Letters of intent often form the foundation for construction works, but they also often form the basis for disputes. Most commonly, the dispute concerns whether or not the letter of intent in question constituted a binding contract between the parties. In this month's newsletter we look at two recent cases on this point: the first relating to the enforceability of a term sheet, and the second concerning a situation where the parties had allowed a letter of intent to lapse and work continue without executing a formal contract.
Maple Leaf v Rouvroy (2009)1
Term sheets are usually regarded as non-binding documents recording intention rather than agreement, and can therefore be considered as similar to non-binding letters of intent.
In this case, somewhat unusually, Maple Leaf and Rouvroy executed a term sheet that expressly stated that it was to be a binding contract. However, the term sheet also envisaged that it would be executed by a third lender, who never signed.
Maple Leaf argued that a binding agreement had been concluded not withstanding the fact that the third lender never signed the term sheet. Rouvroy, however, argued that the fact that the term sheet envisaged the participation of the third lender meant that such participation, evidenced by signature, was a condition precedent to the term sheet becoming binding.
The Court of Appeal decided in favour of Maple Leaf and found that the term sheet was binding on the parties. It held that the emails sent back and forth between the parties supported the position that a binding contract had been executed. Importantly, the judge confirmed that while signatures evidence agreement, they are not a precondition to agreement. Rouvroy could only successfully claim that it did not intend to create a binding contract if Maple realised, or should have realised, this fact.
RTS v Müller (2010)2
In this case the parties had initially intended to enter into a detailed written contract for the supply of equipment which would set out all the complex terms on which the work would be carried out and the equipment supplied. However, as often happens, the terms were not finalised before it was agreed that the work should begin.
The parties entered into an initial contract formed by a letter of intent dated 21 February 2005 and a letter from RTS dated 1 March 2005 (the "LOI Contract"), pending the negotiation and execution of the final contract. The LOI Contract set out the agreed contract price for the whole of the works, authorised RTS to commence all work in accordance with an agreed programme and deadlines, and stated that the full contract terms would be based on Müller's amended form of MF/1 contract and was to be finalised and executed within 4 weeks.
It was agreed that the LOI Contract would expire in May 2005. After this time, the parties continued to negotiate the final contract and the detailed schedules to be appended to the contract. By July 2005, with work still progressing, the parties had drawn up a draft contract which covered almost all of the main points but ultimately it was never executed. The draft contract was expressed to be "subject to contract" and not binding until executed by the parties in counterparts.
RTS ran into difficulties when it delivered the project to Müller without carrying out site acceptance testing provided for in the draft contract. Müller alleged that the work contained defects and refused to pay any further sums until RTS completed substantial performance. RTS sued for the outstanding balance of the sum specified in the LOI Contract; primarily on the basis that the LOI Contract was a continuing contract, but with two alternative arguments, first that there was no contract and therefore it was entitled to be paid on a quantum meruit basis (payment of a reasonable sum for the services performed), and secondly that if there was a contract it was on MF/1 terms. Müller contended that the MF/1 terms never became part of a binding agreement. The importance of the MF/1 terms was that they contain detailed provisions as to many matters, including liquidated damages.
At first instance, the judge held that after the lapse of the LOI Contract the parties reached full agreement on the work that was to be done for the price they had already agreed in the LOI Contract. The natural inference from the LOI Contract was that RTS would execute the works for the agreed price, however it was not essential for the parties to have agreed the terms and conditions for executing the works, and they did not do so. However, the judge declined to hold that the parties' contract included the final draft version of the MF/1 terms as it had not been executed as contemplated.
The Court of Appeal allowed RTS's appeal and declared that the parties did not enter into any contract after the LOI Contract came to an end.
The Supreme Court disagreed. It found on the facts that all of terms of the contract had been agreed by the parties by 5 July, except for provisions relating to a parent company guarantee and matters which were either not necessary to be completed or which were to be completed during the course of the project. Further, the Court held that the parties had, by their conduct, clearly waived the "subject to contract" provision. The Supreme Court concluded that it would be "almost inconceivable" that the parties would enter into an agreement for the performance of the whole project that was not based on detailed terms.
These cases are particularly relevant in the current adverse economic climate in which a party may be considering options for extricating itself from what may have become a bad bargain.
Letters of intent in particular should be used with caution. As the Supreme Court in RTS v Müller warned, parties should be careful of 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 start work later."
If it is necessary for work to commence prior to entering into a formal contract, great care should be taken when drafting the letter of intent. Parties should avoid uncertainty by agreeing in detail the basis upon which that performance will take place3.