Letter of Intent
Updated 12 April 2022
A letter of intent (LOI), also called term sheet, expression or indication of interest in the commercial sectors is an informal offer or recap of the parties’ position on how they would proceed on a business proposal or venture.
In the shipbuilding and offshore industry, where discussions
on technical, commercial and legal matters leading up to a formal contract are
complex and lengthy, letters of intent (LOIs) will often be used as prelude to
the formation of a formal contract. Thus, LOIs will be used:
In RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH
& Co. KG,[3]
Lord Clarke said that in order to consider whether a contract is binding the
court will have to examine the parties’ words and conduct, to objectively
conclude whether they intended to create legal relations, and had agreed upon
all the terms which they regard or the law requires as essential for the
formation of legally binding relations. Even where certain terms of economic or
other significance are not finalised, an objective review of their words and
conduct may show that such terms were not intended as a precondition to a
binding and legally enforceable agreement.
Where an LOI is qualified by the rubric “subject to
contract”, there will be no binding contract until a written contract is signed.[4]
In contrast, it is also possible for an agreement which is ‘subject to
contract’ or ’subject to written contract’ to become legally binding if the
parties later agree to waive such conditions.[5]
The parties may agree to bind themselves to agreed terms,
leaving certain subsidiary and legally inessential terms to be decided later.
In Pagnan SPA v Feed Products Ltd,[6]
it was held that although certain terms of economic significance to the parties
were not agreed, neither party intended agreement of those terms to be a
precondition to a concluded agreement. The parties regarded them as relatively
minor details which could be sorted out without difficulty once a bargain was
struck. The parties agreed to bind themselves to agreed terms, leaving certain
subsidiary and legally inessential terms to be decided later.
Where the scope of work has been identified, the parties may
agree that they will not be bound unless board approval from the parties are
obtained or outstanding requirements are fulfilled. In such a case, the parties
are not bound until respective board approval are obtained.[7]
If an agreement is “subject” to some event it will likely be
classified as a pre-condition rather than a performance condition where (a) the
fulfilment of the subject involves the exercise of a personal or commercial
judgment by one of the putative contracting parties (e.g. as to whether that
party is satisfied with the outcome of a survey or as to the terms on which it
wishes to contract with any third party, and (b) such event that can only be
resolved by one or both of the parties removing or lifting the subject, rather
than occurring automatically on the occurrence of some external event such as
the granting of a permission or licence, the “subject” is likely to be a
pre-condition rather than a performance condition.[8]
Disputes concerning LOIs may arise where one party starts work based on LOI, but before the conclusion of a final contract.
In RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co. KG.,[9] RTS and Muller entered into a letter of intent (“LOI”) for the provision of work and equipment to automate Muller’s product re-packaging process. The terms of the LOI provided that:
·
The agreed price was GBP 1,682,000.
·
RTS shall begin all work and supply by a certain
date.
·
The final contract (based on Müller's amended
form of MF/1 contract) shall be finalised and signed within 4 weeks of the LOI.
While negotiations were ongoing, but before the terms of the final contract were agreed, RTS commenced work based on the LOI. The LOI expired on 27 May 2005. The final version of the draft contract was agreed in the e-mail exchanges of 19 and 25 May, 29 June and 5 July. Though ready for execution, it was never signed. Subsequently, problems arose, and this led to a variation of the delivery plans on 25 August 2005. A dispute later arose between the parties, which led to litigation between the parties. RTS asserted that there was a continuing contract on the terms of the LOI. Alternatively, if there was no contract, RTS was entitled to a quantum meruit, or if there was a contract, that it was on MF/1terms. Müller’s case was that there was a contract on the basis that Müller would pay the price, namely £1,682,000, in return for the goods and services that RTS had agreed to provide as set out in a number of specific documents.
On appeal, the UK Supreme Court (UKSC) had to decide whether
there was a contract between the parties after the expiry of the LOI and, if
so, terms thereof. The UKSC noted the perils of parties agreeing that work should
proceed before a formal written contract is executed, and also commented that
the “moral of the story is to agree to terms first and start work later”. The
court identified the relevant principles to be applied and listed three
possible conclusions that were open to it.
·
There was a contract between the parties on limited
terms - as the parties treated the agreement of 25 August as a variation of the
agreement that they had reached by 5 July, it made no commercial sense to hold
that the agreement between the parties contained some of the terms agreed by 5
July.
·
There was an agreement on some other wider terms
- the court considered that as the parties had reached an essential agreement
by 5 July, none of the issues remaining after that date was regarded by the
parties as an essential matter which required agreement before a contract could
be binding.
