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Cookies on Pinsent Masons website This website uses cookies to allow us to see how the site is used. The cookies cannot identify you. If you continue to use this site we will assume that you are happy with this OK If you want to use the sites without cookies or would like to know more, you can do that here . Topics > Construction contracts Letters of intent in construction This guide was last updated in August 2011. Construction contracts Diversified industrial Real estate Energy In a perfect world employers and contractors, and contractors and subcontractors, would finalise all aspects of their deal and record it in a written, signed contract before any work was performed or expenditure incurred. In reality, however, the parties are often under commercial pressure to commence works or preparatory works as soon as possible and turn to a 'letter of intent' while they continue to negotiate the full contract. In some cases, no formal contract will ever be concluded. Proceeding under a letter of intent (LOI) can allow the parties to get a head start on the construction programme in a number of useful ways, allowing them to begin to instruct subcontractors or begin the design process. However, they give rise to risks on both sides. Some LOIs create binding obligations on the parties and some do not, depending on the circumstances and the drafting. Parties may not get around to replacing the LOI with a formal contract, and if disputes arise they will need to resolve the issue of what kind of legal obligation has been created if any and what rights it gives each party. What is a letter of intent? The term 'letter of intent' does not have a technical legal meaning and is used to describe all

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  • 7/1/2015 Lettersofintentinconstruction

    http://www.outlaw.com/en/topics/projectsconstruction/constructioncontracts/lettersofintentinconstruction/ 1/6

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    Topics>Constructioncontracts

    LettersofintentinconstructionThisguidewaslastupdatedinAugust2011.

    ConstructioncontractsDiversifiedindustrialRealestateEnergy

    Inaperfectworldemployersandcontractors,andcontractorsandsubcontractors,wouldfinaliseallaspectsoftheirdealandrecorditinawritten,signedcontractbeforeanyworkwasperformedorexpenditureincurred.Inreality,however,thepartiesareoftenundercommercialpressuretocommenceworksorpreparatoryworksassoonaspossibleandturntoa'letterofintent'whiletheycontinuetonegotiatethefullcontract.Insomecases,noformalcontractwilleverbeconcluded.

    Proceedingunderaletterofintent(LOI)canallowthepartiestogetaheadstartontheconstructionprogrammeinanumberofusefulways,allowingthemtobegintoinstructsubcontractorsorbeginthedesignprocess.However,theygiverisetorisksonbothsides.

    SomeLOIscreatebindingobligationsonthepartiesandsomedonot,dependingonthecircumstancesandthedrafting.PartiesmaynotgetaroundtoreplacingtheLOIwithaformalcontract,andifdisputesarisetheywillneedtoresolvetheissueofwhatkindoflegalobligationhasbeencreatedifanyandwhatrightsitgiveseachparty.

    Whatisaletterofintent?

    Theterm'letterofintent'doesnothaveatechnicallegalmeaningandisusedtodescribeall

  • 7/1/2015 Lettersofintentinconstruction

    http://www.outlaw.com/en/topics/projectsconstruction/constructioncontracts/lettersofintentinconstruction/ 2/6

    sortsofcontracts.Itistypicallyusedtodescribealetterfromanemployertoacontractor(orfromamaincontractortoasubcontractor)indicatingtheemployer'sintentiontoenterintoaformalwrittencontractforworksdescribedintheletter,andaskingthecontractortobeginthoseworksbeforetheformalcontractisexecuted.WhileanLOImaycomeinmanyforms,itisessentiallyacommunicationexpressinganintentiontoenterintoacontractatafuturedate.

    TypicallyanLOIwilloperateinoneofthreeways:

    asanonbindingstatementofthefutureintentionofbothparties,sometimescalleda'comfortletter'asaninterimcontractonitsownterms,whichwillgoverntherelationshipbetweenthe

    partiesunlessanduntilaformalwrittencontractisexecutedasafinalcontractwhich,despitetherehavingbeennoformalexecution,isdeemedtohave

    incorporatedthetermsandconditionsoftheformalwrittencontractthatthepartiesintended.

