A Brief Introduction to Letters of Intent (LOIs)
Business is not predictable. Things happen unexpectedly and projects get delayed. On the flipside of the coin, projects often have to progress at short notice due to time requirements or other pressures. Sometimes the paperwork is not ready, contracts are still being negotiated or a new project dovetails into a previous one and has to be delivered in a tight timeframe.
Contractors and businesses are often under commercial pressure to commence a project, get on site and commence groundwork (if it is construction orientated) as soon as possible, without a full contract being in place. This is where a “letter of intent” (LOI) comes into play to ensure some certainty whilst the parties continue to negotiate the full contract.
What is a Letter of Intent?
It is 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 the project or works described in the letter. The key matter is that the letter asks the other party to begin those works or project before a formal contract is formed.
Proceeding under a letter of intent (LOI) can allow the parties to get a head start on a project and provides the confidence for subcontractors to be instructed and for materials to be bought and plans made. Depending on how a letter of intent has been drafted and how it is then treated, can lead to risks for those deciding to take action under its instructions.
The key question with an LOI is whether it has created binding obligations on the parties. In theory the creation of the following formal contract should make the risks irrelevant but that sometimes doesn’t happen and then the LOI becomes the centre of attention should a dispute arise.
How Does a Letter of Intent work?
It is worth keeping in mind that the actual term ‘letter of intent’ does not have an exact legal meaning and can be used to describe all sorts of contracts. It is basically a communication method to express an intention to enter into a contract at a future date.
There Are Several Ways an LOI Can Exist:
- the non-binding approach of future intentions of those parties involved. This is often called a ‘comfort letter’;
- a letter that is actually an interim contract. This will outline the on-going business relationship until being superseded by full formal contract;
- the LOI can exist as a final contract which is deemed to have incorporated the terms and conditions of the formal written contract that the parties intended.
For a formal contract to be created, there are a number of elements that must be considered to be in place. These are what the Courts will look for should there be a formal dispute. These are: –
- Intention. Can the intention of the parties to enter into binding legal contract be identified?
- Consideration. This is a key element in any contract. Basically the ‘price’ paid under the contract in return for performance by the other party of its obligations.
- Certainty as to the key terms.
What to Include in a Letter of Intent (LOI)
- Identify the full scale and scope of the project;
- What needs to be resolved, by whom and by when, before the main contract can be entered into;
- If it is the case then make it clear, that the LOI is intended to give rise only to an interim agreement;
- Be careful because even though you may state one thing, it is possible for the parties to inadvertently waive such provisions if their behaviour contradicts this;
- Be clear about what governing law applies;
- Look for other eventualities. What will happen if the main contract is never agreed?
- Clarify the payments structure. Once the intended contract is concluded, any payments under the LOI will be treated as payments against obligations under the main contract once this comes into force;
- Is VAT inclusive or exclusive? By being clear about this at the start you can avoid a dispute further along the line;
- Who is telling whom what to do? Make it clear who is to be the instruction-giver in relation to the work to be carried out;
- Record any changes such as any agreed extension beyond the original expiry date in writing;
What an LOI is Not and What to be Careful Over:
- An LOI is not a substitute for a full contract;
- Don’t have an LOI include all the terms of the contract otherwise you just have a contract;
- Don’t forget to formalise the contractual relationship before the LOI expires and make sure you are not operating beyond the terms of the LOI.
A letter of intent is not intended to be a substitute for a properly drafted contract. It exists to fulfil a purpose and that purpose is to deal with a requirement for a rapid way to react in time critical situations, often in the construction sector. A carefully negotiated contract will always be a superior option but if you do need to use an LOI make sure it complies with a simple checklist of requirements. Replace an LOI with a fully-formed, written contract as soon as possible. Legal advice and drafting at the time of formation can save you a lot of grief and potential problems in the long run.
Need Assistance or Legal Advice?
rhw solicitors have a commercial law team with a vast amount of experience and know-how and we are able to advise and assist in all aspects of contractual agreements including the creation of new contracts and amendment of current agreements.