Letters of Intent: Pitfalls and Possible Solutions

Letters of intent are used widely in the construction industry, particularly where the parties want to get on with a project quickly but have not agreed on all the terms of a contract. However, as the recent decision of the Felton Construction v Liverpool City Council highlights, there are sometimes serious difficulties associated with using letters of intent. As indicated by the length of the judgment, resolving these issues often involves a detailed analysis of correspondence and documentation, which could be avoided through careful drafting.

The courts have given guidance as to when it may be appropriate to use a letter of intent. What are the risks when parties decide to use a letter of intent, and how can we side-step the booby-traps?

Pitfalls

• Legally binding? Not all letters of intent have legal effect, so the parties may not be contractually bound by their terms. The courts have distinguished between letters of intent that create rights and liabilities and those that do not. Some letters of intent are just “expressions of hope”, which are not binding.

• Open-ended? Letters of intent are used as a stop-gap until the final terms of a contract are agreed. If, however, no further agreement is reached, does the letter of intent continue to operate?

• What is the scope of work? A classic problem is that the scope of a contractor’s works is not always clear. This may be because the design or specification of the project is still being developed.

• A “construction contract”? It is not always clear whether a letter of intent constitutes a “construction contract” which is subject to the operation of the Construction Act. The Act will not apply where there is no binding contract, or where the contract is not “in writing / evidenced in writing”.

Possible Solutions

Ideally, a letter of intent should:

• Indicate whether it is intended to be binding or non-binding.

• Provide what the parties’ rights and obligations are in the event that a further, formal agreement is not reached. Important matters to address are the parties’ rights to terminate the letter of intent (and the consequences of termination), payments to be made to the contractor, use of intellectual property on an ongoing basis, and dispute resolution.

• Be as clear as possible on the contractor’s scope of work and any limitations on the work the contractor is to perform (e.g. “up to a value of £x”).

• Specify whether the letter is intended to operate as a “construction contract” for the purposes of the Construction Act. Such a provision will not be effective where, as a matter of fact, the letter of intent actually constitutes a “construction contract”. It is, however, possible to draft a letter of intent so that the Act does not apply, i.e. the letter of intent is not a “construction contract”.

While the courts will seek to uphold a commercial agreement, they will not magic one out of thin air or re-write its terms. Click here for a link to a note on an earlier Court of Appeal decision which concerned problems arising out of a letter of intent.