In the latest article in our Back to Basics series, we consider letters of intent. To what extent do they constitute binding agreements, what terms do they need to cover and how do you deal with them going forward?

At this time of year, lots of us are busy somewhere in between the two extremes of getting the final bits and pieces needed for that perfect Christmas Day, or finally getting ready to start the Christmas shopping. However, by now, many children have already written their letter to Father Christmas setting out all the presents they would like this year, most likely containing an affirmation as to how good they have been over the past 12 months.

Indeed, following receipt of such a notice, countless parents will now be involved in intense negotiations as to whether the desired Paw Patroller vehicle can be ordered in time or whether this can be value engineered and replaced with Elsa's Frozen LEGO Castle.

In a perfect world, all parties to this transaction will be agreed as to the final terms on which it is to be undertaken but, in reality, time and commercial pressures (allied to the possible intransigence of one party or the other) may lead to the parties being unable to reach final agreement on all the terms before the big day.

This situation is one which can also arise in the rather less festive context of entering into a building contract. Perhaps the parties can agree on most of their requirements but have still to finalise the full list, or alternatively negotiations as to certain terms have become bogged down, but there is a requirement to either start on site or order certain items with long lead times.

In this instance, one or other of the parties may suggest entering into a letter of intent.

What is a "letter of intent"?

Within the context of a construction contract, a letter of intent rarely fits its description – in other words, it tends not simply to set out what the parties intend. It often constitutes a legally binding contract rather than a "mere puff" or some form of non-binding indication that a relationship will be entered into at a later date (otherwise known as a "comfort letter").

As there is no one definitive legal concept or meaning of the term "letter of intent" (and bearing in mind that the term can unhelpfully be used to refer to both binding and non-binding agreements) it is often better to avoid using this description as it can lead to confusion. Instead, the term "comfort letter" can be used for non-binding agreements, and binding agreements can be referred to under a variety of different terms which better describe the purpose of the letter - examples include "enabling contract", "early-works agreement" or "procurement agreement".

In reality, not much is to be gained by a comfort letter/non-binding agreement as it leads to uncertainty for both employer and contractor.

If the parties are entering into an agreement which is intended to be binding, better and more predictable results are usually produced when the parties understand from the outset that this is intended to be a contract for a limited scope of works, which will (in time) most likely be subsumed into the final form agreement. Once this principle is established, the parties should understand that the contents of this letter can potentially be as important as the terms of the subsequent building contract itself. The letter will form the basis of an interim agreement between them, which (in the absence of any later agreement) an adjudicator or court may find to have been varied by the conduct of the parties to encapsulate the entirety of the works (which were originally intended to be let under a separate form of contract).

What should a contractual letter of intent contain?

At a basic level, as with any contract, a letter of intent should contain a proper description of the relevant parties and their aims, the scope of work, the amount of remuneration and the usual set of boilerplate conditions, such as choice of law, statutory compliance, notices and termination provisions. Also (in the context of a construction contract), it will need to include compliant payment provisions and conditions dealing with dispute resolution including adjudication, failing which the Scheme for Construction Contracts will apply.

Some other factors that should be provided for include:

  1. the terms and conditions that will apply to the works e.g. JCT Design and Build Contract 2011
  2. responsibility for control and security of the site
  3. requirements for the standard and timing of work
  4. insurances
  5. maximum price clause
  6. copyright provisions
  7. integration into the final contract.

The last point is particularly important - what happens to the letter of intent once the final form building contract has been executed? In short, the letter of intent needs to provide certainty on this issue; providing (in summary) that the formal contract will supersede the letter of intent and will retrospectively cover the works carried out under the letter of intent and the entire contractual relationship between the parties.

If this is done effectively, then the transition between the governing provisions of the letter of intent and the formal contract should be seamless, avoiding ambiguity, and giving assurance going forward. To take an example, works carried out under the letter of intent may well be covered up in due course - as a result, any defects may not immediately manifest themselves. Where a letter of intent is contractually "replaced" by a formal building contract executed as a deed, the employer will have the benefit of the longer limitation period of 12 years.

Managing a letter of intent

Once the parties have entered into the letter of intent, it can often be the case that the focus moves on to negotiation of the terms of the final contract. However, care should be taken not to forget the scope of the letter, and this should be consciously managed.

Depending on the drafting, it may be possible for the parties to vary the terms of the letter either by conduct or perhaps by exchange of emails (which may constitute an agreement in writing between the parties). It is unlikely that either party will want to risk such variations occurring accidentally, and so the letter should not be seen as a substitute for the full contract agreement. In other words, avoid a scenario where the letter of intent is repeatedly extended, instead of the parties grasping whichever nettle is preventing the final form of contract from being signed.

Hopefully, by considering these factors when entering into agreements under time pressure or in the face of determined negotiators (whatever their age), parties can take account of the fact that letters of intent are (more often than not) fully formed contracts which are likely to be binding, albeit these are usually intended to be an interim measure, and so should be treated as such.

Indeed, those letters to Father Christmas may need to be redrafted, or new negotiating positions adopted, as specifications change after seeing the latest advert and/or trip to the cinema to see this year's Christmas release.