Letters of intent – what you need to know

With the recent Court of Appeal decision in Arcadis Consulting v AMEC [2018] EWCA Civ 2222 highlighting the risks involved in working under a letter of intent, it is worth having a recap on this area of law

I. What are letters of intent? 

A letter of intent or LOI, is a general term for a document that expresses an intention on the part of a party to enter into a formal contract at a later date and in the meantime requests the other party to carry out works before the finalisation of that contract.

Typically this document takes the form of a letter given by an employer to a contractor with instructions to carry out works, with the final agreement to be negotiated or concluded later.

An example can be seen in the case of Structure Consulting v Maroush [2017] EWHC 962 (TCC):

“You will proceed with the preparation of a detailed program of details and samples associated with works including liaison and coordination essential to the program. Pending execution of the contract documents, you will accept this as a letter of intent on the understanding that a contract will be placed with your company. If the project is cancelled at any stage by the client prior to the issue of the contract documents, you will be reimbursed your net costs plus overheads and profit on nets costs only which will be agreed by the quantity surveyor. You will not be reimbursed for costs not incurred such as loss of profit et cetera.

II. Why are letters of intent used?

Construction contracts are long and technical. It may therefore take parties a long time to agree all the details in the contract. This delay is commercially undesirable. It is usually cheaper, and logistically more efficient for parties to organise supply chains, procure materials, and commence site preparations as soon as possible.

Letters of intent provide contractors with the confidence and comfort to commence work early, saving everybody time and expense. This is because they usually give the other party an indication of what terms have been agreed so far, remuneration for work done and an assurance that a contract will eventually be finalised.

Depending on the nature of the letter of intent, they may also be binding as an interim agreement, allowing the parties to commence work on a provisional basis.

III. Construing a letter of intent

“It is part of the folklore of the construction industry that there exists a mythical beast, ‘the Letter of Intent’, the legal effect of which, if it is acted upon, is that it entitles a contractor to payment for what he does, but does not expose him to any risk because it imposes no contractual obligations upon him… in fact the legal effect of a letter of intent depends upon the true construction of the communications between the parties and the effect, if any, of their actions pursuant to those communications.” – Tesco Stores v Costain Construction [2003] EWHC 1487 (TCC) – HHJ Richard Seymour QC at para [160].

“Letters of intent come in all sorts of forms. Some are merely expressions of hope; others are firmer but make it clear that no legal consequences ensue; others presage a contract and may be tantamount to an agreement ‘subject to contract’; others are contracts falling short of the full-blown contract that is contemplated; others are in reality that contract in all but name. There can therefore be no prior assumptions, such as looking to see if words such as ‘letter of intent’ have or have not been used. The phrase ‘letter of intent’ is not a term of art. Its meaning and effect depend on the circumstances of each case.” – ERDC Group v Brunel University [2006] EWHC 687 (TCC) – HH Humphrey Lloyd QC at para [27].

As the passages above show the legal effect of a letter of intent depends on its construction. Normal principles of contractual construction and interpretation therefore apply.

Typically most letters of intent will fall within two categories: a) as a binding interim contract, or b) as a non-binding letter of comfort. As the legal differences between the two are significant, it is important that parties are clear and unambiguous in their correspondence.

An employer should expressly state whether a letter of intent is intended to be binding or not. Otherwise, ambiguities in a letter of intent may lead to the court characterising it in a way that catches the parties by surprise.

RTS Flexible Systems v Molkerei [2010] UKSC 14, shows, however, the difficulties involved. In that case, the employer sent a letter of intent containing a draft contract. Crucially the letter of intent contained a ‘subject to contract’ clause stipulating that the terms would not be binding unless it was signed and executed by both parties. This did not occur. However, the Supreme Court held that a binding contract nevertheless resulted from the letter of intent. The ‘subject to contract’ clause was held to be waived by the actions of both parties.

Even where the employer has made it clear that a letter of intent is not to be binding by marking draft terms as ‘subject to contract,’ that may be insufficient if subsequent actions demonstrate otherwise. In RTS Flexible Systems, the key factor was that the parties behaved as if there was an effective binding contract. Work were carried out, payments were made and both parties had then agreed a variation to the programme. They implicitly accepted that a contract was in place and therefore waived the ‘subject to contract’ requirement.

The reasoning in RTS Flexible Systems follows the decisions in Bryen & Langley Ltd v Boston [2005] EWCA Civ 973 and Harvey Shopfitters [2003] EWCA Civ 1757. The general principle is that provided there is agreement over the essential terms and that it is acted out by the performance of the parties, a binding contract will generally be found from a letter of intent despite the lack of formal execution.

Conversely a lack of agreement over terms essential to the operation of a basic interim contract such as the standard of work required, is fatal to the characterisation of a letter of intent as a binding agreement (Whittle Movers v Hollywood Express [2009] EWCA Civ 1189).

IV. The legal effect of a letter of intent

A. Interim Contract

Where a letter of intent is characterised to be binding, the undertaking of work under its instructions will constitute acceptance of a contract.

