Letters of intent are used in construction and engineering projects to allow the employer to mobilise a contractor before the employer is in a position to enter into the full building contact.
Letters of intent usually set out the employer’s intention to enter into a contract with the contractor for construction works, and will set out the terms on which the contractor is authorised to commence works on site/undertake design work/pre-order materials etc before the main contract is executed.
It is common for parties to include a limit on the value of the works permitted under the letter of intent and to express a date on which the instruction under the letter terminates.
The basic rules applying to formation of a contract will apply when determining whether or not the letter of intent is a binding contract:
Given the potential for disputes arising out of letters of intent, the best advice for both parties is not to enter into one and to avoid entering into any contractual arrangements until all of the proposed contract terms have been agreed and it can be executed.
If the letter of intent is not binding, there is effectively no contract between the parties and the letter of intent is said to be only a ‘comfort letter’. Where there is no contract, time becomes ‘at large’ and the contractor will only have to complete the works in a reasonable time. The employer may be ordered to pay the contractor for the work performed on a quantum meruit basis, where the contract is entitled to be paid a reasonable sum for the work undertaken, i.e., the amount that it deserves.
It is therefore usually in the employer’s interests for the letter of intent to be a binding contract.
Given the potential for disputes arising out of letters of intent, the best advice for both parties is not to enter into one and to avoid entering into any contractual arrangements until all of the proposed contract terms have been agreed and it can be executed.
In addition to the potential for legal disputes to arise, there are also commercial drawbacks to using a letter of intent.
From an employer's perspective:
Perhaps most significantly, the employer’s bargaining power is considerably reduced once a letter of intent is agreed. If the final contract sum is still to be agreed, the contractor will realise that it is no longer in an open competition once the letter of intent is signed and, as a result, is unlikely to be as flexible on price and terms as it would have been.
Where works on site have commenced, it will become increasingly difficult to remove the contractor. In addition, where key sub-contractors have commenced works prior to the selection of the contractor, the contractor may refuse to be responsible for this work, fearing that such work may lead to claims not allowed for in the contract sum.
From the contractor’s perspective:
It could be found that in accepting a letter of intent it may, inadvertently, agree to the inclusion of standard terms even though it may be intending to reject certain clauses in negotiations for the main contract.
It is also often the case that the parties lose the impetus to agree the contract once a letter of intent is signed, extending the time to conclude negotiations and in some cases leading to the parties failing to agree the contract at all. Failing to fully execute the contract could have a negative impacted of the contractors intended rights and obligations.
To protect both parties, it is important that any letter of intent is carefully drafted so as to be a binding contract.
If you need help drafting or interpreting letters of intent, don’t hesitate to contact Peter McCarthy LL.M.,BSc., FRICS, FSCSI, FCIArb, Principal Consultant at Conlex Consulting Ltd.
T: Cork - +353 21 4555678 Dublin - +353 1 6392927
M: +353 86 7816358
