Lawyers will generally recommend that you agree and sign a formal contract before starting work on site. That said, despite good intentions, commercial necessity often requires parties to start the works before finalising the contract terms. In this situation, a letter of intent is frequently used and essentially sets out key terms such as the scope of works covered, the price and an intention to enter into a contract at a future date if certain conditions are met. In order for a letter of intent to be binding, the criteria to be met are the same as that for a contract - that is, there must be: certainty as to the key terms; consideration; and both parties must have a mutual intention to enter into a binding legal contract.

A letter of intent should only be used where there are good reasons to start work in advance of the finalisation of all the contract documents (in cases of commercial urgency) to safeguard legal rights whilst the contract documents are being negotiated. Letters of intent should always be drafted carefully to take into account the parties' and the projects' needs and should not be regarded as a substitute for a building contract.

An example of what can go wrong

In the case of Spartafield Ltd v. Penten Group Ltd [2016] EWHC 2295, the court had to consider whether the works proceeded under the parties' letter of intent, or an unexecuted JCT Intermediate Building Contract with Contractor's Design, 2011 Edition (JCT ICD 2011); and, if the latter, when the JCT ICD 2011 took effect and superseded the letter of intent.

The developer (Spartafield) sought a declaration against the contractor (Penten) that it had entered into a contract on the terms of and subject to the JCT ICD 2011. Penten argued that it had carried out the works on the basis of the letter of intent.

The court found that the JCT ICD 2011 had replaced the letter of intent and governed the works, despite not having been formally executed.

The facts

The facts of Spartafield will be familiar to many – particularly the slow progress of the contract negotiations after the letter of intent was agreed.

On 8 February 2013, various contractors, including Penten, were invited to tender for a proposed development in east London. The nature of the works was briefly described as part demolition and part new build of a three-storey roof extension to an existing five-storey building so as to provide eight private residential units and other facilities. The form of contract was identified as the JCT ICD 2011 to be executed under hand between the employer and the contractor.

After Penten became the preferred tenderer in May 2013, negotiations began on the contract including the specification and the scope of works. Those negotiations continued through July 2013, at which point the parties agreed and signed a letter of intent authorising works up to £1,000,000 (the agreed sum). Penten took possession of the site in September 2013, work began and negotiations regarding the contract terms continued. It was intended that a formal contract would be agreed between the parties "in due course".

The parties had agreed the majority of the terms of the JCT ICD 2011 by April 2014. However, Penten did not sign the contract due to concerns it had about delays in the works and collateral warranties not being agreed. Nevertheless, the works continued but, by May 2014, there were substantial delays to the contract period. Penten warned that an extension of time "may be applicable". So far as the contract negotiations were concerned, only the collateral warranties were still to be agreed and a full set of contract documents was given to Penten for signing on 27 May 2014. Penten refused to sign.

In March 2015, Penten advised Spartafield that its works had exceeded the agreed sum. Financial problems were starting to surface; Penten began to wind down its work and sought to rely on the letter of intent (rather than the JCT ICD 2011) to recover its costs. Spartafield contended that the JCT ICD 2011 applied which bound Penten to complete the works for a fixed sum. Contractual default notices were served, the parties relationship broke down and two adjudications and two sets of enforcement proceedings followed.

Decision

Mr Alexander Nissen QC, sitting as a deputy judge of the High Court, had to decide whether the works proceeded under the letter of intent; whether the JCT ICD 2011 contract was agreed between the parties; and, if the JCT ICD 2011 contract was agreed, the date from which this took effect. Mr Nissen QC held that the parties had operated under the letter of intent from the commencement of the works for at least some of the time. He was in no doubt that the letter of intent: was written in contractual language; counter-signed by both parties; intended to have legal effect as a contract between the parties; contemplated the subsequent execution of a formal contract in due course; and incorporated the JCT ICD 2011 conditions (subject to the express terms of the letter of intent); but, did not require a later formal contract to be formally executed to be binding. In addition, Penten had accrued a right to be paid for its works under the letter of intent in accordance with the JCT ICD 2011 conditions.

The crucial question was whether, by May 2014, the parties had agreed to displace the letter of intent with the replacement JCT ICD 2011 even though that replacement contract had not yet been formally executed. In the judge's view they had. They had agreed all of the essential terms of the JCT ICD 2011 by either the end of May 2014 (when the contract was sent to Penten for signing) or, alternatively, by mid-September 2014 (when Penten had agreed it would sign the contract), such as price, commencement and completion dates, and scope of works. The court stated that a number of other terms, such as identifying a named quantity surveyor and named sub-contractors, and agreeing collateral warranties, were not, in this case, essential terms. The JCT ICD 2011 was effectively a replacement contract, which was agreed between the parties.

Mr Nissen QC stated that it was possible to contract on the basis of a JCT contract without it having been formally executed; the terms of the JCT ICD 2011 envisaged that a contract would be subject to execution in writing by the parties to it but there was nothing in the language of the form which indicated that this had to be done as a condition of a contract being concluded on those terms. There was no evidence that execution of a hard copy was a pre-condition to the replacement contract coming into being. The letter of intent clearly anticipated a formal contract being entered into in due course. Mr Nissen QC also rejected a number of alternative submissions by Penten, including that the facts were akin to a situation where the parties had agreed to proceed "subject to contract".

Deal with the contract at the outset

This case provides another example of the potential dangers that can arise from proceeding with works under a letter of intent. In this case, the letter of intent was a valid contract. While the parties clearly believed that the letter of intent could be used for a good while, its vague wording gave Penten the option of leaving site early and did not specifically deal with how payments would be made or what would happen if there was delay. These and other omissions left the parties exposed to uncertainty – and ultimately the time and money costs of adjudication and court proceedings.

Is your letter of intent a patchwork of provisions?

Many parties use and reuse their letter of intent template without considering adequately or at all whether it is suitable. This approach is a recipe for future disputes. This is what Mr Nissen QC said about Penten's and Spartafield's letter: "[It] is not well drafted. I agree with [Spartafield's counsel] that it is an odd document. It appears to be a patchwork of individually familiar provisions that, in combination, do not always sit easily with one another."

A patchwork approach is not a good contract strategy for significant projects. Get the contract agreed and in place as soon as you can.

Guidance and key points to remember

  • Every project is different. Aim to finalise the contract documents before work starts. If that is not possible, it is better to proceed on the basis of a well drafted letter of intent than to start the works on the basis of an oral contract. Carefully draft the letter of intent so that it is appropriate for both the project and the parties.
  • An unexecuted formal contract can still become legally binding and supersede the letter of intent if the parties have effectively agreed all the essential terms.
  • If you require formal execution of the contract to be a pre-condition to the formal contract coming into existence, say so specifically in the letter of intent.
  • If you do agree to work under a letter of intent which contemplates execution of a formal contract, stay vigilant:
    • get to know and understand the terms and scope of the letter of intent;
    • enter into the formal contract as soon as possible;
    • be clear in your communications with the other party on whether you are carrying out the works under the terms of the letter of intent or the formal contract to avoid any later uncertainty.

While working under a letter of intent, monitor the works to ensure they do not exceed the scope of works specified in the letter of intent. If the scope of works changes, renegotiate the terms of the letter of intent.