Numerous contractual and commercial issues

Introduction

In construction there will be numerous contractual and commercial issues to be resolved between the parties intending to contract prior to signing of the contract coupled with pressure to commence the works as soon as possible due to tight time constraints. In such circumstances the employer may write a letter of intent, or a letter of comfort, to give some security to the party commencing the work and indicating a firm intention to enter into contract with them. Although always a matter of construction in all the circumstances of the particular case, a letter of intent will typically express A's intention to enter into contract with B in the future, together with a request from A to B that B commence with the works immediately. When used properly the letter of intent is a useful tool.

However, once the letter of intent is agreed and the works progressing the need for a full contract is often forgotten or put to one side. This is when letters of intent can have a number of unintended and unexpected consequences.

Traditional Position On Non-Binding Effect Of Letters Of Intent

Traditionally a letter of intent creates no binding effect as it shows only an intent to enter into a contract in the future. The leading construction case on the status of a letter of intent is British Steel Corporation v Cleveland Bridge and Engineering Company. Cleveland Bridge sent a letter of intent to British Steel, for the manufacture of steel nodes, requesting that they proceed immediately with the works pending the issuing of the official form of subcontract. British Steel did not agree to this form because of extra liability that it imposed on Cleveland nor did the parties agree on price and delivery dates, which are two fundamental matters. Nonetheless, the claimants manufactured and delivered all but one node. Cleveland did not pay British Steel for the nodes so they then sued for payment. Cleveland then counter-claimed for damages, for breach of contract, on the basis that the nodes had been delivered late and out of sequence. They argued that a contract had come into existence when the claimants started manufacture and that agreement was comprised in a letter concerning the delivery sequence and British Steel's conduct in proceeding with the manufacture of the nodes. Cleveland argued that there was no binding contract between the parties so they were entitled to payment on a quantum meruit and that there was no legal basis for British Steel's counter-claim.

It was held that, since price and delivery dates had not been agreed and that the parties were still in negotiations that by starting work British Steel had not bound themselves to complete the work. British Steel were entitled to be paid upon a quantum meruit.

In Courtney and Fairbairn Ltd v Tolaini Bros Hotels Ltd the defendant need financing for this development and approached the claimant. It was proposed that the claimants find financing and they themselves be employed to build the work. The claimant sent a letter to the defendants asking that if he found finance for the development would to the defendants instruct their quantity surveyor to negotiate fair and reasonable contract sums for each of the three projects. The defendants wrote back agreeing “to the terms specified”. Consequently no agreement was reach on the sums and the defendants employed another builder. The claimant contended that there was a contract by which his company was to be employed as builders for the work, and therefore Tolaini was in breach of contract by employing another builder. In the absence of agreement upon such a fundamental matter as price, it was impossible to say that a contract had been formed. The parties had only reached the stage of negotiation and that could not form the basis of a contract. Per Lord Denning MR:

“If the law does not recognise a contract to enter into a contract (when there is a fundamental term yet to be agreed) it seems to me it cannot recognise a contract to negotiate.  The reason is because it is too uncertain to have any binding force”. 

The Emergence Of Decisions Supporting Contractual Or Extra Contractual Obligations Under Letters Of Intent

However, case law has recognised a number of situations where a letter of intent has created binding obligations and rights. These cannot be reduced to a single legal proposition however.

A letter of intent may result in a binding contract. In Turriff Construction Ltd v Regalia Knitting Mills Ltd, Turriff had to carry out a substantial amount of work to meet programme requirements and as no formal contract could be entered into due to unresolved issues and terms, they wanted an “early letter of intent” to provide them with an indemnity for the urgent work they were about to undertake. The defendants sent the letter of intent which included the words “The whole subject to agreement on acceptable contract”. The project was cancelled. The defendants denied they were liable to the claimants. The judge found that on the facts that, although the letter of intent stated that the proposed contract was “subject to agreement on an acceptable contract”, those words referred only to the full contract and not the preliminary contract by which the claimants were to be indemnified for the cost of the work undertaken by them pending the conclusion of the full contract.

