Advantages and Disadvantages of Letters of Intent - Essay Example

?Letters of intent Introduction Letters of intent does not have a legal meaning, but are used by the employer to the contractor or contractor to a subcontractor as an indication of the intention to establish a written formal contract for the work that is outlined in the letter (Furmston, Norisada and Poole 1998). Letters of intent are mainly used by the construction industry parties who may be under pressure to commence the preparatory works before a formal contract is established. For instance, the letter of intent may instruct the subcontractors to initiate the design process while waiting the signing of the legal contract documents. Letters of intent basically are a non-binding statement of the future intention of the involved parties and serve as an interim contract that outlines the terms that will govern the relationship of the parties before execution of the legal contract. The legal effect of letters of intent in the construction industry is that the contractor can only be paid on ‘quantum meruit’ basis for the reasonable work done (Furmston, Norisada and Poole 1998). The contractor or the employer can stop the work at anytime without a legal notice thus no party will be able to claim any damages for delays or defective work since no legal contract has been established. Another risk of relying on the letters of intent in the construction industry is that parties may presume that a letter of intent has been replaced with a full contract after the expiry of the date of the letter thus leading to non-entitlement of payments (Furst, Ramsey, Williamson, & Uff 2012). Such documents may contain some binding provisions such as non-disclosure agreements and covenants that the parties involved should negotiate in good faith. A letter of intent can simply be referred as an expression by one party of an intention to form a legal and binding contract. In the case of Cleveland Bridge and Engineering Co v British Steel Corporation (1984), the court held that a letter of intent is not binding since important elements of contract such a price were lacking, but contractors have a right to be compensated on a reasonable basis for their work (Furmston, Norisada and Poole 1998). Advantages and disadvantages of letters of intent There are certain advantages for the use of letters of intent in UK construction industry. Though not legally binding, the letter may save the employer the costs associated with attorney fee or accounting fees in the formation of the contract (Ashworth 2012). The letter will signify an intention to enter in to a binding contract before any substantial expenses have been incurred by either party. The letter is usually straightforward and is useful in the contract negotiation process since it provides the opportunity to include contract clauses such as binding terms and non-disclosure provisions. The letter will increase the confidence of both parties to the deal through establishing the time frames, expenditure and payment terms for the work activities. The letter of intent will allow the contractor the opportunity to include ‘no shop’ clause that means that the employer will not allow other contractors to solicit or negotiate for the same construction work (Knowles 2012). The letter allows both parties to adhere to the future contract terms such as non-completion covenants, special agreements, warranties and price (Lewison 2011). However, letters of intent suffer several disadvantages since they cannot bind the parties. Such letters may lead to double negotiation of the work thus delaying the completion of the construction work. After signing the letter of intent, it might be difficult for the parties to renegotiate the substantive terms and conditions of the deal since such letters are non-binding. The employer is left at a disadvantaged position by the ‘no shop’ clause since he or she cannot negotiate or solicit competing offers from other potential contractors. The employer is also at risk since the contractor may dishonor his promise (Furmston, Norisada and Poole 1998). Risks associated with letters of intent in UK construction industry The letter of intent usually authorizes some activities to proceed before the entering of the formal contract. For instance, the letter of intent will pave a way for off-site construction activities, issuance of instruction to the subcontractors such as suppliers, and allow for on-site activities such as planning and design activities (Adriaanse 2010). In determining the risks associated with letters of intent, courts usually consider the facts surrounding each case and whether the letter has the intent of giving any legal liability. In the case of British steel v. Cleveland Bridge, the court held that suppliers are entitled to ‘reasonable sum’ or quasi contract. In order to determine the legality of letters of intent, the courts usually consider the scope and terms contained in the letter and whether the