According to the UKSC, it was possible for an agreement which is ‘subject to contract’ or ’subject to written contract’ to become legally binding if the parties later agree to waive that condition. The court held that on or by 25 August, the parties had agreed to waive the “subject to contract” provision. Any other conclusion makes no commercial sense. The UKSC unanimously allowed the appeal, set aside the order of the court of appeal and held that the parties reached a binding agreement on or about 25 August 2005 on the terms agreed by 5 July (as subsequently varied on 25 August), and that the binding agreement was not subject to contract. In arriving at its decision, the UKSC also stated, inter alia, that in order to consider whether a contract is binding the court will have to examine the parties’ words and conduct, to objectively conclude whether they intended to create legal relations, and had agreed upon all the terms which they regard or the law requires as essential for the formation of legally binding relations. Even where certain terms of economic or other significance are not finalised, an objective review of their words and conduct may show that such terms were not intended as a precondition to a binding and legally enforceable agreement.
Is there a binding contract when work was carried out pursuant to an LOI which envisages that the parties will eventually sign a Protocol Agreement which was never signed?
In Arcadis Consulting (UK) Ltd v AMEC (BCS) Ltd,[10], Buchan (AMEC) engaged Hyder (Acardis) through letter agreement (Interim Contract) to carry out certain design works on a car park in anticipation of a formal Protocol Agreement (Final Contract) that did not materialize. The car park was defective to the point where it may have to be demolished and rebuilt at significant cost (£40 million, including damages). Hyder denied liability and further argued that if they were liable, there was a contract under which their liability was capped at £610k. Buchan contended that there was no contract because the correspondence envisaged a Final Contract and the absence which precluded the existence of any binding contract between the parties.
The questions before the court were whether there was a contract and whether Hyder’s cap of liability (£610k) was incorporated by reference into the Interim Contract. Otherwise, the Hyder could potentially be liable for up to £40 million. The judge at first instance held that there was a simple contract but the cap on liability was not applicable as there was uncertainty on whether the parties intended to be bound by such a cap. The Court of Appeal (CA) agrees with the judge of the first instance that there was a binding contract as the best evidence was the acceptance and conduct in undertaking the work. The CA was of the view that there were two contracts, the Interim Contract under which the parties were currently working and the Final Contract, the terms of which would supersede the Contract once agreed.
However, CA differed from the judge at first instance
concerning the cap of liability and unanimously held that the cap of liability
applied under the Contract. In so doing, Dame Elizabeth Gloster (with whom Lord
Justice Holroyde and Lord Justice Underhill concurred) considers Goff J’s analysis
in British Steel Corp v Cleveland Bridge & Engineering Co Ltd that, if parties are in a stage of
negotiation and one party asks the other to begin work “pending” the parties
entering into a formal contract, it cannot be inferred from the other party
acting on that request that he is assuming any responsibility for his
performance, except such responsibility as assumed under the terms of
the contract that both parties are confident will be shortly finalised.
She refers to what Goff J called an “extraordinary result,”
where a party would “… assumed an unlimited liability for its contractual
performance, when it never would have assumed such liability under any contract
which it entered into.”, and further held that “that is even more extraordinary
in the current context, where the parties had specifically agreed that limit of
liability in relation to the interim contract”.
Summary
While a letter of intent (LOI) is commonly used as the prelude to a formal shipbuilding contract, its complexity must not be underestimated. The formality for the formation of a binding contract must be strictly adhered to. If an LOI is subject to contingent conditions, the contract language must be clear and precise. When considering whether to start work based on LOIs, but before the conclusion of a final contract, the advice of the UKSC “to agree to terms first and start work later” should be noted.
Also, as LOIs may be an interim contract, potential risks
that should to be comprehensively covered, include insurances, exposures to
claim for property damage, personal injury, or death affecting the party’s
personnel or subcontractors, consequential loss, delays, and (c) shipbuilder
total accumulative liability. In this regard, an ideal solution for risk
management is to have a standard internal contract guideline for those involved
in negotiation to abide by, failing which any unauthorised deviations will be
at their own peril.
[1]
ERDC Group v Brunel University [2006] EWHC 687 (TCC), per HH Humphrey Lloyd QC
at para [27].
[2]
Tesco Stores v Costain Construction [2003] EWHC 1487 (TCC), per HHJ Richard
Seymour QC at para [160].
[3]
[2010] UKSC 14, per Lord Clarke at para 45.
[4]
In Star Steamship Society v Beogradska Plovidba (The Junior K) [1988] 2 Lloyd’s
Rep 583, it was held that the effect of the phrase was to prevent any contract
being concluded until all of the terms had been agreed.
[5]
RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co. KG. [2010] UKSC
14.
[6]
[1987] 2 Lloyd’s Rep 60.
[7]
Windschuegl (Charles H) Ltd v Pickering & Co Ltd (1950) 84 Ll L LR 89, 92).
[8]
Nautica Marine Limited v Trafigura Trading LLC [2020] EWHC 1986 (Comm).
[9]
[2010] UKSC 14.
[10]
[2018] EWCA Civ 2222.v1.
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