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Contract administration: trips and traps

What's in a letter?
18 January 2012

In the first of a series of articles on the common trips and traps associated with contract
administration, Duncan Salmon looks at letters of intent and contract formation

This feature follows from my involvement with the working party that developed the Contract
administration guidance note.

There were certain areas the working party did not explore as they fell outside the CA’s usual
contractual obligations or because the level of detail required was outside our brief. In light of this,
we thought it useful to look at some of these areas in a series of articles covering the practical
problems which are regularly encountered – from the start to the end of the process.

With letters of intent and contract formation, experience across a range of projects – particularly
smaller contracts ranging from minor repairs to those of around £5m – may leave the surveyor
assuming responsibility, as there is no other professional involved at that stage to assist the client.

Is a letter of intent a contract?

Letters of intent generally express an intention to enter into a contract. They are intended to
create no liability under that future contract but care must be taken as they can, in themselves,
create a contract.

Letters of intent have been the subject of considerable litigation and the CA could be negligent in
allowing his client to issue a letter of intent if it was inappropriate to do so. Disputes concerning
letters of intent are usually specific to the facts of the individual case. While the courts accept that
letters of intent are commonplace in construction, it has often been commented that the parties
subsequently turned their minds to the construction works and did not eventually complete the
contract documentation.

The reality of such a situation is that the parties can usually avoid confronting difficult ‘sticking
points’ and keep the work going on site. The case of Cunningham and Ors v Collett and Farmer
[TCC 2006] ALL ER (D) 233 (Jul) suggests there are four situations in which a letter of intent could
be properly used:

 the contract works, scope and price are either agreed or there is a clear mechanism in
place for such details to be agreed
 the contract terms are (or are very likely to be) agreed
 the start and finish dates and the contract programme are already agreed
 there are good reasons to start work in advance of finalisation of the contract
documents.  

Key drafting terms

Letters of intent are intended to create no liability under a future contract but care must be taken
as they can, in themselves, create a contract
If a letter of intent is essential, it is important that its terms are precise and as unambiguous as
possible so that the intentions of the parties are clear and the scope for dispute is reduced. It is
also important that the extent to which they create any legal and/or contractual obligations is
clearly set out. The content of letters of intent varies considerably depending on the circumstances
and will often benefit from specialist legal input. If involved with drafting or approving the letter of
intent, the CA should consider:

 the scope of the works being authorised

 the commitment to pay – this should be capped and preferably linked to the proposed
contract using words such as ‘We will pay you for any work properly executed in
accordance with the payment provisions of the proposed [reference to standard form]
contract’
 that it should confirm the contractor’s only entitlement to payment relates to works
and services provided in accordance with the terms of the letter and exclude any
compensation if the proposed contract does not proceed
 identifying time periods for completion of work being authorised
 insurance provisions
 limiting the period of the letter of intent with automatic termination at an expiry date.
It can always be extended but open-ended commitments should be avoided
 including copyright provisions to regulate intellectual property rights
 referring to the tender documentation, form of contract and all documents agreed at
the date of the letter. Further, confirm that all work done under it will be deemed
included in the contract if and when it is entered into and all payments made will be
included within the contract sum of the contract
 saying that either party shall have the right to refer any dispute to adjudication.

A letter of intent and the building contract

It is sometimes thought that if the letter of intent states that it is subject to a formal contract
being executed then the contract will only become binding once this has been achieved. This is not
necessarily the case. The fact that the parties do intend to execute a further formal document does
not necessarily mean that terms already agreed are intended to be or are unenforceable. This
problem may be created if the works start with a letter of intent but are completed without the
formal contract ever being concluded.

If this happens, the client may not get the benefit of all the terms and conditions of the proposed
building contract. The possible outcomes are as follows:

 if there is no formal contract then the employer will not be able to enforce liquidated
and ascertained damages for delay
 the letter of intent may be insufficient to ensure the contractor is obliged to complete
the works as required by the employer. The quality of the work must be contractually
defined through a specification
 conversely, the contractor will still be able to bring a claim to be paid; however, this
would be on the basis of demonstrating the value of the work completed on a quantum
meruit basis (see below).

In an ideal situation, the letter of intent should be used to allow mobilisation and commencement
of any necessary design, with the formal contractual documentation ready for execution prior to
commencement of principal works.

What are the key elements of entering into a contract?

These are well known. They are an offer which is duly accepted for a contract, the key terms of
which are identified – price (the consideration), performance and time – with the all-important
mutual intention to create legal relations. Readers may consider this self-evident but case law
shows a large number of construction disputes require an extensive examination of the facts to
establish whether a contract exists, and if so, its terms. The courts will find it difficult to fill the
gaps that render a contract incomplete.

Ideally, the building contract should be executed together with a crisp set of contract documents
comprising the specification, drawings and contract sum breakdown – all of which are initialled by
the employer and contractor. This may not happen because a letter of intent has intervened or the
parties do not reach a meeting of minds. A frequent cause of this is the so-called ‘battle of the
forms’.

This arises where the parties try to impose their own terms on the other by attempting to accept
an offer on the basis of including the alternative terms. The employer issues the tender and the
contractor responds with his own terms and conditions. The contractor’s response is not an
acceptance but a counter-offer which operates as a rejection of the original offer. Once rejected,
the original offer cannot be accepted. The result of this is that a binding contract may not be
finalised leaving the parties with no contract at all or relying on the limited terms of a letter of
intent. This may leave the employer with quality issues and the contractor seeking payment on a
quantum meruit basis.

Quantum meruit
If a letter of intent is essential, it is important that its terms are precise and as unambiguous as
possible so that the intentions of the parties are clear and the scope for dispute is reduced

Translated as ‘the value that the work is worth’, this is the method to value work where there is no
contractual mechanism. The court is left with the difficult task of valuing the works (the case of
ERDC Group Ltd v Brunel University [2006] ALL ER (D) 468 (Mar) illustrates the difficulties of
doing so). This raises complex issues concerning the time when the works were carried out – for
example, the contractor may not be limited to tender rates. Dealing with defective work is complex
as there is no contractual mechanism to allow a counter-claim but rather the principle of
abatement should be applied. It is a method to deal with a situation which is to be avoided.

Evolving arrangements
The key issues in handling a letter of intent are recognising and understanding the way in which
the negotiations between the employer and contractor are evolving. A letter of intent can be
issued if it assists to achieve progress towards concluding a properly drafted and executed building
contract – with of course the surveyor identified as CA ready to administer the contract. Failure to
enter into the formal contract can lead to complex and expensive disputes.

The next article will consider problems that arise during the administration of the contract when
dealing with extensions of time and claims for loss and/or expense.

Duncan Salmon is a Partner in the Construction and Engineering department of solicitors

Speechly Bircham LLP and was a member of the working party for the Contract
administration guidance note