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20th May 2020

Coronavirus: The rise in the use of letters of intent in construction

Letters of intent are documents drawn up between an employer and a building contractor to signify a commitment to a construction or engineering project. And as Thrings partner Michael Chilton explains, the coronavirus outbreak has brought their importance into sharper focus.

As we slowly emerge from the lockdown and the country starts to get back to business, the people involved in and around construction reflect on the fact the industry – or certainly parts of it – has been one of the few which has continued working during the crisis.

However, the industry has suffered considerably, with a reduction in the number of new starts and work on existing sites progressing much slower than normal. Some clients, perhaps understandably, remain nervous about entering into contracts and are seeking advice on how to protect themselves from delay and monetary claims in the future.

Progress on sites is expected to be slow as contractors comply with Government guidelines and site operating procedures. Meanwhile, the supply of materials and equipment is likely to be disrupted for months to come. Of more concern, however, is what happens if we experience a second wave of the virus.

When it comes to entering into building contracts, one alternative approach being taken by some employer clients is using a letter of intent (LOI) or a pre-construction services agreement (PCSA) to engage with a contractor and to get them to start working a project, even where the contract terms have been agreed. The benefit to employer clients is that it avoids binding them into a building contract and allows them a degree of flexibility in case a situation arises which means the project may no longer be viable in the timescale planned.

LOIs are regularly used in a number of situations – but primarily where the parties to a building contract haven’t agreed all of the key terms and details, and the employer is under a time pressure to get design and procurement activities and/or preparation works started. They generally demonstrate an employer’s intention to enter into a building contract later on and provide a short-term contractual solution until the contract can be signed. It is unusual for LOIs to be used where terms have already been agreed.

Many lawyers would advise against using a LOI unless it’s absolutely necessary and only recommend their use where there is no chance of concluding the agreement of the building contract in time. They would almost certainly suggest LOIs are not used where terms have been agreed.

Notwithstanding the usual reluctance, LOIs, where used, must be drafted carefully to protect both parties, but in particular, to avoid creating a contract which binds the parties in respect of the whole of the planned construction work.

Preparing LOIs – key features and pitfalls to avoid

  • No intention to create a contract for all the works – state that the employer intends to enter into a building contract but is under no obligation to do so.
  • State key features/documents of the building contract to be entered into and what is still to be agreed – the letter should refer to any documents which form the basis of the agreement and what will be included in the building contract. It should also state what is still to be agreed.
  • Works/activities to be carried out under the LOI to be specified – make it clear which activities the contractor is being asked to carry out under the letter, and that no payment will be made if anything else is undertaken without instruction. If these activities include works on site, make sure the relevant insurances are in place.
  • Maximum amount to be paid and how the works/activities will be paid – it is essential that the letter contains a maximum liability for the employer and states that the contractor will not be reimbursed for any expenditure over the maximum amount, unless instructed. The letter should also clarify how payments will be made, either by way of sums allocated to each item of activity or on the basis of reasonable costs incurred. In both cases, the payment procedure will likely follow that set out in the proposed form of building contract.
  • Expiry date – the letter should contain a date after which it will expire. The contractor should not carry out any work after this date and the employer will not be liable to pay for such work.
  • Termination provisions – include an ability for the employer to terminate at any time, subject to notice being given. The contractor should be entitled to be paid for the work it has carried out to the termination date and to reasonable demobilisation costs, but the employer should have no liability for any other costs such as loss of profit or any other consequential losses or for any liability over the maximum amount. Where works have started on site, the clause should state that the contractor will vacate the site and leave it tidy.
  • Contractor withdrawal – if the contractor withdraws from the project without reason, the letter should state that they will be liable to the employer for the costs incurred.
  • Copyright provisions – the contractor should be required to grant a copyright licence to the employer for the use of drawings and other documents prepared for the project and to supply him with copies of the documents.
  • Sub-contracts – if the contractor is permitted to place orders with sub-contractors and suppliers, the employer should consent to the order being placed. They may also want an obligation to assign or novate the order in the event of termination of the LOI or where a building contract is not entered into.
  • Clarify which terms will apply – it is usual to state that both the terms of the LOI and, where necessary, the building contract, will apply. In the event of a conflict the LOI will take precedence.
  • Building contract will supersede the LOI – the letter should confirm the terms of the building contract, once entered into, will supersede the LOI and that payment under the letter and the works carried out will be deemed to be payment and works carried out under the building contract

While LOIs should only be used in certain circumstances and for a limited period of time, in most cases it is preferable for both parties to agree the terms of and enter into a building contract. Employer clients should be aware that the longer a LOI is left in place, the more difficult negotiations may become. Nevertheless, in these uncertain times, LOIs can provide the parties with some flexibility, until the position regarding COVID-19 becomes a bit clearer.

Please note: Nothing in this article constitutes legal advice and we are not liable for any reliance on the information provided. This is a rapidly changing subject, and whilst correct at the time of writing, circumstances may have changed since publication.

To find out more about anything covered in the article, or to discuss the potential impact of the coronavirus pandemic on the construction industry, please contact Michael Chilton or another member of Thrings’ Construction team.

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