In the construction industry, efficiency is a key goal. In striving for this efficiency, principals and contractors often seek to streamline and fast-track common contracting processes and procedures – enter, the “Letter of Intent”.
Letters of Intent allow you to swiftly agree certain key commercial terms to then ensure that the time and effort negotiating a full contract is worthwhile.
While a useful tool, Letters of Intent (LOIs) can be dangerous if not used appropriately. The biggest typical problem is that you end up bound to perform a LOI that you didn’t think was binding, or that an LOI you though WAS binding turns out, in fact, not to be.
In this article, we will explore common features of the LOI, including when it may or may not be binding on the parties that use them.
Letters of intent – What you see is what you get
A key thing to remember about LOIs is that what you see is what you get.
A LOI, by its nature, cannot govern the parties’ rights and obligations in the same way a formal construction contract can.
Courts have even warned against the dangers of relying on LOIs in place of a formal construction contract.
Because LOIs are of a skeletal nature whose classic use is for restricted purposes that do not protect the parties’ interests in the same manner as a formal contract would, it is important to remember that an LOI should never be considered a substitute for a proper construction contract.
Are they binding?
Unfortunately, the answer to this question is “it depends”.
Both the written terms of the LOI itself, and the parties’ conduct may impact whether or not a LOI is considered binding.
However, there are some key things to look out for to assist to determine whether the LOI you receive is binding or not.
Does it have the necessary elements of a legal contract?
To be a contract at law, certain key elements must be satisfied. There must be:
- an offer by one party to another party – think of a builder providing a quote or tender to perform certain works;
- acceptance by the other party of all of the terms of the first party’s offer. If the other party accepts some, but not all of the terms of the offer, this is not acceptance;
- consideration for the first party’s performance of the works or services the subject of the offer. Usually this is in the form of payment, however does not necessarily have to be; and
- an intention to be legally bound by both parties – it is not enough that the first three elements exist, it must also be clear from the terms of the agreement and the parties conduct that they intend to be legally bound by the mutual promises they are making.
If the LOI appears to have all of the above elements, it is potentially binding. In a LOI, it is often the last point that becomes contentious or debatable down the track, especially if someone has started doing work solely on the basis of the LOI rather than awaiting the formal contract.
In addition to these formal elements though, you will also need to consider the sufficiency and level of detail provided by the LOI itself.
Is there enough detail within the LOI?
The key question here is whether the terms of the LOI are sufficiently certain to bind the parties.
If the LOI is lacking in critical detail, it may merely be considered an outline of a future agreement that is intended to be reached between the parties down the track, or an “agreement to agree”.
Is the LOI Expressed to be Non-Binding?
Obviously, if the LOI expressly states that it is not intended to be binding, this is a strong indication of its binding/non-binding effect.
However, while an express statement is a strong indication, it does not finally determine the question if significant factors weigh in favour of reaching a different conclusion (for example, if both parties to the LOI acted as if it was binding and performed its contents).
A Case Study
Imagine the following scenario:
- You are a contractor in discussions to enter into a contract to build a warehouse.
- You provide an initial quote and some correspondence setting out the terms upon which you would be prepared to enter into a contract with the Principal. You also attach a draft version of the proposed construction contract.
- The Principal responds to your offer in writing, accepting it, but noting that they understand the agreement to be “subject to the execution of the construction contract” and provided minimal due diligence is first conducted.
- Later, you send an updated draft contract to the Principal, in which you have included two new special conditions.
- Following this, the Principal informs you that it is not happy with the changes to the contract and that it has already entered into another contract with another builder.
What can you do? Was your agreement with the Principal binding, or was it simply a non-binding “agreement to agree”?
The above scenario is based on the case of Stellard Pty Ltd & anor v North Queensland Fuel Pty Ltd [2015] QSC 119 (which did not actually concern building works, but an agreement to purchase a roadhouse).
In Stellard, the court said that even though the accepting party (i.e. the Principal in our example) stated that the agreement was “subject to execution of the contract” and further due diligence, the agreement between the parties was nevertheless still binding.
Specifically, it was the broader context of the emails exchanged between the parties that evidenced that they intended to be legally bound by the terms already agreed.
Even though the parties intended to execute a further contract in substitution of the initial one, there was still enough detail surrounding the current agreement to say that the parties had entered into a binding agreement.
A Broader Test
In coming to the conclusion reached in Stellard, the court applied a long-standing test from the case of Masters v Cameron (1954) 91 CLR 353.
Often cited in relation to LOIs, Masters v Cameron provides a useful guide for courts when they consider whether an agreement is binding or not.
Specifically, courts generally seek to group preliminary agreements into four key categories, by looking at all of the terms of the documents, communications between and conduct of the parties, and any other relevant factors:
Category 1: a document containing all the terms of the agreement (binding).
Category 2: a document setting out all key terms of the agreement but where performance of certain terms is conditional upon the execution of a formal contract (binding).
Category 3: a document entirely subject to a formal contract (not binding).
Category 4: a document immediately binding the parties but where the parties have agreed to execute a formal contract at a later date (binding).
Attempting to classify a LOI as fitting into one of the above categories may therefore provide a good indication of whether or not it will be binding.
As you can see though, 3 out of the 4 landing places for this test result in a binding agreement, so if that is not your intention then you should tread cautiously.
Practical Tips
In practice, determining whether a LOI is binding or not is not always a simple task.
So, unless the LOI in question is so bereft of detail as to make it impossible to discern any concluded agreement, there are some key things we recommend you do to protect your interests as a contractor:
- make your intentions clear: if you do / do not want the LOI to be binding, make that very clear in writing to the other party;
- be aware of your conduct, and make sure your conduct matches your intentions: be careful not to proceed on the basis that the LOI is final and binding if that is not your intention;
- if you believe the LOI could be binding consider including some key elements such as:
- a limit on your overall liability under the LOI to the Principal;
- excluding your liability for consequential loss;
- clear entitlements to / calculations for payment; and
- a termination clause – either automatic after a period of time, or upon entering into a subsequent formal agreement.
The intention of this article is not to persuade you not to use LOIs – they can be an effective contract and project management tool.
However, you should always be aware of the specific purpose and function of a LOI, as well as its limitations.
