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Lettersofintentinconstruction

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Constructioncontracts

Lettersofintentinconstruction
ThisguidewaslastupdatedinAugust2011.
Constructioncontracts
Diversifiedindustrial
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UK
Inaperfectworldemployersandcontractors,andcontractorsandsubcontractors,wouldfinalise
allaspectsoftheirdealandrecorditinawritten,signedcontractbeforeanyworkwasperformed
orexpenditureincurred.Inreality,however,thepartiesareoftenundercommercialpressureto
commenceworksorpreparatoryworksassoonaspossibleandturntoa'letterofintent'whilethey
continuetonegotiatethefullcontract.Insomecases,noformalcontractwilleverbeconcluded.
Proceedingunderaletterofintent(LOI)canallowthepartiestogetaheadstartonthe
constructionprogrammeinanumberofusefulways,allowingthemtobegintoinstruct
subcontractorsorbeginthedesignprocess.However,theygiverisetorisksonbothsides.
SomeLOIscreatebindingobligationsonthepartiesandsomedonot,dependingonthe
circumstancesandthedrafting.PartiesmaynotgetaroundtoreplacingtheLOIwithaformal
contract,andifdisputesarisetheywillneedtoresolvetheissueofwhatkindoflegalobligationhas
beencreatedifanyandwhatrightsitgiveseachparty.
Whatisaletterofintent?
Theterm'letterofintent'doesnothaveatechnicallegalmeaningandisusedtodescribeallsortsof
contracts.Itistypicallyusedtodescribealetterfromanemployertoacontractor(orfromamain
contractortoasubcontractor)indicatingtheemployer'sintentiontoenterintoaformalwritten
contractforworksdescribedintheletter,andaskingthecontractortobeginthoseworksbeforethe
formalcontractisexecuted.WhileanLOImaycomeinmanyforms,itisessentiallya
communicationexpressinganintentiontoenterintoacontractatafuturedate.
TypicallyanLOIwilloperateinoneofthreeways:
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asanonbindingstatementofthefutureintentionofbothparties,sometimescalleda'comfort
letter'
asaninterimcontractonitsownterms,whichwillgoverntherelationshipbetweentheparties
unlessanduntilaformalwrittencontractisexecuted
asafinalcontractwhich,despitetherehavingbeennoformalexecution,isdeemedtohave
incorporatedthetermsandconditionsoftheformalwrittencontractthatthepartiesintended.
Forsimplicity,wewillrefertothesethreetypesofLOIasTypeA,BandCrespectively.Which
categoryanLOIfallsintowilloftenbesomethingthatisonlydecidedbyacourt.
Thereareanumberofelementsthatmustbeinplaceinorderforalegallybindingcontracttobe
created.Theseinclude:
certaintyastokeyterms
consideration(the'price'paidunderthecontractinreturnforperformancebytheotherpartyof
itsobligationsand
amutualintentiontoenterintoabindinglegalcontract.
Wherethereisdoubtaboutwhetherornotabindingcontracthasbeencreated,thecourtswilllook
toseeifalloftheseelementsarepresent.
LOItypeA:nocontract
TheeffectofaTypeALOIistoauthorisethecontractortocarryoutwork.Howeverasthereisno
formalcontract,thecontractorwillatbestonlybepaidona'quantummeruit'basis,thatisa
reasonablepaymentfortheworkdone.Thecontractorcanstoptheworkatanytimewithoutnotice
andtheemployercanalsocallfortheworktobestoppedatanytimewithoutnotice.Theemployer
willnotbeabletocounterclaimforbreachofcontractinthecaseofdelayordefectiveworkbecause
thereisnocontract,althoughdefectsmaybetakenintoaccountwhenassessingwhattheworkis
worth.
TherearerelativelyfewcasesconcludingthatanLOIisofthistype,asthecourtswillusuallytry
andestablishacontractfromtheletteronthebasisofthepresumedintentionsoftheparties.
However,todosoitmustbeobjectivelyclearthatthepartieswereagreedbothonthosematters
whichthepartiesthemselvesconsiderednecessary,andthosematterswhichareobjectively
necessarytoformacontract.Therewillbenocontract,andtheLOIwillbeofTypeA,if:
theLOIandsurroundingevidencesuggeststhatnegotiationswerecontinuingaboutmatters
whichthepartiesregardedasessentialtotheexistenceofacontractualrelationship
theLOIisexpresslycontingentonaneventwhichdoesnotoccur.
TypeBLOI:interimcontractswhosetermsfallshortofthetermsofanintendedfinal
contract
Themainissuewillusuallybewhethertheinterimcontracthasbeenreplacedbyafullcontract,
especiallyiftheLOIisexpressedasexpiringonasetdateandthepartiesignoretheexpiryand
continuetoperformthecontract.Itisoftentemptingsimplytocarryonwiththework,butif
agreedcapsareexceededthereisariskthattherewillbenoentitlementtopayment.Further,LOIs
willnotusuallyprovideforissuesdealtwithinfullcontractssuchasvariations,extensionsoftime
anddefects.
Conversely,thereisalsoariskthatifthepartiescarryonbeyondtheexpirydatetheymaybetaken
tohaveenteredintothefullbindingcontractthattheyhavebeennegotiating.Thecourtsmayfind
thatbytheirbehaviourthepartieshavewaivedanyprovisionsaboutthefullcontractnotbecoming
bindinguntilithasbeensigned.

