Are letters of intent more trouble than they’re worth?
Work on construction projects sometimes begins with a crucial decision: to commence work under a Letter of Intent (LOI) or to wait for a full contract. LOIs can mean getting on with a job swiftly, but they also present significant dangers for the unwary. This article explores why LOIs are used, common pitfalls and how to avoid them.
Why use a letter of intent?
When a construction project is on the horizon and everyone is keen to get going, an LOI can seem like a handy shortcut. It can be seen as a quick way to say, “Yes, we’re interested, and we’re on board with getting this project moving.” An LOI allows all parties to get the ball rolling, start planning, and even kick off the work while the full contract is still being hammered out.
The commercial attractiveness of this is clear, but there are risks to watch out for.
An LOI is usually a binding contract
While LOIs are sometimes thought of as a stepping stone or a “contract to enter a contract”, it is important to understand that while sometimes they do not create a contract at all, often they are legally binding contracts themselves. This is because when parties start working and receiving payments on a commercial basis, under an LOI or otherwise, courts and adjudicators are often reluctant to find that there is no agreement or contract.
Depending on its wording, an LOI might:
- Create no contract;
- Create a contract for a limited scope; or
- Create a contract for all of the work contemplated under the full contract.
The effect of the LOI will depend on a careful consideration of the words used in it. We often find that parties have signed up to letters of intent that have a different effect to what they anticipated.
This means you should pay close attention to the details in your LOI. They might contain vague or broad language, which can sometimes lead to misunderstandings or disputes. It is essential to be clear and specific about your obligations and expectations to avoid any issues down the line, and you should treat an LOI with the same attention to detail as you would any other formal agreement.
Caps
Caps are commonly found in LOIs:
- Some caps limit the LOI to a certain scope (for example, design and enabling works),
- Some caps limit the LOI to work within a certain period or up to a certain date,
- Some caps set an upper limit on the amount payable.
It is important to be cautious of caps in LOIs. Generally, they are likely to be enforceable. That means that if the amount you are applying for exceeds a payment cap or you carry out work after a time cap or outside of a scope cap, you may not be entitled to payment of the excess, and you may be left having carried out a huge amount of work for free.
Before you agree to any cap, it is critical to evaluate the project’s scope under the LOI. You should consider whether the cap realistically covers the potential costs and you should ensure your LOI includes terms that allow for revising the cap(s) as the scope expands.
Most importantly, if you are nearing your cap, you should consider requesting an increase to the cap or otherwise stopping work if you are able to do so under the terms of the LOI.
Termination of the LOI
An LOI is not necessarily a guarantee of the full scope of work or a final contract. This uncertainty is a key risk that needs careful consideration.
Imagine this: You’re brought on board for a project, offering competitive rates for the initial design phase, driven by the expectation of doing the more profitable construction work later. But then, the unforeseen happens – the LOI is cancelled, and you find yourself replaced, with no construction contract in sight. This scenario is not uncommon and highlights the vulnerability of sub–contractors in these situations.
To safeguard against these risks, it is important to have a clear understanding of the project’s scope and your role. This includes knowing the terms under which the LOI can be terminated and what that means for your business.
Reduction of bargaining power
Most parties enter into an LOI with the expectation of a final contract being executed. However, if the terms of the LOI are skewed against you, the other party may find little reason to enter into a final contract that offers you better terms. Essentially, you could be locked in a less advantageous position, having already committed resources to the job.
The best time to negotiate a contract is before you have started any work at all. If working under an LOI is unavoidable, you should ensure it is as favourable as possible to maintain leverage in future negotiations.
How can I protect myself?
Overall, working under an LOI is often much riskier than working under the detailed standard form contracts such as the JCT or NEC. If you have to work under an LOI, it is worthwhile considering the following points:
- What is preventing a full contract from being issued now?
- Does the LOI give rise to a contract at all?
- Is the scope of works identified in the LOI sufficiently clear?
- What documents are you required to work to? Are they identified properly?
- What is the duration of the work? Is the time available adequate for the scope of work?
- What are the payment terms and are they acceptable?
- Are there caps on scope, time or payment and how do they operate?
- How will changes to the scope of work will be handled? Will the LOI provide a mechanism for dealing with variations, or will these need to be negotiated separately?
- Are the insurance obligations clear?
- How is the transition to a more detailed contract to be handled?
How CCC Can Help
As mentioned above, we often find that parties have signed up to letters of intent that have a different effect to what they anticipated. CCC can assist you if you think you may be in this situation and we have decades of experience in:
- Reviewing contracts and letters of intent to advise parties of contractual risks.
- Helping parties negotiate better terms.
- Helping parties resolve disputes over the work, the account or the contract.
- Assisting parties in adjudication and other dispute resolution processes.
