Commercial Property Focus - May 2009
Letters of intent – use with caution!
The case
The court’s
decision in Diamond Build Ltd v Clapham Park Homes
Ltd delivered in June 2008 made it clear that letters of
intent, often used as a pre-cursor to a formal construction
contract, can be legally binding in themselves.
In the case, the developer accepted a tender
from the contractor for a refurbishment and regeneration contract
relating to a number of houses and flats on the Clapham Park Estate
in South London. The tender document enclosed a specification for
the works and various requirements for the project.
The developer issued a letter of intent to the
contactor instructing them to start work and setting out the
intention to enter into a JCT Intermediate Building Contract 2005,
with Contractor’s Design, once the parties were in a position to do
so.
The letter provided a commencement date, a
completion date and an overall contract sum. It also contained the
usual repayment clause whereby the developer agreed to underwrite
the contractor’s costs for providing various services and materials
to the project up to a specified maximum.
Later, due to delays in the work and some
concerns over the project, the developer wrote to the contractor
terminating the appointment.
The contractor had exceeded the repayment cap
in the letter of intent and therefore sought to recover all of its
wasted costs on the grounds that the letter of intent, and
therefore the cap, was not legally binding.
The court held that as the letter of intent
was sufficiently certain as to the rights and obligations of the
parties; it was clear enough to constitute a simple binding
contract.
The developer was accordingly entitled to rely
on the repayment cap leaving the contractor unable to recover the
whole of its wasted costs.
Commentary
Whilst
letters of intent can be a useful tool for contractors and other
professionals to get on site and commence work, the case
illustrates the dangers of proceeding on this basis.
Contractors are often required to start on
site immediately. Letters of intent allow this to be achieved but
leaving the parties free to negotiate a formal construction
contract.
This could be because a part of the
specification has not been finalised, or documents such as
performance bonds or warranties to end users are yet to be agreed.
Contractors are often instructed to commence preliminary site works
such as ground remediation while those other aspects are
progressing.
This case provides a warning to contractors
and other professionals involved in construction projects to
closely examine the terms of any letter of intent they are
given.
The costs of works carried out beyond the
precise terms of the letter of intent may not be recoverable.
In the case, the court effectively described
the letter of consent as an instruction to provide services in
return for payment. It was not a pre-cursor to a formal contract
specifying those terms or a basis for negotiations going
forward. It was an instruction in itself and had the capacity
to create legal relations as on the face of it that’s what the
parties intended. The court rejected the contractor’s
argument that a legally binding contract would only come into
existence if a later contract such as a JCT Building Contract was
concluded.
As such, letters of intent should no longer be
regarded as “letters of comfort” or non-legally binding “heads of
terms” as was often previously thought to be the case. They can
create binding rights and obligations. They should be clear as to
what works are to be done and give precise details of the payment
terms.
Contractors in particular should ensure that
letters of intent are drafted with far more certainty as to what
works and services are included and what goods and materials should
be paid for by the developer in the event that the project fails.
Once materials have been ordered or works commissioned by a
sub-contractor, the contractor is primarily liable for payment of
them and if a formal contract is not entered into his only recourse
to the developer is under the letter of intent.
To avoid these risks, contractors should
ensure a formal contract is agreed and signed as quickly as
possible after a letter of intent has been issued. They should keep
within any repayment cap prescribed in the letter of intent until
that time.
Developers will inevitably wish to keep the
repayment clause as wide as possible, to enable the cap to apply to
payment for different or extra works commissioned by them after the
letter of intent. Contractors should be wary of this and document
any changes accordingly. Otherwise the developer may not be
required to repay any sums to the construction team that are
outside the letter of intent or above the cap.
Contractors and other professionals should
ensure no onerous obligations are contained in letters of intent
that they would not usually agree in a formal JCT contract, since
they may not get the chance to remove them later.
David
Tabinor
Partner
Weightmans LLP
david.tabinor@weightmans.com