Typically, such a contract will be interim or provisional. Its terms will therefore be superseded by the terms of a subsequent finalised agreement.

As expressed by Edwards-Stuart J at [18] in Twintec Ltd v Volkerfitzpatrick [2014] EWHC 10 (TCC), “…where two parties enter into an agreement to carry out work in anticipation that they will in future enter into a formal contract in respect of that work, if that formal contract is subsequently entered into it there may well be an implied term that the contract will govern the parties’ relationship retrospectively.”

However, in the event that no subsequent contract is concluded, the terms of an interim contract are effectively final.

The advantage of an interim contract is that they provide for terms which the parties have agreed on. This allows work to commence on a clear basis, even when finer points of detail have not been finalised.

For instance, an interim contract will contain details on the scope of the work and payment. It may also provide for key provisions that set out:

• Terms and conditions applying to the works undertaken
• Caps
• Insurance requirements
• A dispute resolution clause

However, interim contracts may also be skeletal. If poorly drafted, a lack of terms will expose parties to risks that would otherwise be accounted for in a final contract. In Ampleforth v Turner and Townsend [2012] EWHC 2137 (TCC), the employer successfully sued the project manager for failing to advise it on the risks posed by letters of intent. The letters of intent in question lacked a liquidated damages clause. The employer was thus unable to claim liquidated damages from the contractor for delays in construction.

Finally it is important to note that an interim contract is an independent of the final contract. The terms of an interim contract are only superseded if the final contract is concluded.

This is evident from the analysis of the Court of Appeal in Arcadis Consulting v AMEC. In that case the Court found that the parties had entered into an interim contract arising from performance under a letter of intent. It also held that a liability cap had been incorporated into that interim contract. This was despite the fact that a liability cap had not been agreed for the final contract. Ongoing discussion and negotiations of the terms of the final contract had no effect on the terms in the interim contract.

B. Letter of comfort

Where a letter of intent is characterised as non-binding, it will not create any contractual obligations on either party but will merely constitute a letter of comfort.

This position poses a greater risk to the contractor as there will be no contractual obligation on the part of the employer to pay remuneration for the work done or liquidated damages in the event of a breach.

Further, the lack of a contract means risk will not have been properly allocated. The contractor may bear the burden of risks that it did not intend to bear insofar as there will be no effective exclusion clauses or liability caps.

This does not mean the Contractor is left without any remedy whatsoever. There will usually be a claim in quantum meruit.

For example, in British Steel Corp v Cleveland Bridge & Engineering Co Ltd [1984] 1 All E.R. 504, it was found that no contract resulted from a letter of intent. Nevertheless, the contractor was entitled to a reasonable sum for work done at the employer’s request because an obligation sounded in restitution.

A quantum meruit does not, however, make up for the lack of certainty and protection which a contractual arrangement would otherwise have provided.

The lack of a binding contract may also be disadvantageous for an employer. In Haden Young Limited v Laing O’Rourke Midlands Limited [2008] EWHC 1016 (TCC), the lack of a binding interim agreement meant that the employer was liable under quantum meruit for a sum that would otherwise have been capped.

V. Scope and expiry of an interim contract

Contractors, because they anticipate a subsequent contract, may do work outside the scope of an interim contract, or may continue work despite its expiry. This raises problems where the final contract is never, in fact, concluded.

Whether there remains an effective contract or not in those circumstances is dependent on the construction of the letter of intent and the actions of the parties. Generally, however, there are three possibilities:

1. A contractual relationship continues to exist. The letter of intent is intended to govern construction works after its expiry in the event that a final contract is not concluded. The terms of the binding interim contract function as the terms of the final contract.In Diamond Build Limited v Clapham Park Homes Limited [2008] EWHC 1439 (TCC), the letter of intent stated that if a final contract was not executed, then the employer would reimburse the contractor for works up to a cap of £250,000. As the final contract was never concluded the Court held that the interim contract’s cap applied.
2. A contractual relationship continues to exist, but not on the original terms of the interim contract. The parties must have impliedly agreed a variation or a new contract despite not formally executing the final contract.In RTS Flexible Systems, the original letter of intent had expired. However, the Supreme Court found that the parties had entered into a new contract despite there being no formal execution of the final contract. It was held that the parties had impliedly waived the requirement that the draft terms were to be binding unless they were formally executed.
3. No contractual relationship exists. After the expiry of the letter of intent and the failure to agree a final contract, there is a lacuna. However, the contractor can make a claim in quantum meruit for the work it has done.This was the position of the Court of Appeal in RTS Flexible Systems before its decision was reversed by the Supreme Court.

Conclusion

Letters of intent are not a legal term of art. Their effect is dependent on their construction. Legal practitioners are therefore reminded that it is important to advise clients as to the risks involved in using a letter of intent. As the cases reveal, it is safer not to commence work until there has been agreement over the terms. If parties opt to commence work under a letter of intent, they should have regard to scenarios where no formal contract is concluded and ensure that there are provisions in place to allocate risk.