Recent cases show risks with letters of intent

When parties want to start on site but have not yet finalised the exact terms of their contract, letters of intent can seem like a sensible way of allowing work to crack on while negotiations continue. However, case law is littered with examples of the problems such letters can store up for the future.

It is therefore crucial for those advising clients to outline the risks involved when entering into letters of intent.

Indeed, in Ampleforth Abbey Trust v Turner & Townsend Project Management [2012] EWHC 2137 (TCC), the employer successfully sued the project manager for failure to advise on the risks posed by starting the works on the back of a letter of intent, having been unable to claim liquidated damages because no formal contract had been entered into.

Typically, it will involve the expression of an intention by party A to enter into a contract with party B at some point in the future, coupled with an indication from the former that the latter should commence work.

However, Richard Seymour QC in Tesco Stores Ltd v Costain Construction & Ors [2003] EWHC 1487 (TCC) argued the 'legal effect of a letter of intent depends [on] the true construction of the communications between the parties and the effect, if any, of their actions pursuant to those communications.'

In other words, as with any contract, you can't make assumptions about what a letter of intent means or its effect – you need to read it. How the parties have conducted themselves pursuant to that letter of intent is frequently crucial in determining whether a contract was actually entered into, and indeed its terms.

It cannot be emphasised enough that letters of intent come in a multitude of forms. They range from nothing more than expressions of hope that a contract may be entered into in the future to documents that are, in reality, the contract that the parties wanted to enter into in all but name. Sometimes, but not always, they have expiry dates which are often ignored in practice.

Where there is no contract then the legal basis for recovery by party B is likely to be quantum meruit, meaning the recovery of a reasonable sum.

Where there is a contract in place in the form of the letter of intent itself, recovering the sum will depend on the terms of that contract.

The problem with a letter of intent is that it is unlikely to provide the full advantages of a detailed contract being in place. Those advantages include certainty as to terms, the ability to assess and manage risk, and a methodology for handling the problems that may arise during construction.

With letters of intent, you may need to assess the extent to which there is a binding arrangement between the parties and the terms of that arrangement, as well as what the position is where the letter of intent has expired but no finalised contract is yet in place.

Where works have continued for a while that can be a difficult task – as demonstrated by the cases that reach the TCC for determination.

When Anchor then sent Midas a JCT Design and Build contract, Midas signed it and added a risk register excluding some parts of the scope. Anchor did not agree the exclusions, so did not countersign. However, the works continued.

When the final account was disputed, a preliminary issue was whether there was a contract and, if so, on what terms. Midas argued that there was no contract and sought payment based on quantum meruit, while Anchor said there was a contract on the JCT terms.

The court agreed with Anchor. Even though it had not countersigned, the contract was still binding. The key terms were agreed at the point Anchor sent the contract to Midas, which had insisted on a written contract, signalled acceptance by signing it, and – again, importantly – went on to perform the works.

The inclusion of the risk register was not a counteroffer because the substance of the terms was not changed; or if it had been, it was only changed in a manner consistent with a variation. The fact Anchor had not signed did not matter, given the other circumstances. 

AMEC (then Buchan) claimed that Arcadis (then Hyder) was responsible for the defective design of a car park and should pay £40m. At stake was the issue as to whether Arcadis' liability was capped at £610,000.

Mr Justice Coulson had held that Hyder's liability was uncapped given that there was too much uncertainty involved with the letter of intent to conclude that a liability cap had been agreed.

Lady Justice Gloster disagreed. She stated that the letter from AMEC to Arcadis of 6 March 2002 'was a standing offer, which if acted on before it lapsed or was lawfully withdrawn, would result in a binding contract'.

In her view, Hyder had accepted the offer in a letter two days later, and Coulson had been wrong in law to claim that it had to expressly indicate it accepted every element of the 6 March letter; the law simply requires the assent to be final and unqualified.

She held that the contract included the term in paragraph 3 of the letter that the work was 'to be carried out in accordance to … the Terms and Conditions associated that [the parties] are currently working under'.

The Court of Appeal accordingly concluded that the terms and conditions governing the contract included the limitation of liability. It was also recognised that during negotiations all exchanges had assumed Hyder's liability would be limited, so this decision reflected the commercial intent, although this was not the basis of the decision.

Once again, the existence of a letter of intent made assessing to which risks each party had signed up far more difficult.

Excessive settlement was subsequently discovered in the section, and Balfour Beatty sought to recover the remedial costs from Van Elle.

Van Elle in turn sought to rely on the limitation of liability in its standard terms and conditions, as contained in the original quotation it had issued for the works. It argued that the formal subcontract subsequently entered into did not apply to the section in question.

Balfour Beatty contended there was one formal subcontract that covered all the works. Mr Justice Waksman held that there was one contract governing all of Van Elle's works.

As part of the evidence supporting this position Mr Justice Waksman noted that the letter of intent entered into by the parties before the formal subcontract, in fact made no reference to Van Elle's (the subcontractors) terms and conditions, including the limitation of liability provisions at all. Further, the subcontract referred to all the piling works.

In other words, if Van Elle had wanted to ensure the limitation in its standard terms and conditions was included in the letter of intent then it needed to state that expressly.

Again, if works had been started only after the formal subcontract had been signed, the argument as to what the limitations on liability were would have been avoided.

At the core of the issues was a letter of intent, and whether it incorporated the terms of the JCT Design and Build subcontract.

The judge noted that the adjudicator had been appointed correctly in accordance with the letter of intent. However, the adjudicator had also determined that the JCT Design and Build subcontract terms applied to the contract.

The judge disagreed, observing that the letter 'contemplated only two possibilities. Either it applied by itself and on its own, with the provision for payment and relevant particular terms contained within it[,] or a JCT contract is actually executed and signed with all the particulars filled in'.

Accordingly, the judge found that the adjudicator should have proceeded to value the contract on a fair and reasonable basis rather than on the JCT terms and conditions. The judge also held that because the adjudicator proceeded on the basis of a contractual basis that had never arisen, he did not have jurisdiction.

While accepting that much of what the adjudicator did award to Oak looked to be 'as if it would arise equally on a fair and reasonable basis', he added: 'It is not for me to try [to] fathom if, and to what extent, the decision would be the same on fair and reasonable basis.'

Before deciding to agree a letter of intent, both parties should stop to ask themselves why they cannot yet enter into a full contract. If the answer is that there are still difficult points of negotiation to be agreed between the parties, then a letter of intent is unlikely to make these issues go away.

From an employer's perspective, a letter arguably places them in a weaker bargaining position as the contractor is on site and works are under way.

From a contractor's perspective, meanwhile, there is always a risk that the employer will decide to use someone else – and it is likely to be able to do so if, for example, the letter of intent provides for an express expiry date or a cap on the amount that can be incurred under the contract in question.

If there is no choice but to enter into a letter of intent, both parties should approach it on the assumption that the main contract may never end up being agreed.

What are the essential terms you need in that letter to ensure you don't face years of litigation along the lines outlined? Are limitations of liability clear? Is there provision for insurance?

Although it may seem beneficial to start work notwithstanding the fact the terms and conditions are not finalised, the advantage of having clear contract terms is that you know what your commercial risk is. After all, the difference in potential liability in Arcadis was between £610,000 or in excess of £40m.

And once you have a letter of intent in place, don't stop trying to agree the main contract. Professional advisers should also be sure to press for this document to be finalised – and warn of the dangers of it not being done.