Good intentions

Recent cases have indicated a shift in the court’s interpretation and attitude towards Letters of Intent. So what exactly are they? Normally, letters of intent are used by employers to request a contractor to start work. They declare an intention to enter into a building contract on terms that have not at that stage been accepted by the contractor.

Letters of Intent are widely used in the construction industry to enable work to commence without having to wait for a contract to be finalised. This means that the team can achieve a premature start on a site to prevent the expiry of planning permission. It can also enable the project to qualify for regional development grants. There are also tax advantages.

Previous case law has held that where a letter of intent was used, no contract had arisen, even though the works had been completed. The courts found that:

• The contractor would have been free to stop work at any time, had they wished.
• The letter of intent was essentially a quasi-contract.
• The contractor could only realistically expect to be paid a reasonable sum for any work undertaken, should a dispute arise between him and the employer.
• The employer had few rights of its own, most notably it could not seek to counterclaim on a letter of intent for breach of contract.

However, recent case law has seen a change of emphasis placed on the enforceability of letters of intent. The Court of Appeal held in the case of Harvey Shop Fitters vs ADI Ltd (13 Nov 2003) that letters of intent could be enforced as a contract only where all the required elements of a binding contract existed. These are:

• an offer;
• an unconditional acceptance, whether in writing or by conduct;
• relevant terms including scope of work, price, length of contract, a cap on the price of the works that can be carried out under a letter of intent.

In this case the letters of intent provided for payment on a quantum meruit basis, which is essentially payment of a reasonable amount for work undertaken. However, the court looked behind the meaning of the words used by the parties to find what they intended.

They found that the requisite elements were present and so there was, in effect, a lump sum contract and a lump sum was to be paid to the contractor.

Implying terms

A significant change in attitude was seen in last year’s case of Tesco Stores Ltd vs Costain Construction Ltd and others. The parties entered into a letter of intent that anticipated a future contract. The court found that, despite no formal contract being entered into, a contract existed on the basis of the letter of intent.

Somewhat surprisingly, however, the court went further and implied into the ‘contract’ a term that the contractor would perform the work in a good and workmanlike manner and, as far as any design decisions were concerned, the contractor would exercise reasonable care and skill to ensure fitness for purpose.

Letters of intent are widely used in the construction industry to enable work to commence without having to wait for a contract to be finalised.

This implied clause was one that the parties would have been unlikely to have included in any formal contract, not least because the inclusion of a fitness for purpose provision is unlikely to be covered by any designer’s professional indemnity insurance.

This case indicates that the courts, in addition to looking behind the apparent meaning of the words used by the parties, may now be attempting to impose clauses on parties that were not intended. It highlights the dangers of letters of intent and the need to ensure that a formal written contract is executed as soon as possible.

Two very recent cases reaffirmed, however, that the courts will uphold any financial limits and not award any additional sums – Eugena Ltd vs Gelande Corporation (29 Oct 2004) and Mowlem Plc (T/A Mowlem Marine) v Stena Line Ports Ltd (6 Oct 2004).

In the Stena case the parties relationship was governed by letters of intent, under which the contractor’s entitlement to be paid was limited to £10 million. It was argued that the contractor was entitled to be paid for sums over £10 million on a quantum meruit basis. The court rejected this argument, essentially finding that any contract between the parties was simply for works up to £10 million and no more.

Warning

To ensure greater certainty and control over any relationship, the parties must ensure that, at the earliest possible opportunity, they enter into a proper written contract and do not rely on letter of intent longer than is necessary.

Martin Salt is senior solicitor at Clarks. Contact msalt@clarkslegal.com or visit www.clarkslegal.com