The dangers of letters of intent
This article originally appeared in Building.co.uk.
An agreement to mobilise the contractor early can be documented in a letter of intent, but beware the pitfalls:
In the economic climate of increasing inflation, letters of intent remain widely used. They serve a meaningful purpose to start works earlier than would otherwise be advisable. Letters of intent issued at the appropriate time, and well drafted, allow the contractor to mobilise before the parties enter into the main contract. With high inflation and costs spiralling, the parties can take advantage of securing goods and materials at potentially lower costs than would be possible later in the programme. With more programmes being dictated by lead-in times and availability of goods and materials, the parties should carefully monitor the contractor’s deadlines for placing supply chain orders to realistically deliver the overall project programme.
Letters of intent should always be approached as interim measures only, while the parties finalise the subsequent main contract as soon as all the commercial and technical details are agreed. Letters of intent are not a panacea for engaging a contractor on a whole project, however, and they should never be viewed as a replacement for the main contract.
Communications referred to by the parties as letters of intent do not always provide clarity as to the parties’ rights and obligations for the initial works. Cases on the interpretation of letters of intent continue to reach the courts. The judges often decipher the wording of the letter to determine the intention of the parties, and its legal status. Does the letter amount to a separate contract, are the applicable terms and conditions clear, has the draft main contract been incorporated, or is it merely an expression of comfort without the intention on both sides for it to be enforceable in law?
One risk when letters of intent are in place is how to manage the inevitable scope creep from the originally authorised works in the letter
If the parties agree to mobilise the contractor early, they should document this with an appropriately worded letter of intent amounting to a contract. One risk when letters of intent are in place is how to manage the inevitable scope creep from the originally authorised works in the letter. The letter should clearly set out a definitive scope of works, and a realistic expiry date until when the contractor can recover its costs. This expiry date should correlate with the date by when the subsequent main contract needs to be in place. These provisions should act as an incentive for the parties to agree the terms and conditions of the main contract, or to allow the employer flexibility to reassess proceeding with the project long term.
Once the contractor starts work and the project momentum gathers pace, the commercial pressure to continue working builds. If the letter allows the contractor to undertake limited initial works and includes a maximum cap on the costs they can recover from the employer, it should closely monitor its exposure before carrying out works outside the original scope. Another key risk is documenting changes to the original authorised works, the maximum limit the employer is willing to pay, and the associated time period for carrying out the works. The employer may not be ready to commit to the whole project, but the contractor has started work and cannot continue with its programme unless it receives more payment security from the employer. Any extension or variation to the terms of the original letter should be appropriately recorded in a manner consistent with the contractual status of the overall arrangements.
It is not uncommon for certain terms contained in the draft main contract incorporated into the letter to be inconsistent with the equivalent terms set out in the letter itself.
Alongside dealing with elements such as any key programme dates, allocating responsibilities in line with the CDM Regulations, clarifying insurances, and specifying ownership of intellectual property rights, the letter should contain clear payment terms. It is not uncommon for certain terms contained in the draft main contract incorporated into the letter to be inconsistent with the equivalent terms set out in the letter itself. Both parties may find themselves in a muddle with interim payment arrangements if, for example, the due dates and final dates for payment are uncertain. Contractors may want shorter valuation cycles or advance payments for any critical path items instructed under the letter. Tangible disputes can arise and impact on the contractor’s cash flow even at an early stage of a project
Employers must review the letter in conjunction with the intended commercial position in the subsequent main contract. The main contract should wrap up the works carried out under the preceding letter. Any payments made to the contractor should be on account of payment of the contract sum, and the main contract terms and conditions should apply retrospectively to the works carried out under the letter.
If the working relationship breaks down and the letter is terminated or the main contract is not entered into, both parties want to be clear on the contractor’s demobilisation impact. Contractors may insist on additionally recovering supply chain breakage costs, while employers may want direct enforcement rights against the contractor’s suppliers.
Before a contractor commences works under a letter of intent, the parties should seek advice to understand what level of protection the letter provides.