    Forsimplicity,wewillrefertothesethreetypesofLOIasTypeA,BandCrespectively.WhichcategoryanLOIfallsintowilloftenbesomethingthatisonlydecidedbyacourt.

    Thereareanumberofelementsthatmustbeinplaceinorderforalegallybindingcontracttobecreated.Theseinclude:

    certaintyastokeytermsconsideration(the'price'paidunderthecontractinreturnforperformancebytheotherparty

    ofitsobligationsandamutualintentiontoenterintoabindinglegalcontract.

    Wherethereisdoubtaboutwhetherornotabindingcontracthasbeencreated,thecourtswilllooktoseeifalloftheseelementsarepresent.

    LOItypeA:nocontract

    TheeffectofaTypeALOIistoauthorisethecontractortocarryoutwork.Howeverasthereisnoformalcontract,thecontractorwillatbestonlybepaidona'quantummeruit'basis,thatisareasonablepaymentfortheworkdone.Thecontractorcanstoptheworkatanytimewithoutnoticeandtheemployercanalsocallfortheworktobestoppedatanytimewithoutnotice.Theemployerwillnotbeabletocounterclaimforbreachofcontractinthecaseofdelayordefectiveworkbecausethereisnocontract,althoughdefectsmaybetakenintoaccountwhenassessingwhattheworkisworth.

    TherearerelativelyfewcasesconcludingthatanLOIisofthistype,asthecourtswillusuallytryandestablishacontractfromtheletteronthebasisofthepresumedintentionsoftheparties.However,todosoitmustbeobjectivelyclearthatthepartieswereagreedbothonthosematterswhichthepartiesthemselvesconsiderednecessary,andthosematterswhichareobjectivelynecessarytoformacontract.Therewillbenocontract,andtheLOIwillbeofTypeA,if:

    theLOIandsurroundingevidencesuggeststhatnegotiationswerecontinuingaboutmatterswhichthepartiesregardedasessentialtotheexistenceofacontractualrelationshiptheLOIisexpresslycontingentonaneventwhichdoesnotoccur.

  • 7/1/2015 Lettersofintentinconstruction

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    TypeBLOI:interimcontractswhosetermsfallshortofthetermsofanintendedfinalcontract

    Themainissuewillusuallybewhethertheinterimcontracthasbeenreplacedbyafullcontract,especiallyiftheLOIisexpressedasexpiringonasetdateandthepartiesignoretheexpiryandcontinuetoperformthecontract.Itisoftentemptingsimplytocarryonwiththework,butifagreedcapsareexceededthereisariskthattherewillbenoentitlementtopayment.Further,LOIswillnotusuallyprovideforissuesdealtwithinfullcontractssuchasvariations,extensionsoftimeanddefects.

    Conversely,thereisalsoariskthatifthepartiescarryonbeyondtheexpirydatetheymaybetakentohaveenteredintothefullbindingcontractthattheyhavebeennegotiating.Thecourtsmayfindthatbytheirbehaviourthepartieshavewaivedanyprovisionsaboutthefullcontractnotbecomingbindinguntilithasbeensigned.

    Ifaninterimcontractisinplaceitisimportantthatthepartiesdonotlosefocusonconcludingcontractualnegotiations.

    TypeCLOI:interimcontractincorporatingfinalterms

    TheproperinterpretationofaTypeCLOIisthatitisacontractwhichhasbeencreatedonthetermsintendedbythepartiesforincorporationintoafinalcontract,eventhoughnoformalwrittencontracthasbeenexecuted.Dependingonthefacts,thepartiesmaybeheldtohaveenteredintoaninterimcontractonthetermsofthefinalone,pendingitsexecution,ortohaveagreedtodispensewithformalexecutionaltogether.

