What's the intention?

Imagine this scenario: It's late in the afternoon, and a general contractor to whom you recently submitted a bid on a reroofing project calls you. The general contractor informs you that your company will be awarded the subcontract to perform the reroofing work. A few days later, you receive a letter of intent from the general contractor. The letter reiterates you have been awarded the subcontract and directs you to proceed with preparations for the work, including obtaining the necessary permits, ordering the required materials and preparing all relevant submittals. The letter also states a form subcontract will be forwarded to you soon for review and signature.

You do as instructed, incurring the costs of the permits, materials and preparation of the project submittals. The general contractor is anxious to get the job going, so you even perform some preliminary tear-off work while you attempt to negotiate the subcontract terms.

Ultimately, negotiations fall through because the general contractor is not willing to agree to any revisions to its standard subcontract form and you are not willing to take on the risks associated with some of the more onerous provisions in the subcontract. As a result, the general contractor decides to use another roofing contractor for the project. In this situation, can the letter of intent serve as a basis to recover the costs you have incurred thus far?

Letters of intent

Unfortunately, the answer to this question usually is difficult to determine because it will depend on the letter of intent's specific language, circumstances surrounding the issuance of the letter and whether the letter (either by itself or in conjunction with other documents or the parties' conduct) ultimately is found to constitute a legally binding contract. If, in the example scenario, the letter of intent is not found to be a contract, you will not be able to make a claim for breach of contract to recover the costs incurred in preparing and performing the project. Instead, you will be limited to other legal theories for recovery.

This may surprise you. A formal letter of intent issued and signed by the parties certainly appears to provide some guarantee of payment for work performed to prepare for a project. Nevertheless, courts often consider letters of intent as nonbinding "agreements to agree" that provide no independent basis for recovery.

For instance, in the 1990 case Showcase Woodworking Ltd. v. Fluor Daniel Inc., Showcase Woodworking, Ashland, Va., submitted a bid to Fluor Daniel, Irving, Texas, the general contractor on the Riverfront Plaza project in Richmond, Va. Showcase Woodworking and Fluor Daniel later met on a number of occasions to review and discuss the bid.

Subsequently, Fluor Daniel issued two letters of intent to Showcase Woodworking confirming the amount Fluor Daniel would pay Showcase Woodworking for the job. Each letter of intent stated: "This letter is to express Fluor Daniel's intent to award and enter into a Subcontract with your company. … [T]he final subcontract agreement for execution by Showcase Woodworking, which will be forwarded at an early date, shall supplant and take precedence over this Letter of Intent, when the Subcontract Document is duly executed by Fluor Daniel, Inc. and Showcase Woodworking Ltd."

Before a formal subcontract could be executed, a dispute arose between Fluor Daniel and Showcase Woodworking regarding certain work to be performed on the project. The parties were unable to reach a compromise, and Fluor Daniel awarded the work to another subcontractor. Showcase Woodworking filed suit against Fluor Daniel, and Fluor Daniel filed a summary judgment motion claiming no valid contract existed between the parties. In response, Showcase Woodworking argued a binding contract existed between the parties as evidenced by the parties' meetings and letters of intent.

The trial court disagreed with Showcase Woodworking and granted Fluor Daniel's motion for summary judgment.

According to the court: "An agreement to agree is not a contract; just as a proposal to contract is not a contract. A formal written contract is not necessary for the formation of a binding agreement. Nevertheless, the fact that the parties intend to have a formal contract drawn up is evidence that they do not intend previous negotiations to amount to a binding contract."

Because the letters of intent clearly demonstrated the intent to enter into a "final subcontract agreement" at a later date, the court found no binding contract was formed.

Intent is key

As indicated by the Showcase Woodworking Ltd. v. Fluor Daniel Inc. case, the enforceability of a letter of intent as a binding legal contract usually will turn on the parties' intentions. If the parties actually intend to be bound by a letter of intent, a binding contract is formed. If there was no intent to be bound, no enforceable contract will exist.

The Illinois Supreme Court case Quake Construction Inc. v. American Airlines Inc. provides a good example of the emphasis courts place on the parties' intentions when determining whether a letter of intent constitutes an enforceable contract.

In this case, Quake Construction, Chicago, submitted a bid to Jones Brothers Construction Corp., Los Angeles, the construction manager on a project that involved the expansion of certain employee facilities and the auto shop at O'Hare International Airport near Chicago. Thereafter, Jones Brothers Construction notified Quake Construction orally that Quake Construction had been awarded the contract for the project and informed Quake Construction a written contract would be prepared for execution.

Jones Brothers Construction subsequently sent a letter of intent to Quake Construction. After the letter of intent was issued, Quake Construction and Jones Brothers Construction discussed and orally agreed on certain changes to the project contract. However, no final revised contract was ever executed.

