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The Rocky Road from Letter of Intent to Formal Contract

09 December 2016 | Tokyo
Legal Briefings

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There is no universally accepted template for a Letter of Intent and very often parties will adopt their own bespoke form. The transition from Letter of Intent to formal contract can continue for much of the progress of the works themselves and may not always result in the execution of a formal contract. If no such contract is entered into, then a dispute may arise as to what was in fact agreed between the parties, whether such agreement amounts to a formal contract or whether the circumstances indicate that the Letter of Intent remained in force. This was the issue raised in the recent English High Court case of Spartafield v Penten Group1 decided in the Technology & Construction Court on 29 September 2016.

The Facts

In this case, works were initially carried out on the basis of a Letter of Intent anticipating a signed contract but the contract was not eventually executed. The issue to be decided by the Court was whether the Letter of Intent had been replaced by a subsequent contract in the Joint Contracts Tribunal ("JCT") Intermediate Form that was referred to in the Letter of Intent.

The Letter of Intent authorised work to proceed for a fixed sum and referred to the intention to enter into a contract. It said that, if a formally executed contract did not come into existence, then the contractor would be reimbursed for any costs paid to third parties and that those sums would, so far as reasonably possible, be determined by reference to the sums payable under the proposed formal JCT contract. It said that the formal contract document would follow in due course.

There were negotiations between the parties in relation to the terms of the draft contract which proceeded for much of the period during which the works were being carried out. The Court found that there was eventually no issue between the parties as to price, scope, applicable JCT conditions and time for completion. However, it was the contractor's case that they eventually refused to sign the contract and that the Letter of Intent imposed a conditional requirement for formal execution akin to "subject to contract". Therefore, the contract was never executed and the parties' contractual relationship remained on the basis of the Letter of Intent.

The decision

The Court considered the law on contract formation, in particular, the Supreme Court's decision in the RTS case (2010)2. This case, and earlier authorities, indicated that the question of whether a binding contract had been entered into depends upon the consideration of what was communicated between the parties by words or conduct and whether that leads objectively to a conclusion that they intended to create legal relations and had agreed upon all the essential terms for that purpose.
If the parties' correspondence had proceeded on a "subject to contract" basis, then this may indicate that the contract was not to become binding until some further condition had been fulfilled. The fact that work had been performed does not of
itself indicate that there must have been a concluded contract but it may be a very relevant fact pointing in that direction. The Court in this case decided that the concluded contract had been entered into. The Letter of Intent contemplated the execution of a formal contract but did not impose a condition that formal execution was required in order for the contract to supersede the Letter of Intent. Such words, as "until", "unless" or "subject to" were not used. Whilst there was a provision catering for the possibility that an executed contract would not come into existence, that did not indicate that only formal execution would operate to supersede the Letter of Intent. The Court held that the parties had reached agreement on all material terms and the absence of formal signature was not a bar to the conclusion of a contract on these terms. However, the Court declined to find that performance alone would operate to create a concluded contract as such conduct was consistent with the prior Letter of Intent.

Conclusion: what it means for you

It is common for works to begin on the basis of a Letter of Intent where it is necessary to start work as a matter of urgency. However, it is unlikely to be satisfactory for the parties to continue on this basis without executing a formal contract. A Letter of Intent is unlikely to set out all the terms necessary to fully protect the parties' respective interests.

In this case, the Letter of Intent did not specify a completion date and it appears that the contractor was hoping to later argue that time thereby became at large (that is to say, completion within a reasonable time) rather than be bound by the completion date that was applicable to the eventual contract. It appears that the contractor put forward this line of argument once it appeared that delays to the works had become inevitable.

This case indicates that failure to execute a contract is likely to be a fertile ground for disputes, particularly where the progress of the works has not run smoothly. In this case, it was only towards the end of the contract period that the contractor indicated it would not sign the proposed contract. However, the Court was able to find that there was sufficient material in the discussions and correspondence to constitute a concluded contract.

Spartafield Ltd v Penten Group Ltd [2016] EWHC 2295 (TCC)

RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2010] 1 WLR 753

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