At the start of a construction project, everyone is keen to get on site and to get underway. The employer and contractor may not have sorted out a formal contract but decide to crack on anyway. So they put together a letter of intent until they can get a contract in place.
But there is often confusion about what a letter of intent actually is and whether they are a good thing to use or not. This can sometimes result in unintended financial consequences.
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What is a letter of intent?
In simple terms, a letter of intent is a document agreed by the parties before they enter into a formal contract. In a construction context it is often used as a stopgap until a formal contract can be executed, perhaps because work needs to commence but terms are still to be agreed, or because the employer is awaiting confirmation of funding and so can only commit to limited financial exposure.
The main problem is that letters of intent can have different implications in different circumstances. Those using them therefore need to be clear about what they want their letter of intent to achieve. Depending on the wording, a letter of intent may not be of binding effect at all. It might simply be an indication that one of the parties may enter into a construction contract at some point in the future with no legal commitment to do so.
At the other end of the spectrum, the letter of intent may in effect be a fully binding contract. Those outcomes may or may not be what the parties intended.
What should we be alert to if using a letter of intent?
Avoid accidentally drafting so carefully that you end up with a binding contract until completion if that is not what is intended. If this happens one of the parties may find themselves bound by standard terms that they would otherwise have wanted to amend in the final version of the contract.
At the other end of the spectrum, avoid using such loose wording that the letter of intent has no legal effect if that again was not the intention.
Letters of intent should be used for no longer than is absolutely necessary. Problems can arise from using repeat letters of intent with increased time and financial limits.
“Once work on site has commenced pursuant to a letter of intent, there can be a danger that the parties no longer focus on executing the contract.”
It is important to consider how work undertaken pursuant to the letter of intent will be valued and if there is going to be a financial cap. If there is a financial cap the position needs to be revisited before the cap is exceeded if the contract has not yet been executed. For example, can the formal contract be executed before the cap is exceeded and if not, should the financial cap in letter of intent be increased?
Employers should not assume that they can allow the contractor to continue to work beyond any specified financial cap or time limit in the letter of intent and then not pay for any work above that cap or limit. Likewise, contractors should not assume that if they undertake work above the limit of the financial cap or beyond a time limit, that they will get paid for it. The effect of exceeding a cap or time limit will depend on the wording of the letter of intent in question and the circumstances of the case.
Parties also need to think about how and when the relationship can be terminated. There may be risks and benefits for both parties of being able to simply stop work when the letter of intent expires if no formal contract has been entered into by that point.
What are the risks for construction professionals advising on the use of letters of intent?
Once work on site has commenced pursuant to a letter of intent, there can be a danger that the parties no longer focus on executing the contract. Professionals advising in these circumstances, who fail to warn of the dangers of proceeding with repeat letters of intent instead of finalising the terms of the contract, run the risk of a claim for professional negligence.
Should we be using a letter of intent?
In one case the court warned of the “perils of beginning work without agreeing to the precise basis upon which it is to be done. The moral of the story is to agree first and to start work later.” While this is the ideal position, there are some circumstances where work needs to commence before the final contract is executed and a well-drafted letter of intent can help to protect the parties.
However, they should be used with extreme care and with professional advice to ensure that they fulfil their intended purpose.
Rowan Turrall is partner and head of dispute resolution at Boyes Turner.