contract are agreeable, or whether there were good reasons for starting the actual construction before the establishment of the legally binding contract (Ramsey 2007). The letter of intent should outline the identity and intention of the parties to the construction work since the parties must be known to each other and reach a consensus as to the nature of the letter of intent. The letter should clearly identify the scope and duration of activities that have been authorized under the letter either through a schedule or incorporating the activities within the letter. For instance, the letter should provide a clear start date and expiry date of the activities since supplementary agreements may allow the letter to exist in indefinite terms (Ramsey 2007). The letters of intent carry the risk of terms being varied by the parties, thus employers will ensure that the letter is capable of termination at their discretion without incurring any profit or loss claims (Uff 2009). On the other hand, the contractors will strive to have terms permitting the cancellation of the letter but allowing for recovery of any associated cancellation costs. Another contentious issue that presents risks to this letters is the price and payment terms. It is hardly possible to estimate the contractual price in the letter of intent thus parties should avoid any risks by specifying appropriate rates for the activities contained in the letter of intent (Stone 2011). The contractors may also leave the rates undefined while the employer may intent the costs not to exceed a certain budget thus creating uncertainty on the price and payment terms for the activities. If the authorized activities under the letter of intent are for 45 days or more, parties to the agreement may elect to use a payment mechanism that is compliant to Housing grants, Construction and Regeneration Act of 1996 (Curtiss 1999). Some employers will usually cap their legal obligations under the letter to a certain amount, thus making the financial burden equivalent to the scope of activities contained in the letter. However, the scope of the activities may be uncertain thus parties will cap their financial burden on a general basis thus increasing the possibility of stifling of activities contained in the letter of intent (Curtiss 1999). All building contracts should be enforceable before work begins According to Alastair Innes, building contracts should be fully enforceable. For instance, the building contracts should spell out the complete performance. In case of part performance, injured parties cannot be discharged from their contract and obligation to pay for the works, but is entitled to a claim for any loss sustained due to incomplete performance. In addition, injured parties cannot repudiate the contract in case of breached condition, but will have a right to compensation for the breach of warranties. The building contracts must also specify the time of performance. Within this time, the parties are required to fully perform their contractual obligations. In the case of United Scientific Holdings Ltd v. Burnley BC (1977) All ER 62, the Lord held that time of performance is an essence of the contract is it is the genuine intention of both parties to execute their contractual obligations within a reasonable time frame. In the case of discharge by breach, the innocent party is entitled to sue for damages for the breach of condition or warranty. The innocent party can consider the contract as discharged if the defaulting party has breached an important term or the defaulting party repudiates before the contract performance. In the case of Bennett v. Inviron, Bennett sought an adjudication award but the adjudicator asserted that such award could not be issued since no binding contract had been formed between the two parties. In the case of Bryen & Langley Ltd v Boston (2004) EWHC 2450 (TCC), Bryen and Bangley were tenderers for a project in Boston. The contractors received a letter stating that the contract would be of JCT 98 form, but no such contract had been signed. The contractors later claimed payments under the interim certificate, but Boston failed to pay. The matter was referred to adjudication whereby the court held that the letter of intent had not incorporated the terms of JCT form thus the adjudicator has no jurisdiction since the provisions are non-binding (Upex, Bennett, Chuah & Davies 2008). For instance, in the case of Brunel v. ERDC, ERDC submitted a tender on a JCT Standard Form of contract, but the parties agreed that they would resort to a formal contract after the planning permission was obtained. In the case, several letters of intent were issued, but the formal contract remained unexecuted until the expiry of the last renewal letter. ERDC went ahead with the works after the expiry of the renewal letter until ERDC decided to refuse signing the formal contract unless quantum meruit valuation basis would apply to the prior work. In the case, Lloyd J held that a clear