Now is the letter of our intent

In this short article we provide an overview of Letters of Intent (LOI) in construction and identify some of the characteristics and risks involved.

Background

In the idealistic construction lawyer’s mind, employers, contractors and subcontractors would agree all aspects of their project and record it in a clear, well drafted, written and properly executed contract before any work was performed or money spent.  This however, is far from the reality and indeed if it was reality, it would deprive other lawyers of the opportunity to argue over what was and was not agreed.

Time and commercial pressures dictate that works or preparatory works must commence as soon as possible and they turn to a LOI as a means to get the project moving, whilst they continue to negotiate the formal contract.  In some cases, no formal contract will ever be agreed or executed.  Commencing under a LOI can allow progress in a number of ways; allowing them to engage subcontractors, get the supply chain moving or begin the design process. However, they give rise to risks on both sides.

What is a letter of intent?

A LOI is typically a letter from an employer to a contractor (or from a main contractor to a subcontractor) indicating the employer’s intention to enter into a formal written contract for works described in the letter, and asking the contractor to begin those works before the formal contract is finalised and executed.  It is essentially a communique expressing an intention to enter into a contract in the future.  Whether or not the LOI is a binding contract may ultimately be determined by the courts and the courts will utilise the key elements that must be in place in order for a legally binding contract to be created (offer, acceptance, consideration and an intention to be legally bound).  There are three main types or categories of LOI:-

1. An interim contract: A standalone contract which will govern the relationship between the parties unless and until a formal written contract is executed;
2. A Comfort letter: A non-binding statement which sets out the future intention of both parties;
3. A final contract: Despite no formal execution, it is deemed to have incorporated the terms and conditions of the formal written contract that the parties intended.

Guidelines on drafting letters of intent

Do not:

• go beyond the terms of the LOI;
• substitute the LOI for a formal contract;
• forget to have the LOI fully signed & exchanged; and
• neglect to formalise the contractual relationship before the expiration of the LOI.

Do:

• identify the exact scope of the works to be completed under the LOI;
• identify the matters to be resolved before the main contract is entered into;
• clarify jurisdiction;
• make provision for a simple dispute resolution mechanism;
• quantify in monetary terms the works to be conducted under the LOI and account for Vat;
• confirm whether the LOI is an interim contract and whether it is non-binding or not;
• confirm once the main contract is concluded it will apply retrospectively;
• make sure the LOI executed by those with the appropriate authority to do so; and
• set out what will happen if the main contract is never formalised.

Conclusion

A well drafted LOI is a useful tool in getting a project up and running quickly, but it will always be inferior to a negotiated and well drafted formal contract.  Operating under a LOI requires vigilance in terms of observing deadlines, monetary limits and liability.  If you are using a LOI, be sure to replace it with a formal, comprehensive written contract as soon as possible, preferably with the advice and input of the Reddy Charlton LLP’s construction law team.

If you have any queries or seek further information on Construction Law or any related area of law, please contact Elaine McGrath at emcgrath@reddycharlton.ie or your usual Reddy Charlton contact.