LEGAL AID — A contractor is withholding £45,000 until a subcontractor signs a new deal. But can a letter of intent and a purchase order be used to extract payment anyway?

My friend owns a subcontractor company. He has entered into a contract with a main contractor for joinery works. A letter of intent and purchase order were issued by the contractor stating that if the subcontractor complies with the letter, payment will be made 30 days after the application date and implying that a modified Dom/2 would be the form of subcontract. A post-tender meeting scheduled out these application dates and is annexed to the letter of intent.

A staff change in the main contractor has changed its view. No payment has been made since August, and £45,000 is still owed. The main contractor says once the subcontractor signs a new document (which doesn’t even describe the subcontractor’s work or times for commencement and completion) then it will release funds, implying no signature, no funds. There has been no notice of non-payment. What is the quickest way to get paid?

The crucial point

Your question raises the same issue endlessly raised in adjudications and litigation: what is the contractual effect of a letter of intent? The answer is never certain. Sometimes they are simply non-binding requests made by a contractor to the subcontractor to proceed with work against a promise to pay if the work is done. Sometimes they create “mini-contracts” with a defined amount of work being requested against a promise to pay a fixed sum.

Without looking at the letter, it’s difficult to be sure, but the fact that you refer to “a letter of intent and purchase order” suggests a formal arrangement, and that there may be a binding contract on the basis of those documents. You also mention that the letter of intent “implies” that a modified Dom/2 would be the form of subcontract. This is a critical issue – was it simply “implied” or is it clear that the terms of Dom/2 were intended to be binding on both parties?

This question of whether or not a contract has come into existence for the whole of the subcontract works is vital. If a contract exists based on the letter of intent, the purchase order and Dom/2, then the best course of action is to give the relevant notice, suspend the execution of the works for non-payment and put in place the necessary warning notices under Dom/2 threatening termination of the subcontract. If that’s not enough to secure payment, commence adjudication.

But if there is no binding contract and the terms of Dom/2 were not incorporated, the position is unclear. Because there may be no binding obligation to execute the subcontract works, it’s probably best to cease work to prevent the problem being compounded, but it’s unlikely you will be able to commence adjudication proceedings. It seems unlikely litigation will be an economic proposition.

The moral of the story is: never commence work under a letter of intent. Always ensure the contractual arrangements are clear.

Ann Minogue, partner in Linklaters

Legal aid panel
(l-r) Ann Minogue, Julian Holloway, Rachel Barnes, Rudi Klein, Andrew Hemsley, Dominic Helps

If adjudication isn’t an option, suspension may be the most useful tactic, but whether this is an effective negotiating tool will depend on the stage the subcontract has reached

Go for a summary judgment

One would have to read all the documents referred to, and maybe obtain other information, to give a firm view. On the basis of the question, it seems there is already a contract between the contractor and subcontractor, on the terms of the letter of intent, purchase order and the attachment to the letter of intent. This means that the subcontractor can sue.

Presumably, an application has been made for the outstanding amount and 30 days has passed since then. It seems the contract is either in writing or, at least, evidenced in writing, so the Construction Act applies, and it seems no notice of withholding payment has been given. In these circumstances, the subcontractor can obtain summary judgment from the court. It could also refer the dispute to adjudication but, in this case, an application to court may be better.

Having said that, the quickest avenue to getting paid may be to negotiate over the terms of the new contract, but that depends on the reasonableness of the contractor. The subcontractor seems to be in a strong negotiating position. Furthermore, it is unlikely to be in the interests of either party to sign the new document referred to; in fact, it could be worse for the contractor than for the subcontractor.

Rachel Barnes, partner in Beale & Company

Contact the contractor

It sounds like your friend believes he cannot free up payment easily by negotiating the contract into a form he can accept. I would therefore suggest that he writes to the contractor immediately stating:

  • The work carried out
  • The sums outstanding
  • When the sums were due and the interest accrued from that period.
It’s important that he states what the agreement was and why there is an obligation to pay. He should refer to verbal agreements and correspondence and attach any useful letters, site minutes or emails. He should tell the main contractor that he is considering formal action, point out he is entitled to suspend works until he is paid and give a date by which he requires payment. He should also meet the contractor to see if he can be persuaded to pay.

Although adjudication is the easiest and most cost-effective way of obtaining payment, this can only be used when there’s a written contract. There may be one here, but he should take advice on the matter. If adjudication isn’t an option, suspension may be the most useful tactic, but whether this is an effective negotiating tool will depend on the stage the subcontract has reached.

Andrew Hemsley, managing director of consulting at Cyril Sweett