How to manage the risks of using a letter of intent

The use of letters of intent is often criticised. Only a few weeks ago Ann Minogue called for the construction industry to learn its lesson from the recent case of Ampleforth Abbey Trust vs Turner & Townsend Project Management Ltd and stop using letters of intent “however close to agreement the parties are and however desperate the employer is to proceed” (31 August, p44).

I entirely agree with Ann’s sentiments. However, I fear the reality is that in some cases, letters of intent are unavoidable. This is particularly so for developments driven by an immovable completion date which, if it is to be achieved, require the procuring of materials, preparation of the site and even the building works themselves to commence before the formal contracts are agreed. Student accommodation schemes are a classic example, where the need to complete works for the start of an academic year often leads to a letter of intent at the outset. This was the position in the Ampleforth case, a decision which we will all now be familiar with.

Don’t call it a letter of intent. The term is misleading. The one paragraph most of these letters can do without is the opening one referring to what is intended in the future

It is worth noting that in this case, the advice of Turner & Townsend to commence works under a letter of intent was not actually criticised. Indeed, the judge acknowledged that it was “at best a necessary evil”. Turner & Townsend’s mistake was in not understanding the effect of the letter of intent, and not properly project managing the closing out of the pre-contract issues.

The reality is that letters of intent are here to stay. Once the decision is taken to use a letter of intent, it becomes a matter of risk management. These are the rules that I would always advise the parties to stick to in managing those risks:

• Don’t call it a letter of intent. The term is misleading. The one paragraph most of these letters can do without is the opening one referring to what is intended in the future. In my experience, this can lead to the parties overlooking the fact that the letter itself is a contract and so should be given the requisite attention. Maybe if it were known as an “early engagement letter” instead, the parties would be more inclined to focus their attention on the key issues.
• Following on from the first point, consider the nature and value of the works being procured by the letter and draft in clauses to suit. There is a significant difference between authorising £20,000 of pre-contract design and doing the same for £300,000 of site-based work. For instance, while the Construction Act will apply to both, the latter should always include an express mechanism for valuing the works and making interim payments, as well as an obligation to maintain public liability insurance.
• The fundamental provisions that all clients should include in their early engagement letters are:

a. An agreed scope of the works to be carried out under the letter
b. the maximum amount to be paid for those works
c. the right to terminate the letter on notice without liability for loss of profit.

• If there is time to do so, then the parties should consider creating a formal early works contract. For instance, any demolition works could be procured under a separate shorter form contract without affecting any funding or warranty issues for the subsequent development. Further, such a contract can be subsumed into the full contract when it is entered into.
• Record those key provisions of the future contract that are agreed at that stage. This could include matters such as the contract sum, liquidated damages, completion dates and amendments to a standard form contract.
• Avoid stating that the letter will apply for a specific period (for example: “This letter shall cover the period from today’s date until 25 December 2012”). To do so risks quantum meruit claims where works knowingly continue beyond the specified period, and also puts pressure on the parties to extend the letter. Provided the scope and value are agreed, there is no need for an expiry date.
• Agree all issues that remain to be resolved and set realistic timescales and actions to close these out.

As soon as a letter of intent is issued, both parties are at risk. The key is to understand and manage those risks, ideally to ensure that a building contract is entered into as soon as possible.

Tom Peel is a partner in the construction and engineering team at law firm Walker Morris