.

Provided this happens promptly, and the contract is subsequently executed, the issue of a letter of intent in such circumstances can allow works to commence perhaps a few weeks earlier than would otherwise be the case, and this could be to the benefit of both parties.

Premature use?

In a recent case in the Technology and Construction Court - Cunningham & Others -vs- Collett and Farmer - it was alleged that an architect had been negligent in allowing his client to issue a letter of intent of the second type described above, as it was inappropriate or premature to do so.

When considering this allegation, the judge set out his views concerning the use of letters of intent and the circumstances where they may be appropriate.

He endorsed the view that the widespread use of letters of intent in the UK construction industry can cause more problems than they solve, and noted that their greatest problem was that once sent, everyone's focus becomes upon construction work and progressing the project, meaning that the need to conclude the contract documentation is not given the appropriate priority.

The consequence of this was that should problems start to arise on site, the absence of a proper contract means that the parties would not have the benefit of its provisions to resolve those difficulties.

Additionally, there was a temptation to use letters of intent to get works started on site and, by so doing, put off addressing potentially difficult contractual negotiations. Of course, in such circumstances, a problem delayed is rarely a problem avoided.

Despite these concerns, the judge recognised that the use of letters of intent could be a useful tool in circumstances where:

"(i) the contract workscope and price are either agreed or there is a clear mechanism in place for such workscope and price to be agreed (ii) the contract terms are (or are very likely to be) agreed (iii) the start and finish dates and the contract programme are broadly agreed (iv) there are good reasons to start work in advance of the finalisation of all the contract documents."

If these preconditions were satisfied, and provided both the contactor and the client were keen to start to work on site promptly, a letter of intent could be appropriate provided that it was carefully drafted to minimise the risk to both parties should a formal contract not eventuate.

In this particular case, the court found that all of these features were present, and that as a consequence, the architect was not negligent in allowing his client to proceed in this way.

[Contract Journal, 13 September 2006, p 30]