In Wilson Smithett v Bangladesh Sugar the defendant decided to place an order for sugar with the claimant in an effort to avoid an anticipated increase in price due to a shortfall in supply. The claimant made an offer which was to remain valid for confirmed and irrevocable acceptance by the defendants until 14:00 hours local Dacca time on June 12, 1981.The defendants then sent a letter of intent on 12 June 1981which stated inter alia:

“We are pleased to issue this letter of intent to you for supply of the following materials ... All other terms and conditions will be as per your ... offer dated 12.6.1981 ... You are advised to submit security deposit/performance bond . . . within seven days from the date of issue of this letter of intent . . .”

The claimants proffered the performance bond within the seven days. Consequently it was decided by the defendants that the sugar was no longer required and not to go ahead with the deal. The defendants contended that no concluded agreement had been reached between the parties. The plaintiffs applied for a declaration inter alia that a valid and binding contract had been concluded between the plaintiffs and the defendants on June 12, 1981 and that the terms of the contract were those set out in the plaintiffs' letter of June 12, 1981 as amended by the defendants' letter of intent. Judge Leggatt found that the letter of intent was acceptance of an offer leading to a binding contract and the reference to a performance bond could not be regarded as constituting a condition.

In Drake & Scull v Higgs and Hill a letter of intent was sent and the correspondence was held to have led to the agreement of an indemnity in respect of reasonable expenditure incurred.

In AC Controls Ltd v British Broadcasting Corporation the defendants were considering the installation of a software system to control and monitor access to 57 of its properties. Tenders were invited and the claimants submitted a tender. The defendants intended to have a formal contract in the near future; however they wanted the claimants to begin work but due to internal policy were not able to process payment without a contract in place. A document that was described as a letter of intent was signed by both parties and was capped to £250,000. The defendant then sent another letter confirming its intention to enter in formal agreement and increased the cap to £500,000. The defendant subsequently terminated the project but a substantial amount of work had been completed. The claimant contended that there was a contract and should be paid £930,000 for work done. The defendants reject this and counted-claimed £123,000 as sums that had been overpaid. The court found that the letter created a contract. This scope was limited to survey and other pre-installation works that would be needed prior to installation work starting and a formal contract being concluded. But the second letter's scope was for the entire works. It was also held that the cap was not a cap on payment but were entitle to stop work once it had reached £500,000. The claimant was entitled to a reasonable sum for the works.

It may exceptionally take effect as an executory ancillary contract entitling the recipient to interim costs if the intended future contract is not made, and perhaps, imposing liabilities, e.g. for the quality or carry out certain performance and promises that, if he does so, he will receive remuneration in return.

But an “if” contract must contain the necessary terms. It may result in no contract, but the law may nevertheless impose an obligation on the party who makes a request to pay a reasonable sum for such work as has been done pursuant to the request if the intended contract is not made.

Traditionally, a letter of intent was regarded as of no contractual effect in most situations (see dicta in Turriff Construction Ltd v Regalia Knitting Mills below).

However, case law has recognised a number of situations where the parties were to be treated as having respective rights and obligations following the issue of a letter of intent, although these cannot be reduced to a single legal proposition.

The Contentious Nature Of Letters Of Intent

If a formal contract is entered into by the parties then it is usual that the letter of intent will be superseded by the terms of the contract. In such situations, the courts will generally seek to give effect to the intentions of both parties by retrospectively applying the terms of the concluded contract to the works carried out as from the date the letter of intent was issued.4 However, a high percentage of projects that commence with a letter of intent will be completed without a contract been signed. In such circumstances, disputes frequently arise as to whether the letter of intent has created a legally binding contract to come in to existence and, if so, then what are the terms of that contract to which the parties are bound and may enforce against each other during the interim period.

