It is not uncommon for parties in construction projects to commence work under a letter of intent, pending the negotiation and execution of a full written contract which sets out the detailed terms and conditions governing contract performance. Construction projects are often time and cost sensitive. For example, in the case of a design and build contract a contractor may wish to commence design and procurement tasks immediately upon the award of a project but before a final written contract has been negotiated and executed. Doing so may alleviate subsequent time pressures, for which the contractor will normally expect to bear the risk throughout the course of the project. However, a recent decision of the English Court of Appeal is a salutary reminder of the potential risks facing parties who start work before concluding the contractual terms and conditions that will govern performance.
RTS Flexible Systems Ltd v Molkerei Alois Müller
In RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG[1]the appellant, RTS Flexible Systems Ltd (“RTS”), had been in discussions over a number of years with the respondent, Molkerei Alois Müller GmbH & Co KG (“Müller”), a leading European producer of dairy products, about updating Muller’s packaging equipment. These resulted in a number of quotations from RTS to design, manufacture, assemble and commission new packaging equipment.
RTS was awarded the contract on the basis of a quotation which referred to its standard terms and conditions. The award of the contract was set out in a Letter of Intent from Müller (the “LoI”), which also referred to Muller’s standard form contract. The LoI provided:
“Please accept this letter of intent as confirmation of our wish to proceed with the Project as set out in the [quotation] subject to the following terms:- … (iii) [t]hat the full contractual terms will be based on Müller’s amended form of … contract and the full terms and the relevant technical specifications will be finalised, agreed and then signed within 4 weeks of the date of this letter.”
Muller’s standard form of contract included a clause (“Condition 48”) which provided:
“The Contract may be executed in any number of counterparts provided that it shall not become effective until each party has executed a counterpart and exchanged it with the other.”
Work was commenced by RTS on the basis of the LoI and the parties continued to negotiate the terms of their final agreement. The four-week period referred to in the LoI was subsequently extended more than once but these periods of extension expired before the parties were able to conclude their agreement.
Muller contended that after the LoI had expired it had no further obligation in respect of work performed by RTS unless and until a final written agreement had been executed by both parties. The issue of whether there was a binding agreement between the parties was referred at first instance to the English Technology and Construction Court (the “TCC”).
The trial judge, Mr. Justice Clarke, observed that this case was “…another example of the perils of proceeding with work under a letter of intent”. Referring to Trentham v ArchitalLuxfer,[2] in which the Court had held it was “unrealistic to argue that there was no intention to enter into legal relations”where the parties had prematurely commenced performance, the TCC found that there was a concluded contract between the parties. However, the TCC found that the terms of that contract did not include the terms of Muller’s standard form of contract, which included terms that would limit RTS’ liability. Rather, a contract was found to exist which contained no limit on RTS’ liability.
RTS therefore failed in its submission that the LoI continued to govern the parties’ relationship and included Muller’s standard terms and conditions, including the terms limiting RTS’ liability. It also failed in its alternative submission that any contract existing between the parties upon the expiry of the LoI included Müller’s standard terms and conditions.
On appeal to the Court of Appeal, RTS pursued a different argument, submitting that there was no contract between the parties following the expiry of the LoI. If successful, RTS would be entitled to a quantum meruit payment of the costs incurred by it, and would be subject to a maximum liability to Müller amounting to the return of the money paid to it by way of abatement for any defects in the works.
RTS sought to distinguish the decision in Trentham on the basis that in that case all obstacles to the formation of a contract had been removed. In the present case it had been clearly agreed between the parties that the negotiations were being conducted on the basis of Condition 48 of Muller’s standard form contract, which expressly provided that “…the Contract … shall not become effective until each party has executed a counterpart and exchanged it with the other.” RTS submitted that, accordingly, despite apparent agreement on particular terms and conditions, no agreement could be said to exist until a contract had been executed by both parties.
Although not referred to by RTS, the decision in Trentham was similarly distinguished in the earlier 2008 case of Diamond Build Ltd v Clapham Park Homes Ltd.[3] In that case, Mr. Justice Akenhead sitting in the TCC rejected arguments that a letter of intent had been superseded by a formal contract agreed in principle but left unsigned. He went on to state that, “the parties must be taken to have been aware of the requirement … that there was to be a formal contract under seal [before the Letter of Intent lapses]. … By accepting the Letter of Intent, the parties were accepting that the terms of that Letter should dictate the rights and obligations of the parties until the formal contract was signed.”
The Court of Appeal in RTS v Müller was persuaded by this argument and allowed the appeal.[4] Waller, LJ noted that the parties’ agreement to Condition 48 meant that “…there is no answer to the argument that no contract came into existence.” The parties clearly intended that following expiry of the LoI there was no intention to create binding legal relations unless and until a written contract was executed by both parties. He noted that the TCC’s finding that a contract existed which contained no limit on RTS’ liability was an “extraordinary result” which did not accord with both parties’ clear intention that RTS’ liability would be limited.[5]
Comment
This decision is a reminder of the perils of proceeding with work under a letter of intent. While commercial pressures will continue to result in contractors commencing work before a full and final written contract is concluded, it is prudent to ensure that critical terms are sufficiently set out in the letter of intent and that final terms are agreed upon in a written contract as soon as possible thereafter. It is also helpful if the parties use clear language to reflect their intentions with regard to the creation of binding legal obligations. If a time limit or “sunset” provision is included in the letter of intent, it is necessary to address the situation in which work has commenced but no formal written contract has been agreed by the date of expiry of the letter of intent.
This article was prepared by David J. Howell (+44 20 7832 3605 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), Partner and Co-chair of the firm’s Construction Practice Group, and James Rogers (+44 20 7832 3616 or This e-mail address is being protected from spambots. You need JavaScript enabled to view it ), a Senior Associate, in the London office.
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[1] [2009] EWCA Civ 26
[2] [1993] 1 Lloyds LR 25
[3] [2008] EWHC 1439 (TCC)
[4] The Court of Appeal also refused leave to appeal. However, leave was sought directly from and granted by the House of Lords on 14 May 2009 and a further appeal is therefore expected.
[5] Cf. British Steel Corporation v Cleveland Bridge and Engineering Co Ltd [1984] 1 All ER 504