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WHAT IS THE EFFECT OF A LETTER OF INTENT?

Fast track construction methods often leave in their wake the procedure for drawing up the contract which in many instances lacks the necessary urgency it merits.

This has led to an increase in the use of letters of intent, the original purpose of which is little more than a method of informing the Contractor or Sub-Contractor that his tender is successful and that a contract is to be entered into at some stage in the future.

The original purpose of the letter of intent has changed in recent times. It is now common practice to include in a letter of intent an instruction to order materials, fabricate and even start construction on site in anticipation of a contract being entered into.

Arguments can arise as to whether the letter of intent itself constitutes a contract and if not, whether the negotiations which follow result in a concluded contract. If it is held that there was never a contract entered into, further disputes can arise as to the basis on which payment is due for the work carried out in accordance with the instruction contained in the letter of intent.

In British Steel Corporation -v- Cleveland Bridge Ltd [984] 1 ALL ER 504, the Court had to deal with the question as to whether a particular letter of intent created a contract. In the context of the case the judge, Robert Goff, said:

"Now the question is whether in a case as the present, any contract has come into existence must depend on a true construction of the relevant communications which have passed between the parties and the effect (if any) of their action pursuant to those communications. There can be no hard and fast answer to the question whether a letter of intent will give rise to a binding agreement; everything must depend on the circumstances of the particular case."

Robert Goff went on to say that if work is done pursuant to a request contained in a letter of intent, it will not matter whether a contract did or did not come into existence because, if the party who has acted on the request is simply claiming payment, his claim will usually be based on a quantum meruit. Unfortunately, it seems Robert Goff took a rather simplistic view as there is no hard and fast rule as to what constitutes a quantum meruit payment.

It is of little advantage to a Contractor or Sub-contractor to learn that he is entitled to payment if there is no agreement as to how much the payment will be.

In the case of Kitsons Insulation Contractors Ltd -v- Balfour Beatty Buildings Ltd (1989) the Court had to decide whether a letter of intent sent by the main Contractor to a Sub-Contractor created a contract.

Balfour Beatty was appointed main contractor for Phase 1 of the White City Development for the BBC. Kitsons submitted a tender to Balfour Beatty on the 28 October 1987 in the sum of £1,109,303.00 for the design, manufacture, supply and installation of modular toilet units and accessories. In the period which followed, a large number of variations were made by Balfour Beatty to the details of the work required by them and as a result Kitsons revised their tender to £1,179.379.00.

Balfour Beatty sent a letter of intent to Kitsons dated 23 March 1988. The general gist of the letter was that Balfour Beatty intended to enter into a Sub-Contract with Kitsons using a standard Sub-Contract form, amended to suit Balfour Beatty's particular requirements, which was to be forwarded in due course.

The approximate Sub-Contract amount was £1,162,451.00 less 2½% discount on a fixed price lump sub basis.

Finally a letter of intent requested Kitsons to accept the letter as authority to proceed with the Sub-Contract works.

Kitsons, as requested, signed and returned the letter as acknowledgement of receipt and then commenced work.

It was not until 22 August 1988 that Balfour Beatty drew up and submitted a formal Sub-Contract to Kitsons. Accompanying the Sub-Contract was a letter indicating an acceptance of Kitsons' offer. The letter went on to say that payment was not to be made until the Sub-Contract had been signed by Kitsons and returned.

Kitsons did not sign and return the Sub-Contract. Their stated reasons being twofold. Firstly, the amount in the Sub-Contract received for signing from Balfour Beatty included a number of variations not provided for in the price. Secondly, the main item of cost related to off site fabrication and to safeguard their cashflow, Kitsons had included with their tender an Activity Schedule for interim valuations and payments. No provision had been made for including this Schedule in the Sub-Contract.

Following commencement of the work by Kitsons payments totaling £992,767.00 were made to them by Balfour Beatty during the period October 1988 to January 1989. These payments were based upon the Sub-Contract conditions (with amendments) which Balfour Beatty considered applied. Kitsons claimed that no binding Sub-Contract had been concluded by the parties and claimed to be entitled to be paid on a quantum meruit basis. In other words, a reasonable sum for the work. It was Kitsons' opinion that the amount paid by Balfour Beatty fell £660,000.00 short of what constituted a reasonable amount.

Kitsons commenced an action against Balfour Beatty and the court had to decide a preliminary point as to whether Balfour Beatty in sending a letter of intent to Kitsons dated 23 March 1988 created a contract.

The court held that no contract had been concluded as the parties had not arrived at the stage where it could be said that full agreement had been reached between them. It was considered that the matters outstanding, in particular the method of payment, were too significant for a contract to come into place.

Whilst this decision settled the question of whether a contract had come into being, it left unanswered how much Kitsons were entitled to be paid.

In C J Sims Ltd -v- Shaftesbury Pic [1991] 25 Con LR 72, the plaintiff Contractors sought payment of more than £1m which they alleged was reasonable remuneration for undertaking work on the erection of an office building for the defendants or, alternatively, damages. They applied for summary judgement and an interim payment under rules of the Supreme Court. Shaftesbury maintained that Sims had failed to comply with a condition precedent to the contract. Whether such a condition precedent existed was tried as a preliminary issue. Sims had tendered for the work under a standard form of building contract and, in response to their tender, was sent a letter of intent. Although the standard contract was not signed, Sims was asked to commence work immediately. The letter of intent provided that Sims would be reimbursed for reasonable costs, including loss of profit and overheads, incurred in the event of the contract not proceeding, all of which was to be substantiated in full to the reasonable satisfaction of the Quantity Surveyor.]
Work commenced and whilst negotiations continued as to the precise terms of the contract, no agreement was ever reached. Sims claimed for what it considered to be "reasonable costs to 31 July" and its probable future costs, arguing that the statement in the letter of intent gave them an unqualified right to such payment. Shaftesbury disagreed with this interpretation of the phrase "all of which must be substantiated in full to the reasonable satisfaction of our quantity surveyor" in the letter of intent. They maintained that the last part of the statement obviously applied to everything that had preceded it, and created a condition precedent which had to be complied with before Sims could recover any costs. Further, it was only commonsense that any claim should be itemised. The Court considered that the wording had to be considered in its context and the circumstances of the contract and its object.

The circumstances here were that the plaintiff had been engaged to erect an office block, and it was common practice in the construction industry for Contractors to submit claims. It was expected that the letter of intent would be replaced by a form of contract which made provision for the submission of claims. The purpose of the last part of the statement in the letter of intent was to make sure that a detailed claim was submitted supported by documentation for consideration, and this last part applied to the whole of the statement. "All" meant "all of the plaintiff's claims" and "all of their reasonable costs". A condition precedent was created by this since the words used were mandatory and took account of construction industry standard practice.

The moral of both these cases is clear. Parties to a contract should make sure that all the terms are agreed before work commences. If this isn't possible, any letter of intent should be adequately worded as to the precise method of payment in respect of any work requested to be carried out.

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