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Don't assume you have created a contract - make it binding

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legal matters

It is good practice to make sure that contracts you enter into are in writing. It makes for certainty, the parties knowing what they have to do and for how much. However, parties often fail to finalise their agreements in advance, in writing or otherwise.

One reason, particularly pertinent to construction, is that contracts can delve into such detail that taking the time to tie up all the loose ends eats into the programme. Hence, in order to get things up and running, letters of intent are a familiar feature of the construction industry.

But what is their effect?

The phrase 'letter of intent' describes a very broad range of correspondence, so there is no easy answer. As Mr Justice Goff, as he then was, said in British Steel v Cleveland Bridge : 'There can be no hard and fast answer to the question whether a letter of intent will give rise to a binding agreement.' The key is that the court will seek to enforce whatever the parties intended to agree.

As with all contractual interpretation, the court takes an objective view, looking at contemporaneous documents to decide what it was that the parties intended at the time. Unsurprisingly, at the dispute stage the court is wary of listening to evidence about what parties thought their correspondence meant. So clarity - in writing - is extremely important.

A letter of intent may create a binding contract. However, that is unusual. Putting in place something labelled a letter of intent, rather than a contract, suggests that the parties intend to create a contract at a later stage, not by way of the letter. If the letter of intent does create a contract, that contract may be in one of two forms.

First, there may be what is known as an 'executory contract', consisting of mutual promises relating to future events. For example, 'A'promises to deliver a box of herrings to 'B' on a certain date, and 'B' promises to then pay for it. There is an immediate binding contract, but neither party has to 'execute' it until the due date.

Second, there may be what is often called an 'if ' contract. In short, 'X' asks 'Y' to do something, promising that if 'X' does so, 'Y' will do something in return (usually pay 'X'). However, a letter of intent may not create a binding agreement at all. For example, even if the parties have agreed on all the terms of the intended contract, but decided that the contract will not become effective until some other event happens - such as a standard form is signed, or the moon is full - there may be no binding agreement until the stipulated event has occurred.

But often, even if a letter of intent does not create the binding agreement that the parties assume, there may be little practical difficulty.

The party who has asked the other to carry out work may be obliged to pay up anyway. To ask someone to do something and then refuse to pay them for it may result in what the courts call 'unjust enrichment'. Under those circumstances, even without a contract, the court can still order money to be paid to the party who has lost out.

However, difficulties may arise if no contract has been created and one party wants to do something more than claim straightforward payment for work done. For example, entitlement to damages, as well as (possibly) the amount of them, may depend on contractual arrangements. A recent example arose in the case of American Design Associates v Donald Insall Associates (9 November 2000, of which more next week), in which it was unclear whether, by correspondence referring to the RIBA Conditions of Engagement, the parties had agreed on arbitration in England in the event of a dispute.

To arrive at its conclusion about what the parties have agreed by their letter of intent, the court will look in detail at the whole correspondence between the parties.

It follows that clarity and consistency in written negotiations and any letter of intent are very important.

If in doubt, when drafting any letter of intent, you would be well advised to take advice.

While you may think you could not possibly have failed to sign yourself, or your client, up to a binding agreement (or vice versa), the court, when rummaging through your entire correspondence file, may take a different view.

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