As a lawyer used to dealing with the fallout in construction and engineering disputes, my advice to clients is usually to avoid using a LOI (Letter of Intent) wherever possible. However, I know that that is neither realistic nor practical in many cases and a well-drafted LOI is certainly more valuable than no written agreement at all.
It is worth noting however that LOIs and PCSAs (Pre-Construction Services Agreements) are used for two quite different purposes. An LOI tends to be used where a contract cannot be finalised before works need to commence, whether because the need for the work to be carried out has arisen suddenly or because it is taking considerable time for the parties to reach agreement on the detailed wording of the building contract. On the other hand, PCSAs tend to be used as part of a strategy to remove risk from a project, for instance in two-stage tendering. This can deliver real advantages to a project which could not be safely achieved without a PCSA or equivalent.
Briefly, for those unfamiliar with the process, two-stage tendering tends to be used where contractor input is required at an early stage. This may allow a quicker start on site and allows the employer to obtain early advice from the first stage contractor at a time when only basic details of the project are available. In complex projects, this approach can also allow the employer to work out how they should be phased and managed. In a two-stage tender, the first stage contractor will not necessarily be appointed at the second stage, although that contractor often will be engaged as a result of their ‘insider’ knowledge of the project. One of the possible disadvantages of two-stage tendering is the possibility that the contractor with his feet under the table may not be as competitive as in a standard tendering scenario. On the other hand, the design and price may be more certain as a result.
In engineering projects, the use of FEED (Front End Engineering Design) contracts tend to be used for much the same purpose; FEED contracts allow for some basic engineering and costing to take place before the execution phase, or EPC (Engineer, Procure, Construct), contracts are put out to tender. They are also used to take projects up to planning or regulatory milestones and final investment decision deadlines.
In construction projects where parties are unable to finalise a building contract before start on site is required, a LOI is the preferred method to attempt to set out each party’s rights in respect of the initial work to be carried out. Parties sometimes seek to use a PCSA in these circumstances, however this is not recommended and is not the purpose of a PCSA. However, proceeding without a building contract and no LOI is also inadvisable as it leaves the parties with no certainty over their respective rights and remedies should things go awry.
PCSAs are helpful where the contracting parties are actively seeking to develop their design, cost estimates and/or procurement approach or to resolve issues relating to those matters. They should not be used to fill a gap where the parties have failed to properly plan a project or where there is a lack of commercial engagement on the part of the contractor.
With the above in mind, the following key considerations are common to the drafting of PCSAs, FEED contracts and LOIs:
- “Letter of intent” is not a term of art (i.e. it has no single legal definition or status). It is used widely for a variety of documents, many of which have little or no contractual status. If you intend to use one, it is of paramount importance that you consider and decide precisely what it is that you want your LOI to achieve. Case law demonstrates that parties have used documents called a “letter of intent” to:
a. create a contract which does not yet contain the full detail (to a greater or lesser extent) of the complete contract eventually intended whether because that detail is as yet unknown or not agreed,
b. form an "if" contract (where one party will receive remuneration if it carries out certain work),
c. form an agreement "subject to contract" or
d. simply set out the parties' aspirations on subject matter which may eventually form a contract.
however not all these are appropriate or indeed recommended. From the point of view of protecting the parties' interests and providing certainty, the only use of a LOI should be (a) above.
- Be clear about payment by setting out any mechanisms that will apply, any conditions precedent to payment and by including a capped value for the work which is to be carried out. Such a cap can also be expressed as a cap on the Employer’s liability and this will also take effect as a limit to the sum payable by the Employer to the Contractor for work done, even if the Contractor exceeds that sum. Contractors should be careful to act before such a cap is exceeded to agree a variation or extension of the agreement if appropriate. If it is not possible to set a cap on the value of work to be carried out, a LOI should instead allow for reimbursement of reasonable costs, ideally limited to certain narrowly defined types of work (which the contractor should ensure covers all of the work it carries out). It is also possible to list specific items of work or tasks and state that if those are carried out, the contractor will be paid a specific sum, such sum to be clearly set out in the PCSA or LOI. In the case of a FEED contract, payment is usually on a Schedule of Rates and this, or any other basis for payment, should be clearly set out.
- The work to be carried out should be specified as clearly as possible in order to avoid “creep” of the scope and subsequent disputes over what was required and which elements of work the contractor is entitled to be paid for.
- Where applicable, these documents should deal with obligations as to workmanship, quality (including any relevant KPIs, etc.) and design responsibility. Note that the JCT PCSA expressly states that the Contractor does not have design responsibility unless and until the parties enter into a building contract. Given the nature of the PCSA and the circumstances in which it tends to be used (i.e. before the design is fully developed and so that the contractor can offer advice and assistance in this regard), it is likely that it will be appropriate to amend this. Design is the primary focus of a FEED contract and care should be taken to ensure the parties’ obligations are appropriately drafted.
- Set an end or longstop date. This is often used where the parties are negotiating the terms of a building contract and hope to have that contract in place by the end date. As with any cap on the cost of the works, the parties must be careful not to allow the LOI or PCSA to lapse while works are continuing and should consider whether it is necessary to vary or extend the LOI or PCSA as the end date approaches. With FEED contracts and PCSAs, it is likely that time will be a key factor so that the building contract/EPC can be put out to tender when required.
- Ensure that the document creates a contract between the parties containing obligations which give the parties certainty on the key points (cost, time, performance, etc.) but which does not confuse the issue by dealing with matters which are yet to be agreed. Those matters would be better dealt with by including a mechanism for reaching agreement on the outstanding points relating to the contract or contracts to follow.
For standard construction projects which are not following the two-stage tender route, it is preferable to have a building contract in place before the contractor begins work. If this is not possible, ensuring that you have dealt with the above points in a LOI will go a long way to avoiding uncertainty and to put you in the best possible position in the event of a dispute. Equally, the success of a PCSA or FEED contract in meeting its objectives will depend in no small measure upon the inclusion of the parameters referred to above and clear and unambiguous drafting.
These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.