The Legal Status Of Letters Of Intent

If a letter of intent is to have any chance of bringing a contract into existence, the recipient must either expressly or impliedly agree to the terms set out in the letter, usually by either countersigning the letter or commencing the works as requested by the letter, respectively. Upon agreement, a contract may come into existence depending on the wording and surrounding circumstances of the letter of intent. Letters of intent fall into a ‘‘grey area'' as far as formation of contractual status is concerned. On the one hand, they represent commercial agreements of a sort to which the courts have always done their best to presume an intention to create legal relations6 and, therefore, uphold a bargain. On the other hand, as most letters of intent are issued whilst negotiation of outstanding terms is being carried out, the agreement effected by the acceptance of a letter of intent is often on the basis of an incomplete set of contractual terms. In other words, letters of intent often form agreements to enter into contracts for future performance regarding which all matters have not been agreed at the time of agreement to enter into the contract; this brings into question the issue as to vagueness or ambiguity of terms upon which the agreement is predicated and, thus, whether the letter of intent evinces the necessary consent to be bound of the parties with sufficient certainty. Further to this is the fact that a large proportion of letters of intent are not drafted by a legal expert, but rather by a construction professional, which often leads to less than satisfactory draftsman ship from a legal point of view. In Atomic Power,7 Megaw J regarded the following four propositions as relevant to be considered when determining whether a letter of intent had concluded a contract on a particular date:

(1) there must have been an intention by both parties . . . to make a contract;

(2) at that date, the parties must have been ad idem on all the terms which they then regarded as being required in order that a contract should then come into existence;

(3) the terms on which the parties were ad idem must not omit any term which . . . was in fact essential to be agreed, as a term of the contract, if the contract was to be workable as a matter of

commercial common sense;

(4) there must be some manifestation by words, conduct or writing, which indicates with sufficient clarity the acceptance by the offeree of the offer as then made to him . . .

The Courts' Approach To Commercial Agreements

As Lord Tomlin explained in Hillas v. Arcos,8 the courts do not see their role as the ‘‘destroyers of bargains'': ‘‘On the one hand the conveyance of real estate presenting an artificial form grown up through the centuries and embodying the terms of art whose meanings and effect have

long since been determined by the courts, and, on the other hand, the formless document, the product of the minds of men seeking to record a complex trade bargain intended to be carried out, both fall to be construed by the same legal principles, and the problem for a court of construction must always be so to balance matters that, without violation of essential principle, the dealings of the men may as far as possible be treated as effective, and that the law may not incur the reproach of being the destroyer of bargains.'' Hence, whether an agreement is recorded in the most sophisticated of contractual documents drafted by a legal expert, or whether it be recorded by businessmen in ‘‘crude and summary fashion''9 the law should not be ‘‘too astute or subtle in finding defects''.10 Thus, where possible the courts will do their best to uphold the validity of a commercial agreement where they are satisfied that the parties entered into it with an intention to contract.

Lack Of Certainty

Despite the courts' desire to uphold commercial bargains where possible, it will be difficult to do so if the wording of the agreement, considered in the surrounding circumstances, is so vague and/or ambiguous so as to make the objective determination of the parties' consent within the agreement impossible. Lord Wright in Scammell v. Ouston11 phrased it as such: ‘‘ . . . the test of

intention is to be found in the words used. If these words, considered however broadly and untechnically and with due regard to all the just implications, fail to evince any definite meaning on which the Court can safely act, the Court has no choice but to say there is no contract.''

If key contractual matters vital to the workability of the contract in question are still to be resolved at the time at which the letter of intent is acted upon, it will not be possible to discern objectively certain fundamental terms of the contract. The question as to which terms are considered fundamental to the contract will be dictated by the commercial facts in each individual case; for example, such terms might include price, delivery times or damages for delay, particularly where the work involved is likely to be substantial and large sums of money are at stake. Further negotiation of these matters will inevitably be required as a prerequisite to the formation of a contract. As the law does not generally recognise a contract to negotiate (an agreement to agree), it is highly unlikely in such circumstances that a letter of intent can create an enforceable contract. Equally, if it discovered that the parties have not yet

put their minds to a salient term of a contract, then a contract may not arise as a result of a letter of intent. This concurs with Lake and Draetta's observation15 that ‘‘completion of agreement is very important in the common law countries, where the traditional concept of contract requires

that a document is either wholly contractual or wholly non-contractual''.

