How do I... draft a letter of intent?

What is a letter of intent?

It is a letter provided by an employer to a contractor in which the employer indicates an intention to enter into a formal contract for the works described and asks the contractor to start work before formal contracts are agreed.

There is no standard letter of intent. They range between a one paragraph instruction to proceed, through to complex multi-paged agreements.

When can I use a letter of intent?

Ideally, parties should not contract on the basis of a letter of intent and should avoid starting any work on site under one. However, there may be circumstances in which items with long lead times need to be ordered before the formal contract has been finalised. In these circumstances a letter of intent can be a useful tool. In addition, particularly in the current climate, there may be valid commercial reasons for commencing work before finalising the contract.

Letters of intent should only be used in the short term and should never be a substitute for a formal contract.

Why should letters of intent only be used in the short term?

Letters of intent do not contain all the terms a formal contract should and are therefore inherently uncertain. The language of the letter itself and the surrounding circumstances, including anything the parties wrote, said or did subsequently, will determine whether it constitutes an interim contract or a final contract between the parties, or whether there is no contract at all. This is important because it will dictate, among other things, what the contractor is entitled to be paid for the work it carries out and what remedies are available to each party for breaches by the other.

How do I draft a letter of intent?

For one to be binding, there must be:

• Certainty as to the key terms. Make sure it contains clear details of the scope of work to be carried out under it. It should also set out the period for which it is valid and limit the amount to be spent under it.
• Consideration. Ensure the letter of intent includes an obligation on the employer to make payment for the work instructed and, if possible, make it clear how that will be calculated.
• An intention by both parties to enter a contractually binding arrangement. The document must be signed by both parties. A common way to do this is to get the employer to sign and send it to the contractor. The contractor should then sign and return one copy to the employer.

What else should I include?

• Make it clear that the letter of intent is an interim agreement and that it will be superseded by the formal contract.
• Set out when works are to commence and complete, together with details of any conditions that need to be satisfied before works start – for example, if the employer requires a performance bond from the contractor or what insurance needs to be put in place.
• State who is to issue instructions in relation to the works.
• Include a limit on the amount the employer is to pay under the letter of intent.
• Set out any restrictions on site access, working hours or methods.
• State what the contractor will be paid if the letter of intent is terminated or a formal contract is not executed. Usually the employer will be required to pay the contractor’s costs incurred up to the terminate date and reasonable demobilisation costs.

What next?

Both parties should:

• Agree a formal contract documentation as a matter of urgency.
• Agree key dates and get regular, perhaps weekly, cost updates to ensure limitation periods and monetary caps set out in the letter of intent are not exceeded.

Employers should:

• Not allow work to continue when a letter of intent has expired (to avoid a quantum meruit claim from the contractor).

Contractors should:

• Not incur any costs in excess of any financial caps stated in the letter of intent without getting the employer’s agreement before doing so.

In the current climate, parties may find it is taking longer to agree formal contracts and that more work than anticipated is carried out under the letter of intent. In these circumstances it is more important than ever that its terms address the issues above.