    Thecourtsrecognisethatpartiesmaysimplyfailtoexecuteafinal,formalagreement.ThereforewheretheLOIindicatesanintentiontocontractonstandardterms,thecontractorstartsworkonthebasisoftheletterandonlyfinalexecutionisoutstanding,thecourtislikelytoconcludethatthepartieshaveenteredintoacontractwhichincorporatesthosestandardterms.

    Thiswillberegardlessoftheabsenceofanexecutedcontract,theuseoffuturetenseintheLOIorthefactthatthepartieshadfailedtoagreefinaltermswhichthecourtregardsasimmaterial.

    However,theLOIcannotbecategorisedasTypeCifanyofthefollowingfactorsapply:

    inrelationtothesubjectmatteroftheLOIthereisanabsenceofagreementonanymatterwhichthepartiesconsideredwasnecessary,orwhichisobjectivelynecessary,toformafinalcontracttherehasbeencontinuednegotiationonmaterialfactorssuchasscope,dateforcompletion

    orpricethereislanguageinconsistentwiththeincorporationofthestandardterms,orwhichmakesit

    clearthatuntilsomethingfurtherhappensthereismerelyasimpleonewayrighttobepaidforworkdone.

    Tipsondraftinglettersofintent

    Do:

    clearlyidentifythescopeoftheworks

  • 7/1/2015 Lettersofintentinconstruction

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    setoutthematterstoberesolvedbeforethemaincontractcanbeenteredintomakeitclear,ifthisistheintention,thattheLOIisintendedtogiveriseonlytoaninterim

    agreementpendingthenegotiationofthemaincontract,andthatneitherpartyintendstobeboundbythemaincontractuntilthewrittendocumentisexecutedbyeachofthem.However,asnotedabove,itispossibleforthepartiestoinadvertentlywaivesuchprovisionsiftheirbehaviourcontradictsthisstatewhatgoverninglawappliesmakementionofVAT,asfailuretodosocanleadtoadisputeonwhetherthesumisinclusive

    orexclusiveofVATincludeamethodofdisputeresolutionwithinthelettermakeitclearwhoistobetheinstructiongiverinrelationtotheworktobecarriedoutmakeitclearthatoncetheintendedcontractisconcludeditwillapplyretrospectively,and

    thatanypaymentsundertheLOIwillbetreatedaspaymentsagainstobligationsunderthemaincontractoncethiscomesintoforcemakesuretheLOIisactuallyissuedbytheissuer,ratherthanbysomebodywithoutthe

    authoritytocontractuallybindtheissuersuchastheprojectmanagerrecordanyagreedextensionbeyondtheoriginalexpirydateinwritingprovideforwhatwillhappenifthemaincontractisneveragreed.

    Don't:

    seeanLOIasasubstituteforaproperlydraftedcontracthaveanLOIwhichincorporatesallthetermsofthecontractforgettosendacopyoftheLOItotheotherpartyforsignatureandreturnforgettoformalisethecontractualrelationshipbeforetheLOIexpiresgobeyondthetermsoftheLOI.

    Summary

    Aletterofintentwillalwaysbethepoorrelationofacarefullynegotiatedanddocumentedcontract.HoweverinthetimecriticalconstructionenvironmenttherewillcontinuetobeaplaceforLOIs,andsoitisimportanttomakesurethattheycomplywithasimplechecklistofrequirementsdesignedtoavoidambiguityandopenendedness.LOIsneedtobemonitoredandmanagedexpiryandrenewaldatesshouldberecorded,watchedandmet,expenditureandliabilitylimitscloselymonitoredandanyrenewalorextensionletterspreparedingoodtime.BetterstillreplaceanLOIwithafullyformed,writtencontractassoonaspossible.

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    LatestConstructioncontractsNews

    Smallconstructioncompaniesthreatenedbylatepayments,researchshows30Apr2012PFIinvestorsoverchargingforrisk,NAOwarns15Feb2012ContractorsshouldchangecontractstoensuretheypassHSEchargestocorrectcompany,

    saysexpert01Feb2012'Costly'PFIneedsreform,saysChancellor16Nov2011Constructionsectorworstforcorruption,reportsays04Nov2011

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