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Explanatory Notes
Letter of Intent (Construction)
B124 LETTER OF INTENT
EXPLANATORY NOTES
Letters of Intent need to be drafted with care and used with caution.
The purpose of a letter of intent, usually, is to confirm to a successful tenderer that the Contract will be awarded to him and to get him to start work before the Contract is signed. It is this starting of work on the basis of a letter of intent rather than after signature of the Contract Agreement which can cause difficulties.
The terms contained in a Letter of Intent are not always compatible with the Contract terms, and argument can later arise, at Contract signature stage, as to what the Contract terms really are. Also, it is not unknown for work to begin on the basis of the letter of intent and for most, even all, of the work to be done without anyone subsequently signing a Contract Agreement. Here again, especially if there is any doubt as to the exact documents which make up the Contract, problems can arise. To give one example: a Contractor's tender includes qualifications to some of the conditions of contract; the Letter of Intent does not refer to these qualifications, but the Employer's intention is to insist on the conditions of contract as originally submitted to bidders. The Contractor, undertaking work on the basis of the Letter of Intent, acts in accordance with his version of the conditions rather than the Employer's. When, a couple of months later, the Employer wants his terms included, the parties fail to agree on the terms of the Contract.
Problems can be avoided if the Letter of Intent does not create any contractual commitment - i.e. it merely states an intention to award a Contract, making it clear that no liability will arise if for any reason the Contract is not subsequently awarded to that person.
Alternatively, if work is required, there are two key requirements. Firstly, the Letter of Intent should make it clear not only that the intention is to award the Contract, but also clarify the terms of that Contract, referring to correspondence and documents to be incorporated in the Contract, as necessary, as well as the contract price and other key commercial terms.
Secondly, the scope of work to be undertaken under the Letter of Intent is best defined, with a price limit and a time limit, probably making it clear that if the Contract Agreement is signed within a certain specified period, the work will' be considered to be part of the Contract work. If, on the other hand, the Contract is not signed within the specified period, the only obligation of the Employer to the Contractor will be to pay for the work done up to that point in accordance with the terms of the Letter of Intent. In other words, a clear distinction is made between the Letter of Intent and the Contract, the Letter of Intent being a preliminary contract with clearly defined terms of its own.
It is recommended that a Letter of Intent should be drafted or, at least, reviewed by a lawyer before it is issued. The form of Letter of Intent which accompanies this Commentary is an example of the principles set out above.
CONSTRUCTION CONTRACTS IN THE UNITED KINGDOM
Please note that Construction Contracts for work within the United Kingdom are likely to be affected by Part II of the Housing Grants, Construction & Regeneration Act 1996 ( the "Construction Act").
Our documents are prepared for international use and not all of them contain provisions which are compatible, or fully compatible, with the Construction Act. These notes are designed to assist purchasers of our contracts who wish to use the documents within the UK.
The Construction Act applies to contracts for "construction operations" within the UK. Broadly speaking, this covers all contracts involving building operations, whether new buildings or maintenance or repairs of old buildings, within the UK. The main exception is construction work for residential occupiers.
The Act contains certain mandatory provisions relating to payment and adjudication as a means of resolving disputes.
PAYMENT
Sections 109 to 113 of the Act deal with payment.
1. Payment
Where a contract duration is likely to be 45 days or more, a construction contract must provide an adequate mechanism for determining what payments become due under the contract, when they become due and contain provision for final date for payment of each sum becoming due. The following wording in a payment clause may be appropriate to deal with this provision:
"Within 5 days after the end of each month, the Contractor will submit an application to the Employer for payment in respect of work carried out during that month. Within a further 5 days the Employer will issue to the Contractor a certificate showing the amount due and the final date for payment which will be 20 days from the date of the Contractor's application."
2. Withholding of payment
Section 111 makes it illegal for a party (usually the Employer) to withhold any amount from a payment which has become due unless within a specified period before the final date for payment, that party has given an effective notice of its intention to withhold payment. That notice must specify the amount to be withheld and the grounds for withholding each such amount.
Suggested wording is as follows:
"If the Employer wishes to withhold any payment which has become due under the Contract, he shall, not less than [5] days before the final date for payment of that amount, give notice to that effect to the Contractor specifying in the notice each amount to be withheld and the reasons."
3. Pay when paid
Section 113 of the Act makes it illegal for a Contract to contain a "pay when paid" clause - i.e. a provision which makes payment under the Contract conditional upon the payer receiving payment from a third party. In other words, a Main Contractor cannot make payment to a Subcontractor conditional upon payment being received from the Employer under the Main Contract.
4. Suspension
The right to suspend performance of a Contract is given under Section 112 to a party who has not received payment in full of the amount which has become due by the final date for payment and no notice of withholding has been given. In those circumstances, the payee must give 7 days notice of its intention to suspend performance, and if payment is made within that period, the right to suspend ceases. There is no need to give this right of suspension expressly in the Contract as it is covered by the wording of the legislation. Some commentators have argued that an Employer would be entitled by contract to exclude the right of a Contractor under Section 112 to give notice of suspension. Not everyone agrees with this argument.
ADJUDICATION
Section 108 of the Construction Act contains provisions which give any party to a Construction Contract the right to refer a dispute arising under the Contract to adjudication. The section states that a party can give notice at any time of his intention to refer a dispute to adjudication and the timetable must be designed to secure the adjudicator's appointment and the referral of the dispute to him within 7 days of the notice, with the adjudicator's decision within 28 days from referral. This 28 day period may be extended by 14 days with the consent of the referring party or for any other period by agreement between the parties.
The adjudicator must act impartially and be able to take the initiative in ascertaining the facts and the law.
The adjudicator's decision will be binding (and must be implemented) until a dispute is finally determined by legal proceedings, arbitration or agreement. If the Contract states, the adjudicator's decision can be final and binding.
It is not possible to contract out of these provisions and if the Contract is silent on adjudication, there is a statutory scheme - the Scheme for Construction Contracts, which will apply.
Thus, even if the Contract is silent, a party to a Contract to which the Act applies can require that a dispute is referred to adjudication.
There are a number of organisations which will appoint an adjudicator and which have adjudication rules which are compliant with the Construction Act. These include most of the main professional bodies - RIBA (Royal Institute of British Architects), RICS (Royal Institution of Chartered Surveyors), ICE (Institution of Civil Engineers) etc.
A suggested clause, under which reference is made to one of those organisations, is as follows:
"Either party may refer a dispute arising out of this Agreement to adjudication by giving notice to the other party. The adjudicator, if not appointed by agreement between the parties, shall be appointed by the President of the [Institution of Civil Engineers] on the application of either party. The adjudicator shall act impartially and be free to take the initiative in ascertaining the facts and the law. The adjudicator shall be required to reach a decision within 28 days of referral or such longer period as the parties may agree.
[The adjudicator's decision shall be binding on and implemented by the parties and unless either party gives notice to the other within [60 days] from the date of the decision, it will be final and binding on the parties and will not be subject to any further legal proceedings."]
It should be noted that the Construction Act is so written that if a Construction Contract does not comply with the Act, the Contract will, in effect, be supplemented by the (statutory) Scheme for Construction Contracts. This sets out details of provisions with respect to payment by instalments and adjudication which will take effect in those circumstances.
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