Starting work with only a letter of intent can prove costly. Alexandra Anderson gives a reminder on the perils of delaying contract terms

It is common practice to start work on projects without first agreeing the terms of the contract or appointment. The works may be well under way before the parties reach agreement on the terms. If a dispute develops, the parties may then be unable to resolve it until a court has decided what contract terms, if any, govern their relationship. Two recent cases have shown once again the risks of proceeding before contract terms have been agreed.

In RTS Flexible Systems Ltd v Molkerei Alois Müller [2008] EWHC 1087 (TCC), the court was asked to decide the terms of a contract for the supply of an automated packaging system. RTS provided a detailed quotation to Molkerei, which referred to its own standard terms. Molkerei then sent RTS a letter of intent, stating that it wished to proceed at the quoted price but with the standard terms set by the Institution of Electrical Engineers (IEE), to be negotiated and agreed within four weeks of the date of its letter. RTS replied that it would accept the IEE wording, subject to amendments.

The parties did negotiate amendments to the IEE standard terms but the document was never formally executed. In the meantime, they agreed terms for the project, including a testing plan. RTS supplied equipment and Molkerei made a part-payment. The company refused, however, to pay the balance on the basis that, since the parties had failed to execute a contract within the four-week deadline, both were discharged from any obligations to each other after that deadline.

Too often, parties get caught up in the momentum of a
project or in meeting project deadlines

The judge disagreed. He concluded that while the relationship between the parties could not be governed by the terms proposed in the letter of intent, those terms having not been finalised within the four-week deadline, nor by RTS’s standard terms (which Molkerei had explicitly rejected), nor by the IEE terms (since the amended document had never been executed), nevertheless the fact that RTS had delivered equipment to Molkerei after the letter of intent had expired, and Molkerei had provided part-payment, strongly suggested that the parties were proceeding on the basis of some sort of contract. The judge therefore concluded that Molkerei was bound to pay the balance of the contract price upon substantial completion of the work to be performed by RTS, that point being when the agreed site acceptance tests had been passed.

By contrast, the letter of intent in Diamond Build Ltd v Clapham Park Homes Ltd [2008] EWHC 1439 (TCC) was not subject to any expiry date. The parties were proceeding on the basis of a letter of intent while they sought to agree terms incorporating the JCT intermediate form of contract. A dispute arose after they had made considerable progress in agreeing the intended contract terms; the only step they had yet to take was formally to execute the document. The court concluded that in the absence of this formal step, the terms the parties had carefully negotiated did not apply. As the judge put it, “by accepting the letter of intent, the parties were accepting that the terms of the letter should dictate the rights and obligations of the parties until the formal contract was signed”.

These cases illustrate how costly disputes can arise when parties fail to agree terms in a timely manner. In the Diamond Build case, the judge emphasised the importance of employers, contractors and consultants ensuring that, if they do agree to start work on the basis of letters of intent, the final terms are agreed and signed as quickly as possible. Too often, parties get caught up in the momentum of a project, or in meeting project deadlines.