In British Steel Corporation v. Cleveland Bridge (‘‘Cleveland Bridge''), British Steel carried out the manufacture and delivery of steel nodes in response to a letter of intent issued by Cleveland which proposed that Cleveland's own standard form of subcontract should be used. British Steel did not agree to this form and, in addition, it was evident that the parties were in disagreement about price and delivery dates, two crucial contractual matters. Cleveland argued that a contract had been formed by the letter of intent, and counterclaimed for unlimited damages for late and out of sequence delivery of the nodes. In this respect, the court found it was apparent from other correspondence between the parties that British Steel was not prepared to accept unlimited liability for damages for delay. This was inconsistent with the terms of the contract which Cleveland asserted was in existence; this pointed to a lack of consensus between the parties on the matter of damages for delay, which was clearly an important term in the circumstances. The court held that, even though Cleveland's request in the letter of intent to carry out the works had been acted upon by British Steel, it was impossible to say that this conduct had formed a contract as crucial terms (including price, delivery dates and damages for delay) of the contract remained unresolved.

Does A Letter Of Intent Form A Contract?

The traditional position of the English courts towards letters of intent was summed up by Judge Fay in the leading case of Turriff Construction Ltd v. Regalia Knitting Mills Ltd (‘‘Turriff'') when he described a letter of intent as follows: ‘‘ . . . a letter is no more than the expression in writing of a party's present intention to enter into a contract at a future date. Save in

exceptional circumstances it can have no binding effect . . . '' The implication of Judge Fay's words is that in most cases letters of intent do not evince an intention of the parties to enter an immediate binding contract; nevertheless there may be certain circumstances, surrounding the issuance of a letter of intent, in which such intention can be derived with certainty by the court. In Cleveland Bridge18 Goff J further alluded to the possibility of a letter of intent being able to create a contract when he stated that: ‘‘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.'' Goff J continued to consider the circumstances under which a letter of intent could give rise to a binding agreement, as follows:

‘‘ . . . there may be an ordinary executory contract, under which each party assumes reciprocal obligations to the other; or there may be what is sometimes called an ‘If' contract, i.e. a contract under which A requests B to carry out a certain performance and promises B that if he does so, he will receive a certain performance in return, usually remuneration for his performance. The latter transaction is really no more than a standing offer which, if acted upon before it lapses, or is lawfully withdrawn, will result in a binding contract.'' It may be the case that, whilst the parties have not reached agreement on all the terms of the intended formal contract, the letter of intent nevertheless contains sufficient salient terms by itself to form an ancillary contract which binds the parties during the interim period. In Turriff,20 for example, the court considered the letter of intent, when taken in the context of other negotiations between the parties, constituted an ancillary contract to cover the question of interim costs for design work carried out by Turriff prior to the eventual abandonment of the project. The ancillary contract in Turriff was cited as an example of an ordinary executor contract by Goff J in his judgment in Cleveland Bridge.

Subject To Contract

Letters of intent usually contain wording to the effect that the parties are required to enter into a formal contract document at some future time. Thus, such letters are akin to agreements ‘‘subject to contract''. In Australia, the leading case in this regard is the High Court's judgment in Masters v. Cameron in which Dixon CJ, McTiernan and Kitto JJ identified three possible classes into which such agreements may fall:

In addition, a fourth possible class was described in Sinclair Scott & Co v. Naughton as: ‘‘ . . . one in which the parties were content to be bound immediately and exclusively by the terms which they had agreed upon whilst expecting to make a further contract in substitution for the first contract, containing, by consent, additional terms.'' This has been referred to as a ‘‘fourth class'' contract in Baulkham Hills Private Hospital Pty Ltd v. GR Securities Pty Ltd (‘‘Baulkham Hills'') and many subsequent cases. Of the four classes noted above, the first, second and fourth form a binding contract. The third class, however, does not. The implication of Masters v. Cameron is that no contract is presumed by the courts to exist in agreements of a ‘‘subject to contract'' nature; however, this presumption may be rebutted if it can be shown that the parties have agreed on all matters, and they intend the signing of a written contract to be a formality. Thus, as long as there is one term still under negotiation at the time a letter of intent is acted upon and yet to be agreed by the parties, and this term is not one which can be implied by the court,28 it seems the court will find that no contract has been formed by a letter of intent.

However, where terms of the formal contract are still the subject of negotiation, it may still be possible for a binding agreement to exist if one party can demonstrate to the court that the common intention was for a fourth class contract to be formed, i.e., that the terms agreed to in the letter of intent would subsequently be supplemented and substituted by the terms in the formal contract. When considering the contractual status of works under a letter of intent,

therefore, it is highly relevant to consider which of the above four classes the wording of letter of the intent, considered in its surrounding circumstances, falls into.

