The dangers of starting work based on letters of intent

Sometimes, works are commenced based entirely on letters of intent. Presumably, this is because the employer wants the work to start immediately, whilst the details of the formal contract are still being worked out. For a contractor, being asked to start work on a letter of intent is oftentimes perceived as being as good as having secured the contract.

So, everything is hunky-dory, right? Well, not quite.

A contractor who starts work on a letter of intent may face difficulty subsequently to claim for its full entitlement should a formal contract fail to be signed. Clearly a contractor would still be able to claim for works actually carried out based on quantum meruit. However, how about the other costs incurred, including preparatory costs, which would oftentimes be provided for by way of preliminaries in a formal contract? How about materials ordered for purposes of the work, but which are not required as yet? Can the contractor claim reimbursement for these materials?

The answer is far from certain, and would very much depend on the wordings of the letter of intent.

Another clear disadvantage for the contractor would be its inability to claim for payment under the Construction Industry Payment and Adjudication Act 2012 (CIPAA) which only allows claims to be made based on a written construction contract. Of course, one may argue that the letter of intent is in fact a written construction contract in essence, but that remains at best an arguable point.

For the employer, it is not entirely without risk as well. If a contractor subsequently refuses to sign on the formal contract, perhaps due to disagreements over certain terms, the employer would be left in a lurch. Appointing a substitute contractor to replace the existing one usually comes at a higher cost. There may also be issues with defects, quality and workmanship of the earlier contractor- how can the employer clearly determine which contractor is at fault? The earlier contractor would also be unlikely to leave the work without raising disputes over payment- how much is in fact due? Is the contractor to be reimbursed only for costs, or for a reasonable and fair valuation of its works? Who is to determine what is reasonable and fair?

All these issues and more ought to encourage parties to sign on to a formal contract where possible before commencing work. This would help all parties clarify their respective rights and obligations, allow the contractor access to CIPAA procedures, and at the same time reduce the potential for future construction disputes.

Kheng Hoe Advocates is a firm of construction lawyers based in Kuala Lumpur, with strategic alliances in Penang, Melaka and Johor Bahru. For queries, contact khenghoe@khenghoe.com.