Letters of intent: Start as you mean to go on

It happens all the time. In the rush to get started with work as soon as possible, parties will often not bother to finalise the paperwork, and won’t execute a formal written contract. But that’s OK because everyone knows what they’ve got to do and everyone’s going to make money, right?

Doubtless many great projects have been completed without formal written contracts in place, and many businesses have thrived without paying attention to the paperwork. But when things start to go wrong, the lack of a written contract can turn even a minor disagreement into a very expensive and complicated dispute, as Volkerfitzpatrick (VFL) and its subcontractor Keller are currently finding out.

In 2007, VFL invited Keller to tender for a piling subcontract. Keller duly won the work. However, VFL hadn’t itself been formally appointed, so couldn’t finalise subcontracts. So VFL issued a letter of intent, with the express intention that a formal subcontract would eventually be finalised that would supersede the letter of intent. There was some later discussion about the terms of the subcontract, but in the end no formal subcontract was ever executed.

VFL is now claiming damages from Keller associated with allegations of defective work. VFL contends that the terms of the subcontract were agreed by conduct by the parties proceeding to carry out and complete the works. Keller in turn argues that no subcontract was ever agreed - there was no agreement of terms and VFL never informed Keller that it was ready to agree a formal subcontract.

Letters of intent are often limited in scope or price, and can create all sorts of complications when those caps are exceeded

The point is central to the dispute between the parties, as VFL relies on terms in the subcontract as the basis for its claim - and if the dispute ever goes to trial, no doubt much court time will be spent attempting to determine exactly what was agreed.

The agreement between the parties is the cornerstone of any contract. Ideally that agreement is written down in a single document, but it might have been reached through an exchange of emails or even over the phone. Often the agreement will be detailed and complex, but it doesn’t always need to be; the court will look for agreement of the terms essential to form the contract, and provided these have been agreed it is likely there will be a contract even if some minor points remain outstanding.

For construction contracts the essential terms that must be agreed are usually: the identity of the parties; the price; the time for the work to be carried out; and the description of the works. However, certain contracts may have other terms that are essential and must be agreed.

If works proceed without a written contract, the subsequent conduct of the parties can be crucial in establishing what was and was not agreed. Where, for example, a contractor pays his subcontractor 15% overheads and profit throughout the course of the works, he is likely to face difficulties after the event if he wishes to argue that the parties agreed on 10%. But if there is a dispute on the point from the outset, it may be that no agreement was reached in the first place.

Letters of intent in turn often create more problems than they solve. VFL’s letter was for the full amount of the works, but letters of intent are often limited in scope or price, and can create all sorts of complications when those caps are exceeded and no formal contract is executed.

Equally, because letters of intent themselves often form a (limited) contract, parties will often trust that they are sufficient and get on with the works, neglecting to finalise the actual contract. In both respects letters of intent can be more trouble than they are worth.

The TCC judges are a practical and pragmatic bunch, and where (as is commonly the case) the works have already been carried out, they will seek to conclude that an agreement was reached and a contract formed. It seems very likely that there was a contract for the whole of the works in place between VFL and Keller. However, the precise terms of that contract will depend upon various findings of fact by the court, and that will not be a simple matter.

With a little care and attention at the outset, these problems can usually be avoided - and although having a formal contract does not prevent disputes, it does usually make resolving them quicker and cheaper. As they pay their legal bills for this litigation, no doubt VFL and Keller would agree.

Steve Nichol is a partner in the construction disputes team at Trowers & Hamlins