Letters of Intent (LOI’s) are widely used in the construction industry, but the legal status of a LOI is not always clear and often misunderstood. This article seeks to identify and briefly explain what the 3 types of LOI’s are, the risk and issues that can occur and how to address them. If you are intending to issue a LOI or might be asked to sign one, this is a good starting point to enhance your understanding and reduce the risks.
What is a Letters of Intent?
There is no absolute definition of a LOI, as it is a term used when a letter is issued indicating an “intention” to enter into a formal written contract for the works described in the letter. It typically asks a party to begin the works before the formal contract is executed, which is often as a result of commercial pressures to get a project started.
In simple terms it is a way of communicating the intention to enter into a contract in the future.
Types of Letters of Intent
- Non-binding statement of the future intention of both parties, sometimes called a ‘comfort letter’;
- Interim/temporary contract on its own terms, which will govern the relationship between the parties unless and until a formal written contract is executed;
- Complete contract and even without formal execution, is deemed to have incorporated the terms and conditions of the formal written contract that the parties intended
Key points…
What the letter actually says is key. If it states “subject to contract”, this can be a strong indicator that a binding contract has not been formed, but not entirely conclusive
For a contract to have been formed there must be an offer and acceptance and each party must be supplying something and receiving something else in return
It would be advisable for any LOI on a construction project to be temporarily binding until the formal contract is created. Where a non-binding LOI is used, the legal positions of each party will remain unclear.
If there is a financial or time limit contained within the LOI, going beyond either would be a risk. It would be advisable in either case to ensure a revised and extended LOI is issued to deal with the issue. If a financial limited was exceeded, the party undertaking the work, would risk non-payment.
What to make sure is included…
- Scope of the works clearly identified
- Identify the matters to be resolved before the main contract can be entered into
- Clarify that the LOI is an interim agreement whilst the main contract is negotiated and that neither party is agreeing to the main contract until the it is executed by them
- State the governing law that applies
- Clarify that the main contract will also apply retrospectively, and any payments made whilst the LOI is in place will be deemed payments made under the main contract
- Address VAT i.e. state if included or not included to avoid later disputes
- Dispute resolution method should be included
- Ensure the letter is issued directly by the party to the contract and not a Project Manager etc
- Set out what will happen if the main contract is never agreed
What to avoid…
- Don’t include all the terms of the main contract
- Don’t see the LOI as a replacement for a properly prepared contract
- Don’t forget to issue a copy of the LOI to the other party to sign and return
- Don’t do more than what is set out by the LOI
- Don’t forget to formalise the main contract before the LOI expires
Conclusion…
So, it is important that to ensure that whilst any Letters of Intent must be carefully prepared and include the correct information it is NOT a replacement for a properly drafted contract. It is there to provide a level of protection for both parties with both time and financial limits until the main contract is finalised.
If you have any doubts about the content of a Letters of Intent that has been issued to you or are seeking some help in respect of one you would like to prepare, make sure you contact someone with the correct knowledge and experience to assist.