Determination Of Intention

Although the wording used in a letter of intent may be critical, it will by no means be the sole consideration of the courts in determining the legal status of a letter of intent. Regard must be given to the surrounding circumstances in which the letter of intent was issued and accepted. In Damon Compagnia Naviera SA v. Hapag-Lloyd International SA, Fox LJ agreed with counsel for the plaintiff who stated: ‘‘In each case the court has got to make up its mind on the construction of the documents and on the general surrounding circumstances whether the negotiations were not to have contractual force until a formal document was signed.''

This means that the courts will consider any ‘‘relevant communications which have passed between the parties and the effect (if any) of their actions pursuant to those communications''.

The Significance Of Contract Formation

Where a contract does not eventuate from a letter of intent, the contractor will be unable to claim payment for the work done and/or goods supplied, in accordance with the valuation methods and procedures which would have been in place if the formal contract had been agreed. However, the contractor can be awarded a quantum meruit for work done or goods supplied under, what the law terms, a quasi-contract. As long as the work was done and/or the goods were supplied at the employer's request and the circumstances were such that the contractor reasonably believed it would be paid for such, then the employer will be liable to pay a reasonable remuneration by way of restitution for unjust enrichment at the expense of the contractor.

The courts will generally assess quantum meruit on the basis of a fair commercial rate for the services. This basis of assessment would be particularly advantageous to a contractor who had submitted an extraordinarily competitive tender. In both the Cleveland Bridge and Abigroup cases, discussed in detail above, the respective courts held that there was no contract brought into existence by the letters of intent and the contractors were entitled to be paid on a quantum meruit.

A contractor, however, will not be entitled to a quantum meruit if the court finds an ancillary, or ‘‘fourth class'', contract to be in existence as was the case in Turriff.44 Instead the court will award payment in line with the terms stipulated in the letter of intent. In C J Sims v. Shaftesbury plc,45 the court found that when the parties failed to agree a formal contract as intended, the letter of intent created a contract and the works carried out were to be valued in accordance with a term in the letter which stated that, in the unlikely event of the contract not proceeding, costs were to be ‘‘substantiated in full to the reasonable satisfaction of [the defendant's] quantity surveyor''. Whilst restitution provides a safeguard to the contractor who has carried out works under a letter of intent, the position of the employer is not so strong in the event of no contract eventuating due to the following disadvantages:

(1) The contractor will be under no entire obligation to complete a defined scope of works and can, therefore, stop work at any time. This state of affairs will erode the strength of the employer's negotiating position as the employer will want to avoid the disruption, in terms of cost and time, associated with hiring another contractor to complete the works.

(2) The employer would lose the benefits of any warranties as to fitness for purpose and quality of the works which may either be expressly conferred by a contract, or implied by statute.

(3) The employer would not be able to counterclaim against the contractor's claim for payment of a quantum meruit as there would be no contract in existence upon which to mount such a counterclaim. For example, the employer's argument in Cleveland Bridge 47 for unlimited damages for late delivery failed due to the absence of a contract. As Goff J stated in that case48: ‘‘ . . .where . . . one party is seeking to claim damages for breach of contract, the question whether any contract came into existence is of crucial importance.''

(4) The employer would lose the normal contractual provisions associated with standard building contracts, such as the recognition of the role of a contract administrator, entitlement to make variations, a stated completion date, liquidated and ascertained damages, an arbitration clause, etc.

