Letters of intent and potential unintended consequences

A letter of intent (LOI) is a frequently used document that enables work to be carried out in advance of a building contract being entered into. This usually happens during the initial stages of the development to enable a contractor to begin the works with confidence that payment will be made, and assurance that they are likely to be the selected contractor for the remainder of the works under the building contract. It is increasingly also being used in contracts where the main contractor has become insolvent (or otherwise left the project), and the developer wants to use LOIs to keep the project moving.

Although commonly used, there is no standard form for LOIs, unlike building contracts (JCT, NEC etc), meaning that the precise effect of an LOI can vary widely from a letter which simply expresses a party’s intention to enter into a contract to effectively a binding construction contract that actually governs the entirety of the works. To be recognised as a contract between the parties, there must generally be offer and acceptance, an intention to be legally bound by an agreement to provide sufficient consideration, and sufficient certainty of terms. Before entering into an LOI, the following areas (amongst other things) should be carefully considered.

Explicit terms

Parties sometimes do not take into consideration what is contained within an LOI as they are often keen to get the project started. As a minimum, it is essential that there is a defined scope of works to be carried out under the LOI, a time period for doing so, a clear payment mechanism, and provisions relating to who will be obtaining the relevant insurance policies. In the event that an LOI does not contain these essential points, there is room for extensive (and expensive!) disputes. For example, payment terms will be implied in by the Construction Act for applicable contracts, which if the paying party is not aware can lead to automatic rights to payment.

Subject to contract

Parties to an LOI sometimes believe that saying the terms of the LOI are ‘subject to contract’ means that the terms will not be binding until a main contract has been entered into, but this is not always the case. The courts are slow to find that there is no binding contract at all where substantial work has been carried out for sufficient consideration. In RTS Flexible Systems Ltd v. Molkerei Alois Muller GmbH & Co. KG [2010] the Supreme Court held that following a LOI being signed the actions of the parties, such as carrying out works, created a binding contract. This was despite the fact that a draft contract was issued with the LOI, which stated that the terms would not be binding until both the LOI and main contract had been entered into.

Mind the cap

One of the issues with an LOI occurs when work goes beyond the authorised scope or expiry date. While practically speaking this is understandable – everyone wants to work in good faith to keep the works progressing while the main contract is negotiated – it can lead to disputes should negotiations stall. Such disputes often regard the relevant terms and, most frequently, about payment for the additional work.

A good example of this is a case from last year (CLS Civil Engineering Ltd v. WJG Evans and Sons Ltd [2024]). Here, a contractor started work under an LOI while negotiations for the main contract were ongoing. That letter provided an explicit overall payment liability cap of £150,000. However, subsequent LOIs issued during the course of ongoing negotiations increased the scope of works and entitlement to £1.1m. Negotiations between the employer and contractor became difficult and they did not enter into a subsequent contract.

The employer then terminated the contractor’s appointment under the LOI and sought to rely on the cap of £1.1m specified in the latest LOI. However, the contractor claimed entitlement to payments in excess of £1.4m based on terms of the standard JCT Intermediate Form of Contract 2016 which had not been formally signed.

The court disagreed with the contractor, holding that the parties were in the process of negotiating the terms and no offer by either party had been unequivocally accepted by the other party, and therefore there was no binding JCT contract. On the other hand, it said that the LOIs formed the basis of a legally binding contract as they defined the relevant works and set out a mechanism by which the contractor would be paid by the employer for the works which they had in fact then undertaken. It followed that the cap on liability specified in the LOIs of £1.1m would be binding on the parties.

In this case, the contractor lost out – it continued to work despite exceeding the cap. But there are some scenarios in which a contractor may not be limited to a capped amount under an LOI. For example, if there is no binding LOI, a cap cannot apply and the contractor will be entitled to payment on a quantum meruit (fair and reasonable) basis. Secondly, and often argued, contractors may be entitled to payment over the cap if it is held that the parties have impliedly agreed a variation to the LOI so as to increase the cap or have waived compliance with that cap. However, both are fact-sensitive and may be difficult to prove, and as such it is always advised that any cap is increased by written agreement before reaching the limit, or that works are put on pause once the cap is reached.

Can you adjudicate under a letter of intent?

In the event that the any of the above goes wrong, and there is a dispute between the parties before a formal building contract is entered into, it is possible for the parties to adjudicate under an LOI. In Harvey Shopfitters Ltd v. ADI Ltd [2004], the Court of Appeal confirmed that a binding construction contract could be concluded under a LOI, provided all the necessary ‘ingredients’ of a valid contract were present, even if further contractual documentation had not yet been entered into. This is yet another reason why the drafting that sits within a letter of intent is so important, in order to avoid any unwanted disputes.

Conclusion

To avoid the above problems many agree that a formal building contract should be entered into rather than an LOI. In the Molkerei case referred to above, the Supreme Court commented that “The moral of the story to is to agree first and to start work later”.

However, it is not always that straightforward in practice and there are times when it is essential to get the work started before the parties will be in a position to agree on a complete building contract. It is in those circumstances where LOIs can be useful, so long as they are carefully drafted and the parties make clear what has and hasn’t been agreed – and then continue to work towards signing that full building contract at the earliest opportunity.