Parties who need to commence services or works before all the terms of the contract are agreed sometimes enter into Letters of Intent. But does this mean there is no binding contract?
Where a Letter of Intent is binding
A letter of intent may itself be a contract, albeit of a limited scope, if it is clear that the parties intended it to have contractual effect. It may create entitlement to interim payment by providing for works to be carried out on the terms of an existing draft contract, pending execution of the contract.
Effect of "Subject to Contract"
Where courts have held there to be a binding contract
- Draft contract sufficient to govern services performed
Some may argue that if a letter of intent is headed "subject to contract", the full terms of a proposed final contract are not binding unless the parties act as if the final contract had been concluded. This issue was addressed in Somerfield Stores Ltd v Skanska Rashleigh Weatherfoil Ltd  EWCA Civ 1732 22nd November 2006, where the Court of Appeal considered a letter of intent which included a temporary arrangement for the provision of facilities management services by Skanska to Somerfield Stores while the contract was negotiated and entered into.
The letter of intent included the following:
- It was expressed to be "subject to contract".
- Somerfield requested the provision of services "which are more particularly described on the draft contract enclosed with the Tender".
- The letter also stated "you will provide the services under the terms of the Contract from 28 August 2000 … until 27 October 2000 ("the Initial Period").
A final contract was never concluded, although two extensions to the letter of intent were given. A dispute arose and Skanska sought to enforce certain terms of the contract. During the dispute it was common ground between the parties that although the letter of intent was headed "subject to contract" it did include an agreement relating to the provision for an initial period of "services" as defined in it. The lower court accepted Skanska's argument that the letter of intent incorporated only the terms of the draft contract that were necessary to define the services Skanska was to provide. In summary, it interpreted the words in the letter of intent by giving consideration to the surrounding circumstances in which it was written. In particular, it referred to the likely short duration of services to be provided under the Letter of Intent.
The Court of Appeal disagreed with the lower court and held that it had erred in deciding that the letter of intent incorporated only the terms of the contract that were necessary to define the services Skanska was to provide. The natural and ordinary meaning of the words "under the terms of the contract" was that the terms of the draft contract would govern the services to be provided under the letter of intent (save to the extent they were inconsistent with the terms of the letter itself) without being limited to identifying the services by reference to the draft contract. It was likely that the parties were content with the terms of the draft contract.
- Waiver of "subject to contract" provision
If the parties agree by contract to waive a "subject to contract" provision in correspondence (including a letter of intent) as occurred in the case of RTS v Muller in the Supreme Court decided on 10 March 2012, a binding contract will exist. In this case, the parties' subsequent conduct in operating the provisions of the contract, including agreeing a variation, was conclusive.
Where courts have held there is no binding contract
In the recent case of Merit v Balfour Beatty  EWCA 1376 TCC 28 May 2012, the Claimant Sub-subcontractor began work under a letter of intent against the factual background that it was the Defendant's Subcontractor's intention to enter into a Contract (including an arbitration clause) with the Claimant. The letter of intent was again expressed to be "subject to contract" and did not include an arbitration clause. Discussions then proceeded between the parties as to the terms of the eventual Sub-subcontract but it was never entered into. The final exchange of letters indicated that the parties had not agreed the Contract price although the difference between them was only some £37,500 as against an overall contract sum of some £1.6 million.
The Defendant sought to rely on the arbitration clause in the Contract and applied to stay the Claimant's proceedings.
The Court concluded that no mechanism had been agreed by the parties to arrive at a "fair" price. The amount in dispute might not seem substantial but it was not de minimis or otherwise non-essential. It probably related to the Contractor's profit figure of some 2.5% but this was unclear. It was not permissible to use the parties' subsequent conduct to aid the construction of the contract (if any) which they had entered into. The Court therefore held that there was no final contract and, therefore, no arbitration clause, because the parties had not agreed on the price so that the work was still being carried out under the terms of the letter of intent. The application was therefore refused.