Watch out for letters of intent

Often you receive a document headed ‘Letter of Intent’. Such a letter is an interim document used in the course of your negotiations, pending the completion and formal execution of a contract. It signifies the intention to enter into a contract at some future date, but in the meantime you start working towards fulfiling the obligations of that contract. This is often due to a tight schedule where finalising the contract would delay the start of the project.

The significance of such letters can be seen in the numerous court cases where they have been held, on the one hand, to give rise to no contractual relationships whatsoever and, on the other hand, have created binding contracts.

The consequent risk to both parties is that they are seldom clear and give rise to the single question, “What did the parties actually intend?” The case of RTS Flexible Systems v Muller 2008 is another example of the perils of going ahead with work under a letter of intent.

In April 2004 RTS produced a quotation for the design, manufacture, assembly, delivery, installation and commissioning of equipment for Muller. Thereafter, RTS produced 10 further quotations for equipment. In August 2004 at a meeting, Muller indicated its wishes to contract on its own terms rather than those of RTS. At a further meeting in September 2004, RTS suggested the use of standard contract MF/1. In November 2004, Muller produced a 27-page draft of amendments to the MF/1 it sought to incorporate, which RTS rejected.

In January 2005, RTS submitted quotation I, based on its own terms, but suggested it would be happy to enter into contract on the MF/1 terms, providing they were appropriately modified. RTS enclosed a copy of its proposed amendments and stated that it would be prepared to commence work on a letter of intent, pending agreement of the terms.

In February 2005, RTS offered quotation J, again based on its own terms. Later that month, Muller sent its letter of intent. The letter made reference to quotation J and stated that the contractual terms would be based on Muller amendments to MF/1, to be agreed within four weeks, after which the letter would terminate.

In March RTS wrote confirming that it had begun work, but that the contract was subject to Muller accepting two qualifications to the letter of intent.

The consequent risk to both parties is that they are seldom clear and give rise to the interpretation of the single question, “What did the parties actually intend?”

A dispute arose regarding the interpretation of the letter of intent. RTS submitted that Muller accepted the whole of quotation J, including RTS' own terms, on the basis that within four weeks the parties would agree a new set of terms. Muller contended that the letter of intent was a counter offer to quotation J, which did not incorporate any of the terms of the quotation, not even those that described the scope of the work.

Also that counter offer was itself the subject of a further counter offer from RTS contained in its March letter, which Muller accepted by conduct in allowing RTS to commence and continue with the project.

Judgement

It was held that quotation J was an offer incorporating RTS’ terms. The letter of intent was a counter offer to quotation J. RTS’ March letter, which accepted the letter of intent terms, was a further counter offer to the letter of intent subject to the two qualifications. That counter offer (March letter) was then accepted by Muller.

The parties then attempted to negotiate the terms of the contract, and the period for negotiation was extended to May 2005. It was not until June 2005 that a contract was held to have been made but surprisingly it did not contain either RTS’ terms or the amended MF/1 terms. This judgement has recently been upheld in the Court of Appeal.

For whatever good commercial reasons, the parties decided to start work before the terms of the contract had been agreed, on a presumption that ultimately terms would be finalised. While a contract was eventually formed, it was not entirely on the terms that the parties had intended. Letters of intent should be treated with extreme caution.

Originally published in EMC May 09 issue as: Worst intentions