Letters of Intent Are Popular But Limited

I HAVE WRITTEN before about this odd creature, the letter of intent, but the phone calls I get from clients convince me that there is still a lot of misunderstanding about what a letter of intent can do, and where danger lurks. In the latest case, the client issued a letter of intent to a small fencing contractor, and in the course of trying to clearly define the scope, he kept hearing him say, I

I HAVE WRITTEN before about this odd creature, the letter of intent, but the phone calls I get from clients convince me that there is still a lot of misunderstanding about what a letter of intent can do, and where danger lurks.

In the latest case, the client issued a letter of intent to a small fencing contractor, and in the course of trying to clearly define the scope, he kept hearing him say, “I didn’t have that in my bid,” or “What’s a shop drawing?” or “How much insurance do you want me to have?”

My client decided that this guy was not professional enough to rely upon and he wanted to just walk away because, after all, he “didn’t have a contract, only a letter of intent.” I had to advise him that he would not walk away scot-free.

There must be very good reasons to use these documents (because contractors insist on using them a lot), but there is risk associated with them. Prudent contractors won’t give or take one without understanding what they’re getting into.

A letter of intent is not a contract. Inherent in saying, “I intend to issue a contract to you,” is the understanding that I have not yet done so. To paraphrase Casey Stengel, there ain’t no contract ‘til there is a contract.

A subcontractor or supplier who goes out and makes binding commitments for materials in reliance on a letter of intent may or may not be able to get paid for the expenditures. It is unlikely, however, that he would be able to get lost profits — the “classic” damages for breach of contract — if the contract itself never materializes.

Thus, if the sub or supplier getting a letter of intent turns down other work because the work covered by the letter of intent will keep his shop or workers busy, he will not generally be able to get back the lost profit from that work.

A letter of intent does, however, give the recipient the right to rely on it. This means that any expenses that the sub or supplier reasonably incurs in reliance on the letter of intent will be recoverable. What is “reasonable” will depend entirely on the circumstances.

If there is a long lead time on equipment, and the contractor issuing the letter of intent knew this and issued the letter so that the sub could feel comfortable issuing purchase orders, then the contractor will likely be responsible for any cancellation charges the sub incurs if the contract never comes to pass.

If any design or shop drawings are needed right away, and the sub/supplier can show that this was the reason for issuing the letter of intent, those expenses will be recoverable.

If it can be proven that the party issuing the letter of intent understood that the party getting it needed to get sub-subcontractors on board, or get a trailer on the site, or apply for permits, etc., all reasonable expenses will be recoverable.

Protect yourself by specifying the scope of the current obligation. Whether you are getting or giving a letter of intent, it is in your interest to have the letter clearly set out how far the party getting it is entitled to rely on it to incur expenses. Some examples are:

“This letter is your authorization to initiate preparation of shop drawings.”

“This letter is your authorization to place an order for XYZ’s Model GT234 pump.”

“This letter is your authorization to begin fabrication of ductwork, not to exceed $2,500.”

It is never a good idea to allow any work on site based on a letter of intent. Issues of insurance, supervision, scheduling, safety and so forth are all items that have to be taken seriously and pinned down before workers can be allowed on site. If you are going to go through all the trouble of working these issues out and getting insurance certificates, then you’ve already done most of the work of putting together a subcontract anyway. If there isn’t time to address these issues in writing, keep off the site!

The longer parties operate under a letter of intent, the harder it will be to resolve fuzzy issues later. If a general contractor’s form subcontract has some tough language in it (such as a pay-if-paid or no-damages-for-delay clause), it will be harder and harder to force a sub to accept it the longer the sub has been working under a letter of intent.

While a sub or supplier might think that this is a good thing — and it is better than having these clauses forced on you — it surely is better to not have a fight in the first place. Most of the time the sub’s money is held up while the parties “negotiate” and the sub risks losing the right to do the rest of the work, or worse, if matters aren’t resolved.

The moral here is that no one should give or receive a letter of intent without pinning down what actions can be taken in reliance on it, and what happens if the parties can’t agree on a contract down the road. But as long as contractors decide not to do this, I stay busy.

Susan McGreevy is a partner at Husch & Eppenberger, Kansas City, Mo., tel. 816/421-4800, e-mail to [email protected].

TAGS: Law