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Letters of intent – what have I agreed?

09 Mar 2013

Letters of Intent are commonly used within the construction industry but their terms and effect are often misunderstood, with potentially disastrous consequences.

What is a Letter of Intent?

A Letter of Intent is commonly used where one party wishes to have some work commenced by the other party before a formal contract has been agreed and signed by both parties. It can take many forms, but is essentially a communication expressing an intention to enter into a contract with the receiving party at some future date. If the contract never materialises, the terms of the Letter of Intent must explain the extent of the agreement (if any) the parties have reached.

Depending upon the precise wording used, the Letter of Intent can be:-

  • a non-binding statement of the future intention of the parties;
  • an “interim” agreement which is legally binding containing express limitations which must not be exceeded, such as a financial limit or a particular description of work;
  • a complete and legally binding contract.

It is important to ensure that the Letter of Intent properly reflects the author’s intention. There is a wealth of legal cases built upon the absence of this basic requirement.

Precautionary tales

A recent case in the Supreme Court (RTS Flexible Systems Ltd v Molkerie Alois Muller Gmbh & Co) concerned an appeal in respect of the effect of a Letter of Intent. The Judge observed:-

“The different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story is to agree first and to start work later.”

A salutary lesson can be learned from the case of British Steel Corporation .v. Cleveland Bridge and Engineering Co. Limited which was decided in 1984. A Letter of Intent had been issued but the parties were not able to subsequently agree the terms of the contract.

The Judge stated that there was no binding agreement in view of the wording used in the letter of intent. There was simply a legal obligation upon Cleveland to pay British Steel a reasonable sum for the work it had carried out. In view of this, Cleveland’s substantial set-off and Counterclaim had no legal standing, as the absence of a contract meant there could be no damages payable for breach of that contract.

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A different outcome can be seen in the case of Mowlem plc .v. Stena Line Ports Limited in 2004. Stena issued a series of Letters of Intent, which allowed Mowlem to incur expenditure in respect of the works executed to a maximum sum of £10million. Mowlem exceeded this financial cap and argued that Stena was prevented from relying on the financial limit as Stena was aware that Mowlem had carried out work which exceeded this sum. The Judge held that the wording of the Letter of Intent imposed an obligation upon Stena only to pay Mowlem for the work carried out up to the agreed financial limit. There was no implied term requiring Stena to pay more. Mowlem were required to stand the excess.

A contrasting outcome occurred in the case of Harvey Shopfitters Limited .v. ADI Limited (2003) when the Court of Appeal once again was required to interpret the wording and effect of a Letter of Intent that had been issued. The Judge found that the Letter of Intent contained details of the major terms of the contract that the parties ultimately intended to enter into, including the scope of the work, the price and the time period for completion of the works. He decided that there was, in fact, nothing more for the parties to discuss or reach agreement about. The judge therefore found that a complete and binding contract had been formed due to the wording contained in the Letter of Intent. Despite this, formal contract documents had not been produced.

The lack of clarity in the wording of a Letter of Intent may well result in the parties seeking judicial assistance and the court declaring its own interpretation of the wording used, which may bear no relationship to the author’s original intention. Prevention, in terms of good drafting, is better than cure, as the medicine the court administers may taste very unsavoury.

It is wise to consult a lawyer if you have any doubts about the wording to be included or its likely legal effect. For further information or advice, please contact Graham Sutton on 0191 232 8345 or email graham.sutton@hay-kilner.co.uk

Please note: This article is not legal advice; it is intended to provide information of general interest about current legal issues. Please contact us to discuss how the contents of the article may affect you.