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Ifaninterimcontractisinplaceitisimportantthatthepartiesdonotlosefocusonconcluding
contractualnegotiations.
TypeCLOI:interimcontractincorporatingfinalterms
TheproperinterpretationofaTypeCLOIisthatitisacontractwhichhasbeencreatedonthe
termsintendedbythepartiesforincorporationintoafinalcontract,eventhoughnoformalwritten
contracthasbeenexecuted.Dependingonthefacts,thepartiesmaybeheldtohaveenteredintoan
interimcontractonthetermsofthefinalone,pendingitsexecution,ortohaveagreedtodispense
withformalexecutionaltogether.
Thecourtsrecognisethatpartiesmaysimplyfailtoexecuteafinal,formalagreement.Therefore
wheretheLOIindicatesanintentiontocontractonstandardterms,thecontractorstartsworkon
thebasisoftheletterandonlyfinalexecutionisoutstanding,thecourtislikelytoconcludethatthe
partieshaveenteredintoacontractwhichincorporatesthosestandardterms.
Thiswillberegardlessoftheabsenceofanexecutedcontract,theuseoffuturetenseintheLOIor
thefactthatthepartieshadfailedtoagreefinaltermswhichthecourtregardsasimmaterial.
However,theLOIcannotbecategorisedasTypeCifanyofthefollowingfactorsapply:
inrelationtothesubjectmatteroftheLOIthereisanabsenceofagreementonanymatterwhich
thepartiesconsideredwasnecessary,orwhichisobjectivelynecessary,toformafinalcontract
therehasbeencontinuednegotiationonmaterialfactorssuchasscope,dateforcompletionor
price
thereislanguageinconsistentwiththeincorporationofthestandardterms,orwhichmakesit
clearthatuntilsomethingfurtherhappensthereismerelyasimpleonewayrighttobepaidfor
workdone.
Tipsondraftinglettersofintent
Do:
clearlyidentifythescopeoftheworks
setoutthematterstoberesolvedbeforethemaincontractcanbeenteredinto
makeitclear,ifthisistheintention,thattheLOIisintendedtogiveriseonlytoaninterim
agreementpendingthenegotiationofthemaincontract,andthatneitherpartyintendstobebound
bythemaincontractuntilthewrittendocumentisexecutedbyeachofthem.However,asnoted
above,itispossibleforthepartiestoinadvertentlywaivesuchprovisionsiftheirbehaviour
contradictsthis
statewhatgoverninglawapplies
makementionofVAT,asfailuretodosocanleadtoadisputeonwhetherthesumisinclusiveor
exclusiveofVAT
includeamethodofdisputeresolutionwithintheletter
makeitclearwhoistobetheinstructiongiverinrelationtotheworktobecarriedout
makeitclearthatoncetheintendedcontractisconcludeditwillapplyretrospectively,andthat
anypaymentsundertheLOIwillbetreatedaspaymentsagainstobligationsunderthemain
contractoncethiscomesintoforce
makesuretheLOIisactuallyissuedbytheissuer,ratherthanbysomebodywithouttheauthority
tocontractuallybindtheissuersuchastheprojectmanager
recordanyagreedextensionbeyondtheoriginalexpirydateinwriting
provideforwhatwillhappenifthemaincontractisneveragreed.
Don't:
seeanLOIasasubstituteforaproperlydraftedcontract
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haveanLOIwhichincorporatesallthetermsofthecontract
forgettosendacopyoftheLOItotheotherpartyforsignatureandreturn
forgettoformalisethecontractualrelationshipbeforetheLOIexpires
gobeyondthetermsoftheLOI.
Summary
Aletterofintentwillalwaysbethepoorrelationofacarefullynegotiatedanddocumentedcontract.
HoweverinthetimecriticalconstructionenvironmenttherewillcontinuetobeaplaceforLOIs,
andsoitisimportanttomakesurethattheycomplywithasimplechecklistofrequirements
designedtoavoidambiguityandopenendedness.LOIsneedtobemonitoredandmanaged
expiryandrenewaldatesshouldberecorded,watchedandmet,expenditureandliabilitylimits
closelymonitoredandanyrenewalorextensionletterspreparedingoodtime.Betterstillreplace
anLOIwithafullyformed,writtencontractassoonaspossible.

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