Letters of Intent: Avoiding those Bear Traps*

The use of letters of intent can be fraught with difficulty. In this Insight we review the key case law on letters of intent of the past few years and seek to highlight some of the lessons that can be learned from them.

Introduction

Letters of intent are widely used in the construction industry as a way of letting procurement, site preparation or indeed construction works commence before the negotiations for the detailed construction contract have been completed. The exact form they take varies widely but, typically, they will provide for a contractor or subcontractor to start an aspect of their work associated with the project. They often expressly provide for a cap on value1 or a drop dead date after which the letter of intent will no longer be valid. It is not uncommon to see such limits repeatedly increased or revised letters of intent being issued, as the contract negotiations between the parties drag on. In one case Fenwick Elliott advised on, 27 separate letters of intent had been issued and the construction contract had still not been signed.

Many commentators (with good reason) advise against the use of letters of intent2 and they are frequently criticised for not being used with "adequate care and attention" by contractors and employers alike.3 Too often they are used because people are used to using them, and consider them to be part of the process, rather than because they actually need to use them. It is also not uncommon for the lawyers to be called in too late, i.e. to interpret what has already been written and agreed rather than to write the document itself.

However, the commercial reality is that sometimes, in order to keep a programme on track, letters of intent do need to be used. It is with this in mind, that we will look at some of the lessons emerging from recent cases and then suggest some practical tips for those considering or entering into a letter of intent.

Is there a contract?

Perhaps the most common argument running through the cases is whether any binding contract has been reached as a result of the letter of intent. Various tactics are sometimes used by parties to try and avoid a binding contract being reached. A classic tactic used by contractors and their non-legal advisors is marking the letter of intent "Subject to Contract".

RTS v Muller

The leading case on this remains the Supreme Court case of RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co. KG.4In the opening paragraph of his judgment Lord Clarke noted:

"The different decisions in the courts below and the arguments in this court demonstrate the perils of beginning work without agreeing the precise basis upon which it is to be done. The moral of the story is to agree first and to start work later." [Emphasis added]

The case involved a letter of intent marked expressly "Subject to Contract" which also had an expiry date, and the question of whether the contract did or did not incorporate the MF/1 conditions.

Lord Justice Clarke summarised the principles as to whether or not there was a binding contract, and, if so, what the terms might be as follows:

"45... It depends not upon their subjective state of mind, but upon a consideration of what was communicated between them by words or conduct, and whether that leads objectively to a conclusion that they intended to create legal relations and had agreed upon all the terms which they regarded or the law requires as essential for the formation of legally binding relations. Even if certain terms or economic or other significance to the parties have not been finalised, an objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a precondition to a concluded and legally binding agreement." [Emphasis added]

In the Muller case, the Supreme Court held that the contract included the MF/1 conditions (as amended). Whilst there were some terms still to be agreed, those terms were not essential and did not prevent a contract existing. By their conduct, the parties had affirmed the existence of the contract by carrying out the...