Use of letters of intent

Letters of intent, as they are used in the construction industry, are agreements under which works can commence while negotiations of the principal contract conditions are being concluded, and while the principal contract itself is being drawn-up and compiled ready for execution.

Letters of intent may be used to enable a supplier or contractor to pre-order materials or to create a site establishment. They are often drafted on the basis that if agreement is not reached on the main contract, the client will reimburse the supplier for his or her reasonably incurred expenses.

The risks inherent in such contracts are obvious, not least in that they often put the client in a weak position vis-à-vis the conclusion of negotiations. It is also common to find that works have proceeded under a letter of intent far beyond the original intentions of a party, and far beyond the abilities of the letter of intent to manage the risks and capture the intentions of the parties. See for example Tesco Stores Ltd v Costain Construction Ltd & Ors [2003] EWHC 1487 (TCC).

If a dispute arises before the formal contract has been signed it will often be in the interests of one of the parties to argue that the terms of the proposed contract do not apply. This can lead to huge expenditure in legal costs trying to resolve the fundamental uncertainty as to the applicable terms. See for example RTS Flexible Systems Ltd v Molkerei Alois Muller GMBH [2010] UKSC 14.

While the main contract remains unsigned, the employer is potentially liable to the contractor on a quantum meruit basis. Quantum meruit is a term used to refer to a reasonable recompense for work done, and is often based on the amount of money expended, in addition to a reasonable allowance for profit.

The advice of this author is that all forms of letters of intent should be avoided wherever possible. Where it is not possible to avoid a letter of intent, its use should be minimised by diligently progressing the execution of the main contract.

Letters of intent are at best an interim measure. At worst, they can create a false sense of security, with the parties believing that they have a far greater level of protection that they in fact do.

When works are being undertaken in parallel with negotiations to change the contractual basis from a letter of intent to a more formalised contract it can often be difficult to establish the point at which the parties had reached agreement that the works would proceed on the formalised basis. This will cause difficulties if a dispute arises between the parties. See Pagnan SPA v Feed Products Limited [1987] 2 Lloyd’s Rep 601.

If a practitioner is responsible for proposing a letter of intent which exposes their client to unexpected risks, the client may look to the practitioner for compensation. Unless a practitioner is legally qualified and has the necessary professional indemnity (PI) insurance to cover the provision of legal advice, it is usually prudent to advise a client to obtain separate legal advice on the drafting of a letter of intent.

In The Trustees of Ampleforth Abbey Trust v Turner and Townsend Project Management Limited [2012] EWHC 2137 (TCC) Turner and Townsend were criticised for failing to take the steps reasonably required of a competent project manager for the purposes of finalising the contract. The court judged Turner and Townsend liable for the liquidated damages which the trust were unable to recover from the contractor by reason of the construction contract not having been formalised.