Letters of intent and their contractual effect

Letters of intent are commonly used in the construction industry during the time when one party is carrying out preparatory works (or works under the intended contract) before a formal contract is finalised. Preparatory work in this context may include preliminary design work, obtaining necessary consents, and so on.  Typically, letters of intent will express the parties` intention to enter into a future contract on terms to be agreed between them in the course of negotiations. In terms of the content, as between the principal and contractor, a letter of intent will usually specify the period for which it is intended to cover and set out the principal`s acceptance of responsibility to pay the contractor for any expenditure incurred in furtherance of the prospective contract. The letter may also confine the scope of preparatory works and restrict the principal`s liability so that it does not extend beyond the payment of expenditure incurred, or a reasonable price for work and material actually supplied.  In practice, it is common to find a situation where no formal contract ever materialises. The question then arises as to whether the letters of intent can evidence a binding contractual relationship.

Traditionally, letters of intent were regarded as no more than an expression in writing of a party`s present intention to enter into a contract at a future date.[1] On the other hand, there is a view that the letter may be treated as intending to create a binding agreement for a limited scope of work and costs pending the conclusion of a formal contract. As Robert Goff J in British Steel Corp v Cleveland Bridge and Engineering Co Ltd [1984] 1 All ER 504 noted, there is no hard and fast answer to the question whether a letter of intent will give rise to a binding agreement and everything must depend on circumstances of the particular case.

Recently, the High Court in Electrix Ltd v Fletcher Construction Co Ltd(No.2) [2020] NZHC 918 considered whether a binding contract was formed based on letters of intent. In this case, Fletcher (as principal) engaged Electrix as its preferred electrical sub-contractor for the Christchurch Justice and Emergency Services Precinct project. The parties undertook and paid for electrical works on the project without agreement on contractual terms. There was an expectation that they would be able to reach agreement on the contract, but this never happened. Fletcher argued that there was a partly written and oral contract. As one of the grounds, it claimed that the letters of intent provided a minimum significant base level of agreement between the parties.

The High Court concluded that the letters of intent failed to provide evidence of an intention to be immediately bound, although the letters were the standard and the only formal instrument used by Fletcher and Electrix to regulate their relationship. Palmer J viewed that the letters only provided evidence that the parties were both working with the “intent” that there would be a contract. In that case, the letters merely indicated some general parameters around the expected price and scope of works. They were not evidence of an intention to be immediately bound nor constituted an agreement on a contract price.

Letters of intent should not be relied on as a document in lieu of a formal contract. In circumstances where the use of the letter of intent is unavoidable, parties should ensure the scope and terms of the letter are set out clearly. The letter should in minimum include the following:

  • Contain the principal`s intention to accept the contractor`s offer/tender;
  • Identify the terms and scope of the work which the contractor will carry out;
  • Limit the value of works;
  • Specify a commencement date, duration and instruction to commence work; and
  • Provide details on how the letter will govern payment for work done in anticipation of a contract (payment term).

It is important for the parties to consider whether the letter intends to have a limited effect or a broad effect. Often the contracting parties may wish to create only a temporary legal obligation under a letter of intent before they agree on a formal contract. If this is the case, then the letter should state that it will be superseded by the contract which is still being negotiated. Therefore, clarity is an essential key here to protect the interests of both the principal and the contractor.  Once the letter has been drafted and sent to the contractor, the next step for the parties is to promptly finalise the intended contract before any further significant work is undertaken.

Footnote:

[1] Turriff Construction Ltd v Regalia Knitting Mills Ltd [1971] 9 BLR 20.

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