Letters Of Intent For A Limited Scope Of Works

Sometimes an employer may seek to limit the authority of terms contained in a letter of intent by stating a spending cap or stating that the letter of intent only applies to a defined scope of preparatory works, e.g. design work. In such situations, the question arises as to whether the terms contained in the letter of intent will bind the contractor for any portion of works which exceed the spending cap or the defined scope of preparatory works. In Monk Construction Ltd v. Norwich Union Life Assurance Society,49 a letter of intent was issued to Monk (the contractor) authorising mobilisation and ordering of materials up to a maximum expenditure of £100,000. The letter also stated that if no contract materialised, Monk would only be entitled to their ‘‘proven costs''. In the event, Monk completed the whole of the project works with no formal contract ever being agreed. Monk claimed a quantum meruit for the works carried out in excess of the stated spending cap. The employer, Norwich Union, argued that the terms of the letter of intent should cover all the works carried out in the event that no contract materialised, and that Monk was only entitled to their proven costs for the whole of the project works—which would have amounted to a lesser sum than valuation on a quantum meruit basis. The court held that the words contained in the letter of intent were only intended to apply to the preliminary works referred to in the letter in the event that no formal contract was agreed and no further works in addition to the preliminary works were carried out by Monk. Monk was, therefore, successful in their claim for a quantum meruit.

Conclusion

It is a common situation in the construction industry for a contractor to commence works in response to a letter of intent which expresses the employer's intention to subsequently enter into a formal contract with the contractor. Experience has shown that in such situations the intended formal contracts frequently do not eventuate, and the parties are left in dispute with regard to whether a contract has come into existence and how payment for the works done should be evaluated. The traditional position of the English courts has been that a letter of intent does not generally form a binding contract, unless under special circumstances. This position has been clarified somewhat by subsequent case law in both England and Australia; nevertheless, the question as to whether a contract has been formed by a letter of intent still remains a complex issue and must be determined objectively by considering, not just the letter of intent itself, but also all the surrounding relevant documents and communications between the parties.

In Australia, it is possible for a letter of intent to form a contract under the following circumstances:

(1) where the parties have agreed on all the terms of the formal contract, but have issued a letter of intent in the interim until the terms can be drafted in a fuller form and/or the formal document is drawn up and executed; and

(2) the parties have not agreed on all the terms of the formal contract, but the letter of intent issued in the interim contains all salient terms necessary for the formation of an ancillary, or ‘‘fourth class'' contract, which will bind the parties until the formal contract is agreed.

However, a letter of intent will not form a contract where:

(3) the parties clearly did not intend, either expressly or impliedly, for the letter of intent to be binding; and

(4) the parties may have intended for the letter of intent to form a binding contract, but the parties have not agreed on all the terms of the formal contract. In addition, the letter of intent does not contain all salient contractual matters necessary to form an ancillary, or ‘‘fourth class'' contract, in the interim. Where all the terms of the formal contract have been agreed, as in (1) above, payment will be made to the contractor in accordance with the payment provisions contained in the formal contract. Where an ancillary, or ‘‘fourth class'' contract has come into existence, as in (2), above, payment for works done will be in accordance with the terms contained in the letter of intent. If, and when, a formal contract is concluded, the payment provisions of the formal contract will usually have retrospective effect and supersede those contained in the letter of intent. Where the letter of intent does not result in a contract being formed, then the contractor will be entitled to be paid a quantum meruit for works carried out if a formal contract does not eventuate. The contractor who has carried out works under a letter of intent is, generally, in a stronger position than that of the employer. If a formal contract does not eventuate, the contractor will be able to successfully claim payment of a quantum meruit. In addition, the contractor may decide to stop works at any time without fear of recrimination. The contractor, however, should be careful not to inadvertently become bound to an ancillary, or 50 As per the first and second classes defined by the court in Masters v. Cameron (1954) 91 CLR 353.

‘‘fourth class'', contract wherein the payment terms are less favourable than those contained in the contractor's tender or on a quantum meruit basis.

Whilst a letter of intent enables an employer to achieve expeditious commencement of the works, the employer may be disadvantaged in several aspects if the letter of intent fails to have contractual effect including an erosion of the employer's negotiating position for the formal contract and the absence of any right to launch a counterclaim against the contractor.

The employer, therefore, should seek to ensure that, if all the terms of the formal contract have not yet been agreed, the letter of intent includes all the salient terms in respect of the works requested. These salient terms should at least include provisions with respect to price, payment, programme, scope and specification.52 Furthermore, the employer should be aware that these salient terms should be consistent with communications between the parties surrounding the letter of intent, and that subsequent conduct of the parties should be consistent with such a contract having been formed. Additionally, the employer should be aware that if the letter of intent attempts to limit the scope of works under its authority in any way and the contractor progresses with the works beyond this limited scope, it is unlikely that the terms of the letter will apply to the works completed.