intention to create a legal relation lacked and that works carried out on the letter of intents was based on a contemplated contract and thus could not be valued on a quantum meruit basis. However, since there was a similarity between the work carried out under the last letter of intent and after the expiry of the letter of intent, ERDC deserved to be paid on contract rates, but no on a contract plus profit basis (Ramsey 2007). Another risk associated with letters of intent when a contract is nut fully negotiated and enforceable is the possibility of exceeding the monetary limits. The budget threshold may be exceeded in several ways. For instance, the expenditure may exceed when a limited letter of intent expires or an agreement to renew is not possible. In some cases, the employer’s aggregate financial liability cap may be waived if the employer continues to pay out sums of money after exceeding the cap without any renewal or authorization after the expiry of the letter of intent (Murdoch & Hughes 2008). The employer can insert expenditure caps on the letter in order to control the costs of work, but such caps have unintended consequences if the employer does not terminate after work at the cap limit (Furmston & Powell-Smith 2012). In the case of AC Controls v BBC (2002), the court held that caps did not necessary limit the financial burden of the employer, but act as a right to terminate the work after the cap has been exceed. In such cases, the contractor has the right to continue with the work and receive compensation on a reasonable basis for the work done over the cap. In addition, the terms of the letter of intent may be insufficient for the on-site work activities. A common danger in using the letter for the on-site activities is a deficit in a number of fundamental terms that should govern the UK construction industry such as insurance for third party properties or work insurance (Adams & Brownsword 2007). The letter of intent may also be silent on critical issues such as indemnities for personal injury, health and safety requirements and subcontracting agreements thus limiting its applicability of a legal document during court proceedings in case of personal injury to personnel or third parties (Ramsey 2007). Conclusion All building contracts should be properly negotiated and enforceable before the actual work begins. Reliance of letters of intent will present numerous risks to both parties. These letters are an expression of intention to enter in to a future binding contract thus there are potential risks of non-completion of the work or non-payment of actual work done. The letters may not outline the warranties, dispute resolution mechanisms, the expiry period or the actual price of the contract. The purpose of the letter is to expedite construction work especially the off-site activities. Courts have occasionally declined to imply that rights and obligations of parties to fulfill a contemplated contract can arise from the letter of intent, thus such rights are limited to those expressly stated in the letter of intent. To ensure that a letter of intent is sufficient in details, the parties should clearly describe the works to be carried and agree on the price including the maximum expenditure cap. The parties should also state the expiry date, the termination procedure, dispute handling mechanisms, methods of determining the interim payments and also the entitlements to each party after the termination of the letter due to frustration or revocation by either party. Reference list Adams, J., & Brownsword, R. (2007). Understanding contract law. (5th ed.). London: Sweet & Maxwell. Adriaanse, J. (2010). Construction contract law: the essentials. (3rd ed.). Basingstoke: Palgrave Macmillan. Ashworth, A. (2012). Contractual procedures in the construction industry. (6th ed.). Harlow: Prentice Hall. Curtiss, U. (1999). Letter of intent. New York: Chivers North America. Furmston, M., & Powell-Smith, V. (2012). Powell-Smith & Furmston's building contract casebook. (5th ed.). Oxford: Blackwell. Furmston, M., Norisada, T and Poole, J. (1998). Contract formation and letters of intent. London: John Wiley. Furst, S., Ramsey, V., Williamson, A., & Uff, J. (2012). Keating on construction contracts. (9th ed.). London: Sweet & Maxwell. Knowles, R. (2012). 200 contractual problems and their solutions. (3rd ed.). Chichester: Wiley- Blackwell. Lewison, K. (2011). The interpretation of contracts. (5th ed.). London: Sweet & Maxwell. Murdoch, J., & Hughes, W. (2008). Construction contracts: law and management. (4th ed.). London: Taylor & Francis. Ramsey, V. (2007). Construction law handbook. London: Thomas. Stone, R. M. (2011). The modern law of contract. (9th ed.). London: Routledge. Uff, J. (2009). Construction law: law and practice relating to the construction industry. (10th ed.). London: Sweet & Maxwell. Upex, R., Bennett, G., Chuah, J., & Davies, F. R. (2008). Davies on contract. (10th ed.). London: Sweet & Maxwell. Read More