Letters of Intent: Still Crazy After All These Years?

by Melanie Grimmitt

Reviewing the wealth of commentary on the use of letters of intent in construction contracts, one might speculate that at the time the pyramids were being built some well-intentioned Egyptian lawyer was earnestly hammering out hieroglyphics warning his contemporaries of the potentially dire consequences of commencing construction works without a concluded contract in place. Nevertheless, despite the plentiful guidance cautioning contractors against relying on letters of intent which has been produced by legal professionals in more modern times, a significant proportion of construction projects do, in fact, proceed on the basis of a letter of intent. This practice is particularly common within the UAE and the wider Gulf Region.

The reason why the use of letters of intent within the construction industry gives rise to such concern is because, despite the fact that they often look like a piece of official contractual documentation, the very nature of these letters is such that they can easily be perceived as merely a part of the negotiation which took place between the parties prior to the conclusion of a contract, rather than as a contract in their own right. A contractor may, therefore, commence works, believing that a letter of intent somehow guarantees a particular entitlement to payment, when, in fact, it provides no additional legal rights at all.

It might seem crazy for a contractor to expose its business to such a needless risk. However, the crux of the issue is that the risk is not ‘needless’. Construction contracts often contain a great deal of technical detail which can take time to finalize; yet neither contractor, nor employer, wants to wait around for every last calculation to be checked or specification to be agreed before they can commence with preparatory activities such as mobilization and material procurement. Indeed, it may seem to contractors trying to win work in the marketplace that lawyers are crazy for advising against entering into the letters of intent.

The fact that letters of intent present a ‘risk’ is not a problem in itself. Risk is an intrinsic part of all construction projects. Problems arise when there is no assessment or management of this risk. The questions set out below are some of the questions that a contractor might want to consider before commencing work on the basis of a letter of intent.

Is it really necessary?

Although letters of intent are often a necessity within the construction industry for reasons set out above, it is useful for contractors to look at the real reason why a letter of intent is being proposed. If the failure to conclude negotiations of the contract is down to a lack of diligence or commitment from one or both of the parties this is the issue that needs to be addressed. If a contract can be concluded in time for works to commence, it should be.

Does this letter actually provide my company with any legal rights at all?

A letter of intent needs to be a binding contract if it is going to provide a contractor with any rights in addition to those it would have had if it had just commenced work without it. It is beyond the scope of this blog to explore the various legal requirements for an enforceable contract in the UAE and in other GCC jurisdictions and any contractor considering entering into a letter of intent should take legal advice on these issues. However, the issue of intention to create legal relations is of central importance and care will have to be taken in the drafting of such a letter if it is to stand as a contract in its own right not simply as a non-binding record of the parties’ intentions during negotiations.

Is my company clear about its rights and obligations under this letter?

In practice many letters of intent do not tend to stipulate lengthy terms and conditions for the performance of the works being undertaken pursuant to them. This is usually because the parties intend to agree detailed termed and conditions as part of the contract. However, it is important that the letter of intent is sufficiently detailed to allow the contractor to understand the nature and scope of the work that it is being required to do, how it will be expected to perform this work (including any requirements in respect of the timescale of the works), what it will be paid for doing this work and how such payment will be made.

What happens if a contract is not concluded?

Ultimately a contractor that proceeds with a construction project without a detailed contract in place is in the same position as someone who is playing a card game where he is not sure of the rules. He might get lucky, but, ultimately, the chances of him losing are higher than they would otherwise have been.

A contractor may be prepared to take this risk while the contract is being negotiated. However, the risk that the contract will not be finalized and the contractor will never be certain of the rules of the game must be addressed by making provision within the letter of intent to allow both parties to terminate before the full scope of work on the project is completed.

Some letters of intent will stipulate an expiry date (and, if one does, in the vast majority of cases, the contractor should not work past it). Where there is no expiry date in the letter of intent and there is a genuine stalemate in contractual negotiations, then the contractor will have to make a judgment call between whether to cut his losses and terminate the letter of intent or risk suffering losses as a result of performing a contract where the rules of the game are unclear. However, where the contract has not been concluded simply because the contractor has been happy to continue to proceed on the basis of the letter of intent and has allowed the contractual negotiations to fall by the wayside, then this is an instance where the contractor is risking proving the doom-mongering lawyers right.

Co-authored by Rachel Larkin, a solicitor in Pinsent Masons’ Dubai office

Klawr