‘Plugging the gap’: Letters of intent

18 September, 2018

What are they and why are they necessary?

Whilst a ‘letter of intent’ can have an ambiguous and varied meaning across other legal practice areas, typically in construction, it is a letter from an employer to a contractor indicating the employer’s intention to enter into a building contract for the works detailed in the letter.

In an ideal world, employers would have everything finalised and documented in a final form contract before work commences.  Unfortunately, this is not always possible.  The construction industry is rife with commercial pressures and tight deadlines and this often means that contractors are required to enter site and start works prior to finalising the formal building contract.

The letter of intent, if drafted properly, can be a way to ‘plug the gap’ in this pre-contract stage whilst the terms of the building contract are negotiated.  It affords the parties more protection than an oral agreement, whilst allowing the parties to get a head start on the project in a number of ways – accessing the site, starting the works, hiring sub-contractors, ordering materials and regulating payment.

For the contractor, it provides comfort that they will be paid for the work done prior to entering into a final contract.  For the employer, it provides sufficient certainty of terms so that the contractor can start the design early, allowing them to adapt to commercial pressures; bring forward the completion date for the works; and potentially reduce borrowing costs.

The letter of intent therefore should be viewed as a ‘temporary fix’ (no pun intended!) prior to drafting the formal building contract.

Features of a binding letter of intent

If drafted improperly, problems of uncertainty in fundamental details of the works can arise such as timeframes, site access and control over materials.  To successfully ‘plug the gap’ in between commencing works and entering into a full building contract, all the usual features of a contract must be present.  That is:  offer, acceptance, consideration, intention to create legal relations and certainty of terms.

So what might you like to include?

Preferably, the parties should be certain on the key operative provisions, such as the standard of care expected, the quality of work and when the employer expects it to be completed.  On the flipside, the fee structure should also be addressed.  As would be the case with a building contract, insurance, copyright, dispute resolution and termination are also important provisions which should be agreed if possible.  For an employer’s protection, the letter should also be limited to only certain works and a certain value.

However, it is more than likely that if all of these key provisions had already been agreed, the parties would proceed straight to contract.  And as a result, in practice and due to the urgency of a project, it might be that the only aspects addressed are the terms concerning payment and time (whilst remaining aspects are negotiated).  With very little formally agreed, it is no wonder that uncertainty might arise if something does not go to plan …

Is it too good to be true?

Essentially, the letter of intent is a necessary evil where time is tight.  Whilst sometimes useful, they are infamous for creating uncertainty, such as in the much discussed cases of Arcadis Consulting (UK) Ltd v AMEC (BCS) Ltd and Spartafield Ltd v Penten Group Ltd.

Letters of intent are no substitute for carefully negotiated and professionally drafted building contracts.  This point was illustrated in Trustees of Ampleforth Abbey Trust v Turner and Townsend Project Management Limited.  Due to the urgent need to provide sufficient student accommodation for the approaching academic year, the contractor was required to begin the construction of a new boarding house for Ampleforth College without a formal contract (and without agreeing various terms).  The works were completed later than anticipated and the employer wanted to rely on the industry standard remedy of liquidated damages.  Whilst the letter of intent attached a draft building contract which stated that liquidated damages were payable at £50,000 a week, the letter itself explicitly stated that the terms of the draft contract were not incorporated.

The employer therefore brought a claim against their project manager for lost liquidated damages and the court found the project manager liable because the project manager had failed to exercise their reasonable care and skill by not procuring an executed building contract.  The judge stated that efforts to finalise the contractual arrangements are of central importance, and that the execution of a contract should be seen not as ‘a dispensable luxury’, but as fundamental.

Whilst not a ‘dispensable luxury’, as those in construction will know, the industry is time critical and the market calls for projects to be delivered quickly so that they can begin serving their purpose and start earning profit.

So, if the inevitable happens and urgent circumstances require a letter of intent, ensure it is tightly drafted and avoid any open ends.  But, as soon as practically possible, ensure you take out the temporary ‘plug’ and replace with a more permanent solution:  a good sturdy building contract.