It is indeed regrettable that the construction industry continues to utilise an instrument, the letter of intent, which adds little or no value to the relationship between the parties and, in addition, has the potential for creating significant disputes between the parties. Despite the complete absence of any tangible benefit in using a letter of intent many sectors of the construction industry continue to labour under the misapprehension that it provides some sort of benefit.
As a general rule letters of intent do not create legally binding arrangements. The letter of intent does not constitute acceptance of the contractor’s intention but is rather a statement of the intention to accept it at some later date. It is for this very reason that it is referred to as a letter of “intent”. In its purest form it can do nothing other than to create a sense of comfort on the part of the recipient. Perhaps, maybe, sometime in the future the issuer of the letter of intent will enter into a contract with the recipient. There is however no guarantee that that will happen and, should it not, the recipient of the letter of intent will have no rights of recourse against the issuer and may well have committed itself to expenditure which is not recoverable in the absence of the contract itself coming into being.
Over the years we have seen letters of intent which have created substantial difficulty and caused one or other of the parties to the non existing contract to incur considerable irrecoverable cost.
The problem is compounded by the fact that frequently a letter of intent is issued which purports to contain an instruction to carry out a portion of the tendered work. Since the power to instruct can only arise out of a valid contract, it necessarily follows that, in the absence of binding offer and acceptance, the letter itself cannot miraculously bestow upon the issuer the power to instruct the other party. For example, frequently we have seen letters of intent purporting to instruct the recipient to order long lead items alternatively to commence the design work. In truth this is not a letter of intent but in fact a counter offer and the recipient is now free to accept or reject the counter offer. The situation is further complicated by the assumption, incorrect in most instances, that the work “instructed” in the letter of intent will be paid for in accordance with the terms of the contract which has not yet come into being. It necessarily follows if there is no contract then the terms of payment associated with those items are not yet in place. Since acceptance by conduct is a valid form of acceptance, should the contractor elect to proceed with the work purportedly instructed, and should this performance come to the attention of the issuer of the letter of intent, then a mini contract will have come about which will not include many of the terms and conditions of the enquiry and will, in large measure, be governed by the common law. To the extent that the price for the work “instructed” has not been agreed then the probability will be that the price will be governed, in the absence of subsequent agreement, by the common law approach of cost plus a reasonable profit. However, what constitutes a reasonable profit is frequently viewed differently by the employer compared to that view held by the contractor. Of course, if the entire contract is subsequently put in place then the mini contract will usually be novated and incorporated into the entire contract and the problem will go away. If, however, the employer elects not to proceed with the work or to change the basis upon which it issued the enquiry then the tenderer may be unwilling to enter into the overall contract and the parties may once again end up in dispute in regard to the scope of work which has been executed under the letter of intent.
All of these problems could be obviated if the construction industry recognised that the basis of contracting is consensus and a letter of intent will not usually lead to such a consensus where it incorporates a purported instruction.
The Contractor’s Point of View
From the contractor’s perspective the safest way to deal with a letter of intent which contains a purported instruction is to acknowledge it and advise, in writing, whether the contractor is prepared to carry out the work instructed and, if so, to set out the contractual basis and, in particular, the payment required for such work. This will then constitute a further counter offer which the employer would be free to accept or reject.
From the Employer’s Point of View
The employer should be seeking to obtain clarity and create certainty. Since it will usually be the author of the letter of intent, although of course we have seen, on many occasions, main contractors issuing letters of intent downstream to their proposed sub contractors, it is in the employer’s best interest to ensure that the contractual terms surrounding the mini contract are clear and comprehensive. This will cover the situation where the original overall contract does not come into being and will then avoid the possibility of a costly dispute. Such disputes are rarely governed by the dispute resolution clause because, until such time as the overall contract is in place, alternative forms of dispute resolution, adjudication, arbitration and the like are not incorporated. Obviously, by agreement, the parties to the mini contract could elect to proceed by way of alternative dispute resolution but one of the parties may be obstructive in this regard.
Our best recommendation is not to use letters of intent. We have not found any persuasive argument whatsoever which would encourage us to recommend their use. If the employer requires some aspect of the original enquiry to be carried out before it is in a position to place the full contract then it should enter into a proper mini contract with all the terms and conditions incorporated for the protection of both parties. Letters of intent create uncertainty and it is our experience that, wherever uncertainty is created, a significant opportunity for dispute will arise. Contracting should be like playing tennis. Never let the ball go dead on your side of the court since otherwise you will then lose the point!
Binnington Copeland & Associates