Project lifecycles are often dictated by an end date. The procurement of a project has many stages, some of which may not always go to plan. This often results in condensing of the construction programme leading to an urgency to get the contract negotiations complete.
In addition, construction contracts can be incredibly complex. It can take a long time for the parties to negotiate and agree the full contract. Often, whilst negotiations are taking place, the contractor may be in a position to begin part of the works or procure materials and/or services. In such cases, the employer may turn to a ‘Letter of Intent’ to enable the contractor to get a head start on the project.
This can be advantageous in allowing work to begin. However, there are risks to consider before starting the works and/or services under a Letter of Intent. In this article, we are going to consider those risks and identify some of the pitfalls should the only option be to begin working under a Letter of Intent.
What is a Letter of Intent ?
The first thing you need to understand is that ‘Letter of Intent’ is not a defined legal concept. They often cover many scenarios. As such every ‘Letter of Intent’ will come with its own obligations and risks. A Letter of Intent is only a stated intention of the parties to enter into a formal contract at some time in the future. It only instructs specified works and limits the employers financial obligation to pay.
Typically, a Letter of Intent is a letter from the employer to the contractor. It indicates an ‘intention’ to enter into a formal contract for construction works in the future. The Letter of Intent will ask the contractor to undertake specific works or services. These will be agreed in principle agreed between the parties, with the Letter of Intent to be in place until they can sign a formal contract.
When and why should you use a Letter of Intent?
As mentioned above, it can sometimes take parties a long time to agree on the full terms of the contract. A contractor might use this time wisely to get a head start on the project.
For example, it may be that some of the materials needed for the project have long lead-in times. Or due to the time of year, you may wish to make a start on enabling works or ground works whilst the weather is good.
In these circumstances, a Letter of Intent allows the contractor to begin work. It creates contract obligations for the works stated in the Letter of Intent. Moreover, it removes the risk that the contractor will not receive payment for the works or services undertaken.
The employer should not use a letter of intent to award the works, continue or settle negotiations in the full contract or as a way to incentivise a Contractor to sign the full contract. You should deal with these issues separately. Addressing them in the Letter of Intent may open you up to risks you had not considered.
Are Letters of Intent binding?
Letters of Intent are often drafted ambiguously, in order to avoid contract certainty or to create doubt. In many instances, the instructions within the letter do not contain the words Letter of Intent, thus creating further uncertainty.
For a Letter of Intent to be binding, it must contain the three essential elements of a contract: agreement, intention and consideration.
- Agreement: There must be an offer by one party (in this case, for the contractor to be paid for work he begins before the contract is signed) and acceptance of that offer (the contractor begins work).
- Intention: The parties must intend to enter into a legal relationship where obligations are enforceable (e.g. the contractor must complete the work and be paid for it).
- Consideration: The parties exchange something of value with each other (in this case, the employer will pay the contractor for works completed or materials ordered prior to the full contract being signed).
When drafted correctly and including the three elements above, a Letter of Intent forms a contract between the parties, for the works or services specified within the Letter of Intent.
The question as to whether a letter of intent forms a contract has been the subject of a number of cases. Law firm Fenwick Elliott have a summary of some these cases and what their implications are here.
What should a Letter of Intent include?
The form and content will vary, depending on the scope, value and time to undertake the works. Some come in the form of a one-page document, others are pages and pages of obligations almost as long as a contract itself. There is no fixed and agreed structure for a Letter of Intent, so their format varies widely.
However, there are certain requirements to ensure that the obligations of the parties are clear. A well drafted Letter of Intent will include:
- The parties to the contract.
- The project and clear definition of the works the contractor is expected to carry out.
- The price (if agreed).
- The intention to enter into a formal contract.
- A timescale to complete those works.
- The dates for possession and completion.
There should be a clear end date, at which point the formal contract should be signed so the project can continue. If at this point parties have failed to conclude negotiations, the works should stop and the instructions under the Letter of Intent end.
Where applicable it is also important to address other contractual matters that may not be expressly stated:
- Payment terms and an adequate payment mechanism.
- Insurance of the works.
- Third party liability insurance.
- Dispute resolution: adjudication procedure, nominating body and the final determination whether by arbitration or litigation.
- Whether the Employer’s liability is limited by a financial ceiling and if so at what level and how this can be revised.
- Procedure for terminating the Letter of Intent by either party.
- The expiry of the Letter of Intent on execution of a formal contract.
- The incorporation of the Letter of Intent on the execution of a formal contract.
- The power of the architect/engineer to issue certificates and instructions.
- The status of those certificates and instructions once the contract has been executed.
What happens next?
Once you have begun work under a Letter of Intent you should continue contract negotiations. It is often tempting to forget about the tricky subject of signing a contract once the work has started. However, working without one leaves both the contractor and employer at risk.
Where there is an end date in the Letter of Intent, you should either enter into the formal contract or issue a new or extended Letter of Intent.
If there is no end date, or the parties continue the works beyond the scope of the Letter of Intent, the parties may find themselves in a difficult position. Whilst the works may continue, Letters of Intent rarely make contractual provision for issues such as variations, extensions of time or the rectification of defects. Should such issues arise, the parties may become embroiled in an expensive dispute.
The purpose of a well drafted and properly negotiated contract is to ensure that key risks in a construction project are correctly allocated between the parties. This enables change to be managed, claims to be made and disputes resolved with certainty and clarity.
Where a properly formed contract is not entered into, there will always be a risk of ambiguity. This leads to a wealth of work for lawyers and consultants, but much cost and frustration for both contractor and employer.
If you are considering starting work under a Letter of Intent and want some advice, get in touch with us to see if we can help you make the best decision for your project.