Best intentions

In an ideal world all contracts on construction projects should be properly drawn up and signed before work commences. It seems that in ever increasing instances this is not the case.

Few contracts of any size arise where work starts with only verbal evidence of the existence of the contract. In many cases, however, the parties are anxious to make an early start, often before all the key contractual matters have been agreed and a formal contract drawn up.

It is now common practice for the employer to send the contractor a letter of intent, which allows the contractor to make a start on site, commence design or order materials. As the contractor does not feel fully secure with only a letter of intent, it is often reluctant to conclude formal subcontracts with the subcontractors. Anxious for some of them to start work, it will send them letters of intent.

If contracts

There are more varieties of wording in letters of intent than stars in the sky, which makes it difficult to generalise as to their effect. Many give rise to disputes because there is no standardisation and each one has to be dealt with on its merits.

When the parties fall out, usually in relation to payment, the court has to decide whether the wording is sufficiently explicit to form a contract. In the case of British Steel v Cleveland Bridge (1984) the court had to invent an “if” contract. This in essence provides that if the contractor carries out work as specified in the letter of intent the employer will make a payment.

Sometimes the letter of intent will stipulate that certain conditions are to apply. This occurred in the case of Mitsui Babcock Engineering v John Brown (1996) where the letter of intent stipulated that the MF/1 conditions would apply. The parties had not agreed all essential matters such as the amount of liquidated damages. Nonetheless the court held that despite the lack of a formal contract and the agreement of all essential terms a contract had come into being.

This seemed a close call and no doubt had the case been heard in a different court on another day the decision could have been that no contract had been entered into.

Cap on expenditure

It is becoming popular for there to be a cap on expenditure included in the letter of intent. Where the cap is exceeded, which occurs more often than not, and the work comes to a halt for a variety of reasons, a dispute usually arises.

The contractor expects to be paid the extra as it considers that it has provided value. On the other hand the employer, having inserted the cap, sees no reason why more should be paid.

The case of Monk Building and Civil Engineering v Norwich Union Life Assurance Society (1993) involved a dispute in relation to a letter of intent that included a cap on expenditure of £100 000. In fact the total costs of the work undertaken came to £4 million.

The parties agreed that extra work had been ordered since the letter of intent was sent. However, if the letter of intent constituted a contract the contractor would have been entitled to payment in accordance with contract rates. If these had been applied it would come to a total of much less than the £4 million of contractors’ costs. It was held that as some of the essential terms of the contract had not been agreed no contract had come into being.

A slightly different story emerged in the case of AC Controls v British Broadcasting Corporation (2002) where the contractor was required by a letter of intent to undertake essential survey work and a financial cap on expenditure was fixed at £250 000. Work proceeded beyond this figure and the contractor claimed a sum of £411 000. The employer insisted that the capped figure only was payable. It was held that as the employer was entitled to determine the arrangement with the contractor when the cap was reached, and failed to do so, the contractor was to be paid the full amount.

Contractor caught out

A bizarre set of circumstances occurred in the case of Mowlem v Stena Line Ports (2004) over the building of a new ferry terminal at Holyhead, Anglesey.

The employer sent 14 letters of intent; the last one on 4 July 2002. The final letter of intent included a cap on expenditure of £10 million but no formal contract was entered into. Due to the discovery of rock in the excavation and instructions for extra work being given by the employer after 4 July 2002, expenditure was incurred which well exceeded the £10 million limit. The court held that the contractor was entitled to payment of only £10 million as once this expenditure cap had been reached the contractor could have stopped work.

Perhaps we are all getting less formal in our commercial dealings or we are so anxious to get underway that we let formal procedures take a back seat. It seems clear, however, that if the parties are prepared to start work before all essential terms have been agreed and committed to writing then they must be prepared for disputes over payment to arise if the negotiations regarding contract terms stall.