Well-drafted letters of intent can be very useful for contractors, but are no substitute for a carefully negotiated and well-managed contract. Here are the main points to consider when putting together yours.
In an ideal world, employers and contractors would finalise all aspects of a deal and record it in a signed contract before any works are carried out or expenditure incurred.
In reality, construction and engineering projects involve technical aspects which can take time to agree, and financial and commercial considerations mean that parties will often be under pressure to commence the works as soon as possible.
In such circumstances, a temporary arrangement may be entered into while the parties continue to negotiate formal contractual provisions.
In this context, it is easy to see why letters of intent are attractive. Parties can begin preparatory works, instruct subcontractors or begin the design process, without being held up by lengthy contractual negotiations.
For an employer, the sooner works are completed, the sooner a development can start producing income. For a contractor, a letter of intent provides comfort that it will be paid for works carried out before the contract documents are signed.
However, letters of intent can present risks and uncertainties on both sides. If a dispute arises, parties need to be able to determine what kind of legal obligation has been created (if any), and what rights the letter of intent gives each party.
What is a letter of intent?
There is no single definition of the term ‘letter of intent’.
“A non-binding letter of intent or a ‘comfort letter’ can be useful if the parties want to indicate their goodwill to each other but do not wish to enter into a contractual relationship”
It is typically used to describe a letter from an employer to a contractor or from a contractor to a subcontractor that (i) indicates an intention to enter into a formal written contract for certain works, and (ii) asks the contractor to begin those works before the formal contract is executed.
Letters of intent can be legally binding or non-binding, depending on the drafting. A non-binding letter of intent or a ‘comfort letter’ can be useful if the parties want to indicate their goodwill to each other but do not wish to enter into a contractual relationship.
However, as a general rule parties will usually want their letter of intent to provide certainty in relation to key matters such as the scope of work, payment and time for completion. For this reason, a binding letter of intent will usually be more appropriate.
A binding arrangement provides certainty and enables an employer to tailor the letter to its needs. It can (and should) limit the sum to be paid and the scope of works to be carried out.
What constitutes a legally binding letter of intent?
In order to be legally binding, there must be:
- Certainty of key terms (further described below);
- Consideration (the price to be paid in return for the performance by the other party of its obligations);
- A mutual intention to enter into a binding legal contract.
The dos and don’ts
- State the names of the parties;
- Clearly describe the scope of the works to be carried out;
- State the price and, if appropriate, any cap on the contractor’s entitlement pending execution of the formal contract;
- Include a statement of the intention to enter into a formal contract;
- Describe the procedure for calculating payments;
- State the entitlements of both parties in the event of frustration, revocation or repudiation;
- Describe the required insurances;
- Confirm the termination procedure;
- Confirm that the letter of intent will terminate upon execution of the formal contract;
- Include a procedure for dispute resolution.
- See the letter of intent as a substitute for a properly drafted contract;
- Forget to send a copy of the letter of intent to the other party to sign and return;
- Forget to formalise the contractual relationship before the letter of intent expires;
- Go beyond the terms of the letter of intent.
A well-drafted letter of intent provides a mechanism for starting construction works in advance of the parties agreeing a formal building contract. However, the letter of intent is not a substitute for a carefully negotiated and formally documented contract.
Once in place, the letter of intent should be monitored and managed – expiry and renewal dates should be recorded and met, and the letter of intent should be replaced with a formal, written contract as soon as possible.