Letters of intent (LOI) are widely used in the construction industry. They can enable work to commence prior to the formal building contract being in place and can be particularly useful in time-sensitive projects, where any delay could have a material impact on programme and costs.

Here we explore what LOIs are, their role in the industry and how they can be used effectively.

What is an LOI?

“Letter of intent” is a general term, without a clear legal definition. Parties need to be clear if the purpose of the LOI is:

(i)             to outline a party’s intention to enter a formal contract (i.e. a full building contract) with another party, but acknowledging that the parties are not yet in a position to entered into a formal contract; or

(ii)            more commonly, to outline a party’s intention to enter a formal contract (i.e. a full building contract) with another party and instruct the contractor to commence with certain activities and allow works to progress without delaying the programme.

Why use an LOI?

The main driver for entering into an LOI is programme risk. They allow activities to proceed whilst the formal contract is finalised. This can be particularly useful if there is an urgency for the works to progress, such as getting started on surveys or to get site mobilisation underway. We commonly see LOIs put in place to allow for the order of materials either with a long lead-in time or where a competitive price will only be held for a relatively short period.

The risks

Although a practical tool when used properly, LOIs carry inherent risks and we generally caution against their use without good reason.

Key risks include:

• Ambiguities: If not drafted precisely, LOIs can leave crucial details like limitations on liability or payments terms open to interpretation. Where there is no clear mutual understanding, an LOI may well be less suitable.
  
  
• Binding agreements: The binding nature (or otherwise) of an LOI has been debated at length. Depending on their terms, LOIs (helpfully!) may be binding or non-binding which can readily lead to costly disputes.
  
  
• Unintended scope: The scope of works, unless detailed explicitly and clearly, can expand unintentionally, leading to unforeseen costs and liabilities.
  
  
• Delay: Once an LOI is in place, parties can become slow to enter into the formal building contract and LOIs may be extended past their initial expiry a number of times. 

How to use an LOI effectively

To mitigate these risks effectively, parties should:

• Seek legal advice on whether an LOI is appropriate for the project and on the form to be used.
    
• Scope of the letter should be clear and precise: One option to start drafting an LOI is to use a standard form, such as the standard form of construction letter of intent, published by the City of London Law Society’s Construction committee. The 2024 version is influenced by the new 2024 edition of the JCT suite of contracts and recent legislation changes, such as the Building Safety Act 2022, with noticeable changes to the overall theme being shifted towards improved health and safety. 

However, any standard form should always be considered in light of the specific project risks and requirements, with bespoke amendments, if required.

It should be clearly stated:

-   what activity is authorised, whether the contractor will be taking possession of the site and what the payment arrangements are for the activity;

-   what is agreed and what is still to be agreed (as a rule of thumb, it should be very obvious why a formal contract is not yet in place!):

-   if there are any pre-conditions to the activity commencing - for example, if starting on site, does the employer still need evidence of the contractor’s insurances?

-   who will be issuing instructions for the works, and

-   what happens if the main contract is / is not signed and how the LOI may be terminated. 

• Payment/monetary cap: The payment provisions should be clear.  Payments are often on a cost reimbursable basis with reference to priced bills/activity schedule, subject to a monetary cap. It should also be clear when the payment is due (for example, does it form part of first payment under main contract?).
  
  
• Expiry date: The LOI should contain an expiry date and clearly set out the consequences of the expiry of the LOI - for example, is it clear that there should be no activities undertaken after the expiry date, that any extension must be in writing ands that the formal contract to be signed prior to the expiry?  It should be clear that if the contactor carries out activities after the expiry, such activities may not be covered by LOI. A risky position for both employer and the contractor.

A place for LOIs

Whilst LOIs can be incredibly helpful from a practical perspective, they must be approached with caution and include appropriate legal and commercial safeguards. LOIs should not be used as a substitute for a formal contract. By striking the right balance however, LOIs can facilitate progress of the works and mitigate potential programme delay.  

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