By Terry Reid*
I was working with a client company recently and the contract team leader had issued a very clear directive to all staff that under no circumstances should a letter of intent (LOI) be issued to any contractors. I was informed that the concern was such letters could create contractual obligations for the company. Is this a good strategy? The use of letters of intent is very common as a device which allows a contractor to commence work prior to the more detailed contract document being finalised. So what is the legal status of such letters?
When it comes to forming contracts the law has always emphasised substance over form. This means that whether a contract exists is dependent on whether the key elements are included and not what we actually call the document. Judges have never agonised over labels such as letter of intent, memorandum of understanding, letter of award, letter of comfort etc. It is clear that labels never determine contract obligations. As Shakespeare said “what’s in a name”. It makes no difference what we call something but it makes a difference when the key elements are met when it comes to creating contractual obligations.
This being said – it would be very easy to create a contract by issuing a letter of intent. So is the prohibition of such letters the best way to manage this? I don’t think so. What is more important is what is put into the letter rather than what the letter is labeled. The letter must set clear limits and controls on the obligations. It is often crucial to a transaction that work needs to commence prior to finalisation of the detailed contract so issuing such letters is a good practice and provides an opportunity to ensure all parties responsibilities are clear. It may be a good idea to ‘cap’ exposure under such letters to ensure that the parties know what the maximum extent of their liability is.
It is often common in letters of intent to include such phrases as “subject to contract”. More recent consideration of this phrase by judges has indicated that the conduct of parties may waive this control and a contract will be found even if no written final contract is found. The commencement of work prior to a more detailed contract being agreed therefore does create risk. This can be managed by being very clear in the LOI of the work the contractor can commence as well as including a clear statement limiting the amount of liability.
So should companies prohibit the issuing of LOIs? I think this is only a partial control as liability is not prevented by simply denying the use of a document. What companies need to do is ensure that any communication issued contains the necessary restrictions on liability and that conduct by the parties does not indicate that a contract is in place. The label on the document is not relevant to the contractual liability of the parties.
* Terry has over 23 years’ experience as a barrister and solicitor and in the delivery of courses on a variety of legal topics, covering a wide range of audiences. Terry regularly provides courses for professional organisations, public and private sector clients, advising on topics such as contract law, legal compliance in the business sector and regulatory reform in financial markets.
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