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Can a Letter of Intent “morph” into a binding contract?

It has become fairly commonplace in the yachting industry to see letters of intent being used to “secure” a deal, or an exclusivity period to negotiate a particular transaction for example, particularly with an impending boat show or some other event on the horizon or – as has recently perhaps been seen with the value of the Pound dropping so significantly as against, predominantly, the Euro and the US Dollar – in response to a particular event. The common understanding in such situations is that the letter of intent will be “subject to contract” and that, outside of any agreed parameters intended and expressly stated to be legally binding (such as an obligation relating to confidentiality, for example), it will not create binding legal relations. So far, so good. However, an over-relaxed attitude towards letters of intent due to a perception that they are not actually binding in the absence of a “formal” contract can lead to altogether unexpected results and protracted legal skirmishes as has recently been demonstrated by the case of Spartafield Limited -v- Penten Group Limited [2016] EWHC 2295 (TCC).

I should like to pause here to make a very important point at the outset. Letters of intent come in all shapes and sizes. Sometimes they are called letters of intent, sometimes they are given a different title, or no title altogether. The content varies depending on the source and in many – if not most – instances they will already have been signed before they make their way anywhere near the parties’ lawyers. In any case, lawyers will probably tell you that they know one when they see one. What they will also almost certainly tell you is that, under English law at least, the legal implications of any document purporting to be a letter of intent will depend entirely on its content, which is exactly what happened in the case which forms the subject matter of this article.

First things first, Spartafield v Penten concerns the development of some residential units in a building in London, so it’s a real estate construction case. This is important, as a large part of the judgment is devoted to matters specific to that sector and is in many ways alien to the world of yachts and yacht building. I will therefore ‘skirt round’ those aspects and simply focus on the question whether the letter of intent agreed between the parties had – in this case – eventually been replaced by a subsequent contract without such contract ever actually having been signed by both of those parties.

Secondly, the procedural history in this matter is convoluted – it runs to some 14 pages in the judgment – but at its heart lies an agreement, as embodied in a letter of intent dating back to July 2013, between Spartafield (a developer) and Penten (a contractor / builder) relating to the construction of a substantial, 3-floor, roof extension to an existing 5-floor building in East London. Penten won the tender for the work and, wishing to press on with placing orders and getting the works generally underway, suggested the parties proceed under a letter of intent (“LOI”) whilst the remaining contractual and financial / technical aspects are finalised.

The LOI was based on a document Penten had used in connection with an earlier development, and was approved and signed by Spartafield. Amongst its key terms, the LOI expressly authorised Penten to “carry out all necessary pre-contract planning, taking dimensions, place on order such materials that [Penten] require[s], plant and sub-contract sufficient to commence the works in an expedient manner [sic]”, and just as crucially, authorised works up to a figure of £1m which reflected almost 90% of the total build cost agreed as part of the tender process. The LOI went on to confirm that when signed it “will then form a provisional but binding contract as if a contract had been formally executed in accordance with foregoing terms … The formal contract document will follow in due course”. On the same day as the date of signing of the LOI Penten’s representative confirmed the contractual start date (9 September 2013) and a completion date of 14 July 2014.

Construction proceeded in earnest, Penten submitting (and Spartafield paying) periodic invoices in line with the contractual mechanism referred to in the LOI, whilst the contract discussions also moved forward, Spartafield being keen to formalise this aspect, albeit at a much slower pace due predominantly to Penten’s actions and their need to consider and review terms each time a new iteration of the contract documentation was presented. The key point here, as was emphasised by the Judge, was that the nature of Penten’s objections was minor as the contract was in a standard form (known as the JCT form) which had already been identified and accepted by Penten during the tender – pre-LOI – stage. There were some delays to the project and come mid-September 2014 (some 2 months after the originally agreed completion date) Penten finally confirmed that they would sign the contract documents within the next “2 weeks” thereby indicating that there remained nothing further of substance left to be agreed.

However, come March 2015 there was still no signed contract, the development hadn’t been completed, Penten wrote to Spartafield to inform them that the value of the costs authorised under the LOI had been exceeded, and Penten also started to wind down their on-site presence pending resolution of the funding issue. Spartafield countered by arguing that Penten had no authority to cease work as there was a binding contract in place. Come 27 April 2015, Spartafield served notice of termination of the contract on Penten leading, via a web of adjudications, to the judgment of Mr Alexander Nissen QC in the present case just over a year later.

The key question to be determined, as foreshadowed above, was whether or not the LOI eventually “morphed” into the standard form construction industry contract (in this case, a document known as the JCT form, an analysis of which is outside the scope of this article). In delivering his well-reasoned judgment, Mr Nissen QC sought guidance from key past authorities in order to assist him on the applicable law, noting that “each case depends upon its own facts”, and that “it is for the parties to decide whether particular terms were of economic significance and whether the need for agreement on those terms was a precondition to a concluded agreement”. At paragraph 122 of the judgment, he made the following observation which is worth quoting:

Although, as I have said, the letter of intent is not the easiest of documents to construe, I do not consider that it imposes a condition that the contemplated replacement contract must be the subject of formal execution. It plainly envisages there will be a formally executed contract document in due course but it does not, in my view, make the existence of that document a pre-condition to the conclusion of a replacement contract. I reach that conclusion for the following reasons. There are simply no words which could be said to impose such a condition. Words such as “until”, “unless” or “subject to”, the type of language to be expected if a condition is being imposed, have not been deployed.

Crucially, and to Penten’s detriment, Nissen QC then found that come by latest September 2014 (when Spartafield argued, and the Court agreed, the key principles of the contract had been agreed) the parties had agreed by their conduct to displace the LOI with the replacement contract on the industry-standard JCT terms, even though the contract had not actually been signed by Penten. As such, Penten was bound by its terms.

So, what does this ruling mean in practice? Are all letters of intent going now to be binding or, worse still, somehow end up “morphing” into binding subsequent agreements? Of course not. The message in this article is simply to highlight that letters of intent need to be deployed with caution, as they can end up creating binding obligations on terms which eventually lead to a party’s detriment. They can also, in not carefully drafted, create legal uncertainty something which one would be looking to avoid where possible. AS Nissen QC highlighted, each case depends on its own facts. At the end of the day, there is no harm in having your solicitor give any letter of intent being proposed a “once over” before it is actually signed.

The content of this article is provided for general information only. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content herein.

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