Carrying out works prior to completion of contract

13th February 2019

Walker Morris consider the common scenario where parties do business together prior to concluding a formal contract, and offers his practical advice.

It is a very common commercial scenario: at the outset of a venture, relationships are positive and parties are eager to just get on and do business together, rather than wait for the lawyers to dot the ‘i’s and cross the ‘t’s. Parties therefore go ahead and start work, pending completion of a formal contract.  However, when markets or circumstances change, relationships sour or disputes arise, the parties realise that, without a concluded contract, they lack certainty or common understanding as to the terms which govern their business relationship.

Formation of contracts: What businesses need to know

A contract is formed when all of the following key elements are present: offer; acceptance; consideration (that is, money or money’s worth); and intention to create legal relations.  Contracts can be made orally (face-to-face or via some communication medium such as the telephone); via an exchange of e-mails or other correspondence; or they can even arise by virtue of the parties’ conduct. Crucially therefore, with some limited exceptions, contracts can be formed without any written documentation or other formality whatsoever.

A lack of understanding about the formation of contracts can have devastating consequences. For example, a party may have invested significant time and money in a project on the understanding that its opposite number was contractually bound to the scheme, only to find that no binding obligations are actually in effect and that its opposite number can walk away scot-free, leaving the project to collapse, at any time.  Similarly, a party may be operating under the assumption that key terms (say, as to price, limitation of liability or termination options) are still to be agreed, only to find that their conduct, or something they said to their opposite number several weeks ago, has committed them contractually to what is now an unfavourable deal.

What can businesses do?

In the vast majority of commercial cases, the best advice will be for parties to wait until a formal written contract has been finalised and completed before they start work or otherwise invest any significant time or money in a venture. But what can parties do in cases where that is just not practicable?

A sensible option is often to put into place a ‘letter of intent’, which should concurrently provide comfort that the parties are equally committed to the venture and that they intend to be contractually bound in the future when contractual documentation is completed and guard against the risk of a binding contract arising inadvertently by words or conduct in the meantime.

What are the risks?

Even that option can carry risks, however. In the recent case of Arcadis Consulting v AMEC [1], the parties commenced works and put into place a letter of intent while they conducted negotiations on a construction project contract that never materialised.  However, the letter of intent was not clearly drafted – either as to its legal status and force, or as to its terms.  To the intense chagrin of one of the parties, the letter of intent was ultimately found, by the Court of Appeal, to constitute a contractual offer, which was accepted by exchange of correspondence and/or by conduct when works began.  Not only was that party therefore inadvertently landed with a binding contract per se, but also it was bound by terms contained within what it had thought was merely a non-binding letter of intent.  One of those terms was a liability cap of £610k.  That proved disastrous for the party’s damages claim when works went wrong and it faced a potential loss of £40m.

WM Comment and practical advice

Commercial parties should review their negotiating practices and be aware of the risks associated with informality in the formation of contracts. It is essential that businesses educate their staff as to the risks of both inadvertent contract formation and of conducting business (and therefore going on to incur expenses and responsibilities) on the assumption that contractual backing exists when in fact it may not.

The lack of any specific requirement for formality and/or documentation means that it is important that parties should not discuss terms or act in any way that is inconsistent with their contractual intentions in case a contract comes into effect prematurely, inadvertently or on unsuitable terms.

Equally, parties should be very clear about their intention to create legal relations (or not) because, depending upon the particular circumstances (and as the Arcadis v AMEC example shows), it can be a costly mistake to assume that a contract has not come into being at all.

An understanding of some key contractual principles, as well as an awareness of the practical scenarios in which informal commercial discussions may arise for any particular business, will be key to getting the balance right between being able to quickly obtain sufficient comfort to enable parties to proceed with their plans, and becoming legally bound when that is actually required.

Letters of intent can be a very helpful tool. However, it is absolutely essential that a letter of intent is clearly and accurately drafted to confirm both that it is the parties’ intention that neither will be contractually bound unless or until formal contract documentation is completed and as to the terms (or lack of terms) that govern the parties’ relationship and venture in the meantime.

If you would like any advice, assistance or training on the issues considered in this briefing, or if you would like any specialist input on a letter of intent, please do not hesitate to get in touch.

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[1] Arcadis Consulting (UK) Ltd v AMEC BCS Ltd [2018] EWCA Civ 2222