Exercise Caution in the Use and Drafting of Letters of Intent
In the Malaysian construction industry there is a growing tendency for works to be carried out on the basis of unsigned contracts and letters of intent. In many instances there are legitimate commercial reasons to begin the works before all the contractual terms have been agreed, but there are risks associate with this if the letters of intent and not right. Whether the letter of intent is issued for no more than a letter of comfort and is not intended to create a contractual relationship until such time as a further letter or contract is executed or as a preliminary contract or alternatively as a vehicle to direct the contractor to start the works whilst executing the contract documents such should be clearly stated.
In the case of Diamond Build Limited v Clapham Park Holmes Limited the parties proceeded on the basis of a letter of intent and never executed a formal contract. The letter of intent provided for a cap on the amount payable by the Employer to the Contractor and the Court held that the cap limited the amount payable to the Contract although the Contractor had executed works far in excess of the cap.
In the case of Turriff Construction Ltd. V Regalia Knitting Mills Ltd., the court held that the letter of Intent was merely an expression of an intention to enter into an acceptable contract and therefore, not a binding contract but the subsequent contract which Regalia agreed to undertake was a binding one.
In another case Haden Young Limited and Laing O’Rourke Midlands Limited failed to enter into a formal agreement and the court further held that the parties had failed to agree to the terms and conditions of the contract. This allowed Haden Young to successfully claim payment under the doctrine of Quantum Meruit.
The case of British Steel Corporation v Cleveland Bridge and Engineering Co. is the subject of many construction legal books and texts as it is often quoted in relation to the doctrine of quantum meruit. In the case The court found in favour of British Steel that there was no contract between parties since parties were still in negotiation and therefore, without a contract there could not be damages out of a breach of contract.
To avoid similar problems it is recommended that the scope of the letter of intent is clearly defined by reference to the works to be carried out, the validity period of the letter of intent and the amount which the parties are to expend under it. It is also prudent to include how and on what basis payment will be made in respect of works executed under the letter of intent show as to establish consideration. It is considered prudent to include a term providing that the formal contract once executed is to have retrospective effect and that any payments made under the letter of intent are deemed to have been made under the formal contract. Attention should also be paid to the content of the Contracts Act 1950 which clearly stipulate the requirements necessary to establish if a contract is indeed construed as an enforceable contract.
Contractors should not continue to work and incur costs above any financial limits stated in the letter of intent without ensuring their rights to payment for those costs by agreeing a further letter of intent or signing a formal construction contract.
Employers should not instruct work, or permit work to continue, under a letter of intent that has expired as they would run the risk that the contractor would be entitled to payment on a quantum meruit basis for the works and be afforded a reasonable time in which to complete the works opposed to what the Employer many have envisaged.
It is recommended that a clause should be included providing that any subcontract entered into by the contractor should be assignable to the Employer in the event that the parties fail to enter into a formal contract, by doing so this will help minimise disruption to the progress.
The wording of the letter of intent should make it clear the letter of intent is intended to create a contract if this is the intention of the parties. It should also make it clear which terms and conditions are agreed and which terms and conditions still remain to be resolved in the formal construction contract to be entered into. The letter of intent should state that it is contractually binding on the parties.
It is always prudent to include how disputes under the letter of intent will be resolved between the parties.
The parties should consider keeping in place their own internal risk management measures to prevent a project being continued or completed where the underlying contract documentation has not been agreed. This should involve diarising key dates and accurate and regular cost reporting and updates.
Finally the parties should not regard a letter of intent as a substitute for a construction contract as it is unlikely to contain terms that are adequate for either for either of the parties’ protection and may leave many important issues unresolved. It may also be found that may also find that the contractual remedies that they thought they had are not available if things go wrong.
Other relevant cases to consider in relation to letters of intent:
Kitson Ltd v Balfour Beatty (1991)
J Jarvis & Sons PLC v Galliard Homes Ltd (1999)
Monk Construction Ltd.v Norwich Union Life Insurance Society CA (1992)
ERDC Group Ltd v Brunel University (2006)
Allen Wilson Shopfitters v Anthony Buckingham (2005)
Mowlem PLC v Stena Line Ports Ltd (2004)
Khaw Kim Chua & Anor vs Dayani Sdn Bhd (2005)
Lam Hong Hardware Co. Sdn Bhd vs Incacon Sdn Bhd (2006)
Ayer Itam Tin Dredging Malaysia Berhad vs YC Chin Enterprise Sdn Bhd (1994)