APC extras: Letters of intent

This topic is relevant to the contract practice (T017) competency, which is a core competency for the quantity surveying and construction (to level 3), taxation allowances (to level 2) and project management (to level 3) pathways as well as being an optional competency for other pathways.

This article will look at what exactly letters of intent are and the purpose that they serve within the construction industry. Letters of intent are widely used and candidates will be expected to have a detailed knowledge of the purpose they serve, their limitations, what should be included in one and what happens when a letter of intent is silent on time, cost or quality.

What are letters of intent?

A letter of intent is a document that records and outlines, in broad terms, an agreement between two or more parties to enter into a contractual relationship. The issuance of a letter of intent allows work to proceed before the contract is finalised and/or executed or while the negotiations are ongoing.

The three types of letter commonly referred to as letters of intent are:

• Comfort letters
• Instructions to proceed with consent to spend
• Letters recognising the existence of a binding contract(s).

Comfort letters

A comfort letter is a letter expressing a party’s intention to act in a particular way at some point in the future, or at the time of issuing the letter. Such a letter will not oblige the party making the statement to actually act in that way and the author will be liable only if the expressed intention was not actually held at the time the letter was issued.

A comfort letter will not create a contract between the parties but may impose on either or both of the parties certain obligations in relation to payments due for any work undertaken.

Instructions to proceed with consent to spend

A letter with instructions to proceed and consent to spend is sometimes referred as an “if’” contract. This type of letter allows work to proceed up to a certain value while the contract itself is being finalised.

This type of letter will create a legally binding contract between the parties which will pre-date the principal contract but be superseded once the principal contract is executed.

Letters recognising the existence of a binding contract(s)

This type of letter is also referred to as a letter of acceptance and is used by some forms of contract (such as FIDIC) to formally execute the contract itself. Generally such a letter will be issued only once the contract has been substantially agreed and usually marks the completion of negotiations between the parties.

What should be included in a letter of intent

To ensure that a letter of intent is fully enforceable and will withstand scrutiny, the following information should be included in clear and unambiguous terms:

• The parties – the names and titles of the parties as stated within the contract documents
• The works – described in clear and concise terms
• The price (if agreed) – clearly stating the currency and whether this price is to be considered a maximum expenditure limit until the formal execution of the contract
• A statement of the intention of the parties to enter into and be bound by a formal contract
• The dates for possession and completion and whether there is any sectional completion envisaged or required within the contract
• Entitlements of both parties upon the revocation, frustration or repudiation of the contract
• Procedure for calculating interim payments if work proceeds
• Procedure for calculating and issuing final payment should the work not proceed or if a formal contract is not executed between the parties
• Insurances that are to be provided
• The maximum expenditure limit allowed under the letter of intent
• Termination procedure
• Confirmation that the contract created by the letter of intent will terminate upon execution of the principle contract(s)
• Dispute resolution procedure.

If time, quality and cost are unspecified

Time

If there is no time for completion specified within the letter of intent, then a reasonable time for completion will be implied. What is considered reasonable will be a question of fact to be determined in relation to the circumstances that existed at the time the contract was formed.

Quality

If the standard of workmanship and quality to be applied to the works is not stated within the letter of intent then, notwithstanding any statutory obligations, the requisite standard will be that the contractor must carry out the work with proper skill and care using materials that are reasonably fit for purpose and of merchantable quality.

Cost

If the letter of intent does not provide for a method of payment, the contractor will be entitled to payment of a reasonable sum that reflects the value of the work carried out or the advantage derived therefrom. This is known as payment on a quantum meruit basis and is a well-established legal principle that roughly translates as “as much as he has deserved”.

The starting point when calculating quantum meruit will usually be the actual cost reasonably incurred by the contractor in performing the work, in addition to which a reasonable percentage for profit will be allowed. In some cases this will amount to payment on a cost-plus basis and in other cases to payment of fair and reasonable commercial rates.

When valuing work on a quantum meruit basis, loss of profit will not generally be included, as this remedy arises from a breach of contract. In the majority of cases that involve a quantum meruit calculation, a contract will not be deemed to have been formed between the parties and therefore no breach can arise.

Summary

To conclude, although there is no substitute for actual experience when drafting a letter of intent, the facts outlined above should give candidates enough of an understanding on this topic to answer most questions to a level three standard.

The most important points for a candidate to be able to explain are:

• When and why letters of intent are used
• What should be included in a letter of intent
• The advantages and disadvantages of using letters of intent
• What happens if a letter of intent is silent on time, cost or quality.