Streetwise Guide to Letters of Intent (LOI’s)

Unless they are carefully worded LOI’s can leave Specialist Sub-Contractors at serious financial risk

Letters of intent are useful for making an early start on a project, but what about your contractual relationship? What if things don’t go according to plan?

Unless they are carefully worded, they can leave you the Specialist Sub-Contractor at serious financial risk! A Specialist Sub-Contractor who goes out and makes binding commitments for materials, labour, or design etc., in reliance on a letter of intent may or may not be able to get paid for that expenditure.

A letter of intent is usually a letter issued to a successful tenderer to enable it to start work before essential terms of the contract have been agreed or before certain matters relating to the contract have been resolved.

What Is Meant To Achieve ?

The aim of a letter of intent is to allow some work to begin without the parties, resolving the terms of the whole contract at this stage.

Part of what a letter of intent does is to help parties think through and agree on key terms of the contemplated contract. Even if it is a nonbinding letter, it will be used by both sides as an agreement in the negotiation process if either side attempts to vary from its terms.

A great deal of preliminary negotiation may well go into a letter of intent because key elements such as price, specification and delivery are included. The intention is to put key elements of the deal on paper so that both parties can have the same intention before a contract is concluded.

Specifics can vary from relatively little detail to quite detailed. The more detailed a letter of intent is, the more likely it is to be ruled binding. However, rarely will you see a letter of intent spell out dispute resolution provisions such as adjudication, arbitration or choice of law.

Is Such a Letter Binding?

It is possible for businesses to believe that they are not bound by a letter that actually is binding. If a dispute arises, the courts examine the letter itself and the behaviour of the parties to determine if the parties are legally bound to the terms of the letter.

What kind of disputes can arise between the two parties that have signed a letter of intent?

Obviously, the biggest dispute that can arise is whether or not the letter is binding, which is usually only tested if the deal falls apart. Not going forward can end up being an extremely expensive process for one or both of the parties involved.

The Court of Appeal case RTS v Muller February 2009, dealt with the situation where RTS had started work for Muller, the yoghurt people, on the basis of a letter of intent. The LOI had been extended and although the parties had agreed the terms of the MF/1 contract the accompanying schedules had not been agreed and the contract had not been signed.

The circumstances of the case are typical of the scenarios that unfold for Specialist Sub-Contractors every day. In this case RTS were to install and commission a flow wrapping line with a contract value of £1,682,000.

Not a bad little job that you might think would have warranted sorting the contract out properly! However, RTS continued to build and deliver the equipment long after the LOI had expired.

Surprise, surprise, Muller stopped paying RTS and that’s why the parties fell out and went off to court!

The original trial judge had decided that there was a contract between the parties but the Court of Appeal reversed that decision and decided that there wasn’t.

What a mess. What a massive waste of money. Can you imagine how much all this has cost? Not to mention the fact that RTS still hadn’t been paid!!

Whilst letters of intent may be regarded by some parties as only the first step towards a contract, they can themselves have very substantial legal and financial implications. As can be seen from the RTS case they may reflect substantial commitment on both sides, without either party really knowing their legal position.

Letters of intent are themselves explicitly not contracts, but inevitably, the question arises as to whether they can create a contractual relationship. This obviously matters because whether a contract is in place or not will most certainly affect your rights to be paid for any work carried out, or costs incurred.

What If you Incur Costs And The Job Doesn’t Proceed?

So, what happens if you take action and incur liabilities and then the Contractor or Client pulls out of the deal?

Typically, such a letter contains terms such as: ‘This letter is to be taken as authority for you carry out design, and to proceed with ordering of materials up to a maximum expenditure of £xxx. In the event that we do not conclude a contract with you, your entitlement will be limited to the costs incurred by you in accordance with the authority given by this letter.’

Letters of intent are certainly useful tools when it comes to getting you to make a prompt start on a construction or engineering project. But unless they are carefully worded, they can, backfire on you with dramatic consequences.

In Monk Construction v Norwich Union (1992) a letter of intent covered only mobilisation and materials up to a maximum expenditure of £100,000.The letter said that, in the event that a contract was not concluded, only ‘proven costs’ were to be recovered.

In fact, Monk did start work on site and then sued on the basis of ‘quantum meruit’ see the definition in Streetwise Wiki.

The judge allowed Monk to recover quantum meruit but found that the letter of intent covered only the situation where no work beyond mobilisation or ordering of materials was undertaken. The reference to ‘proven costs’ could not be applied to any of the work when it proceeded beyond that stage.

What If All The Terms Are Not Agreed?

In British Steel Corporation v Cleveland Bridge (1984) the supplier was asked to begin the manufacture of steel nodes by a letter of intent ‘pending the preparation and issue of an official form of sub-contract. Surprisingly, the specification, price, delivery dates, damages for late delivery were never agreed.

British Steel delivered all of the nodes to the site but the last one was delayed. Cleveland Bridge refused to pay, and when British Steel went to court for payment of its invoice, Cleveland Bridge put in a counterclaim for damages in respect of the late delivery of the final node.

The court decided that, because there was no agreement as to the relevant contractual terms, there was no contract at all and therefore there was no obligation in respect of delivery time.

Cleveland Bridge’s counterclaim failed and the irony of this decision is that by issuing a letter of intent rather than setting out a proper contract, Cleveland Bridge failed to secure any right to have British Steel deliver by an agreed date.

Whether you are getting or giving a letter of intent, it is essential that the letter clearly sets out how far each party is entitled to rely on it to incur expenses. For example:

“This letter is your authorisation to carry out full design and drawings.”

“This letter is your authorisation to place an order for …”

“This letter is your authorisation to begin fabrication of …”

More recently, we have the Appeal Court’s decision in Jarvis v Galliard (2002). Here, Galliard issued a letter of intent to Jarvis in respect of a housing development. The letter set out the intention to enter into a JCT 1980 with a Guaranteed Maximum Price (GMP) and contained the following words: ‘In the event that we do not enter into a formal contract with you through no fault of [yours], you will be reimbursed all fair and reasonable costs assessed on a quantum meruit basis.’

Jarvis started work and completed a number of flats while discussions were ongoing about costings and various prices indicating a GMP. The Client and Contractor shook hands on a lump sum figure (but not a GMP) and a few months later Galliard sent the articles of agreement to Jarvis and proposed a supplementary agreement to accommodate a GMP.

When things subsequently went wrong, Jarvis sued Galliard for payment on a quantum meruit basis. When Galliard tried to have the matter settled by an arbitrator, Jarvis argued there was no contract and so there was no agreement to arbitrate. The question than was what agreement did ‘the handshake’ seal?

The two parties could not agree whether there was a guaranteed maximum or lump sum price, even though Jarvis had started work. The court found that there was no contract and that the handshake was only an ‘agreement to agree’

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