Following the pre-construction meeting, Quake Construction was terminated from the project. Quake Construction brought suit against Jones Brothers Construction and the owner under a number of legal theories, including breach of contract, to recover the costs Quake Construction incurred to expand its office space, hire a project manager, secure subcontractors for the project and otherwise prepare to perform work on the project and for Quake Construction's anticipated profits. In doing so, Quake Construction alleged the letter of intent was a binding contract between the parties and Jones Brothers Construction had breached that contract.

The trial court disagreed with Quake Construction and dismissed its complaint. Quake Construction appealed to the Appellate Court of Illinois. When reviewing the trial court's decision, the appellate court focused on the parties' intentions. The appellate court found the letter of intent was ambiguous as to the parties' true intentions, so it remanded the case for further proceedings on this issue. Jones Brothers Construction subsequently appealed to the Illinois Supreme Court.

During its review, the Illinois Supreme Court discussed the law concerning the enforceability of letters of intent, stating: "If the parties intended that the document be contractually binding, that intention would not be defeated by the mere recitation in the writing that a more formal agreement was yet to be drawn. However, parties may specifically provide that negotiations are not binding until a formal agreement is in fact executed. If the parties construe the execution of a formal agreement as a condition precedent, then no contract arises unless and until that formal agreement is executed. … Thus, although letters of intent may be enforceable, such letters are not necessarily enforceable unless the parties intend them to be contractually binding."

Ultimately, the Illinois Supreme Court concluded, as the appellate court previously had done, the letter of intent was ambiguous as to the parties' intent. The court found portions of the letter evidenced the parties' intent to be bound. For instance, the letter included detailed terms of the agreement, including the scope of work, price to be paid for the work and schedule for the work. The letter also stated the contract was awarded to Quake Construction and that the letter "authorizes the work."

Conversely, the court pointed to several references in the letter of intent regarding the execution of a formal contract by the parties, which could indicate the parties' intent not to be bound by the letter. Because the parties' true intent could not be ascertained, the court remanded the case to the trial court for further proceedings to decide this issue. How the trial court ruled after the remand is unknown; trial court proceedings generally are not reported.

Conduct is relevant

Courts also will look to the parties' specific conduct when determining whether an enforceable contract exists. If a letter of intent and the parties' conduct indicate an agreement has been reached, recovery for breach of contract generally will be permitted.

This standard was applied in the North Carolina case Industrial & Textile Piping Inc. v. Industrial Rigging Services Inc. In this case, the Appeals Court of North Carolina affirmed a trial court's conclusion that Industrial & Textile Piping, Charlotte, N.C., a general contractor, and Industrial Rigging Services, Raleigh, N.C., an equipment rigging subcontractor, entered into a binding contract because "communications and conduct between the parties [including a letter of intent] manifested a mutual assent."

Industrial Rigging Services submitted a bid to Industrial & Textile Piping for certain equipment rigging services. Industrial & Textile Piping subsequently accepted Industrial Rigging Services' bid and ordered Industrial Rigging Services to staff the project. The parties agreed to the specific tasks Industrial Rigging Services was to complete on the project, a time schedule for performance and payment terms.

Thereafter, Industrial & Textile Piping sent a letter of intent to Industrial Rigging Services to "solidify [their] mutual understanding" and agree on a price to be paid for Industrial Rigging Services' work. The letter stated the parties would "meet for the formal contract signing" once Industrial & Textile Piping's contract with the project owner was in place.

Industrial Rigging Services commenced its work on the project, and Industrial & Textile Piping made initial payments to Industrial Rigging Services. However, Industrial Rigging Services subsequently refused to sign Industrial & Textile Piping's form subcontract because it contained new terms to which Industrial Rigging Services had not agreed and would not agree.

Industrial & Textile Piping demanded Industrial Rigging Services either sign the subcontract or leave the project. Industrial Rigging Services chose to leave the project, and Industrial & Textile Piping sued Industrial Rigging Services to recover the costs it incurred when completing the equipment rigging work. Industrial Rigging Services counterclaimed against Industrial & Textile Piping for payment for the services it had performed before leaving the project.

In support of its affirmation of the trial court's decision that a binding contract existed between Industrial Rigging Services and Industrial & Textile Piping, the appeals court stated: "The parties' failure to reach agreement on the written subcontract does not preclude the conclusion that an express contract existed." Here, the parties' conduct and the letter of intent created a contract "despite lack of the formal document which the parties contemplated."

Proceed with caution

Given the urgency that many owners and general contractors have to get their projects up and running as quickly as possible, there is no doubt you may be called upon to perform preparatory work pursuant to letters of intent before executing formal contract documents. When this occurs, be aware that a letter of intent, by itself, may not constitute a binding agreement upon which a claim for payment for such work can be made. Instead, you only will be entitled to recover if there was the intention, by both parties, to be bound by the letter of intent and an enforceable contract is found to exist. Absent this, you will need to look to other legal theories for recovery.

Brian P. McCormick is an attorney with Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.

An alternative path to recovery

There are other legal avenues to recover costs you have incurred as a result of relying on a letter of intent even when the letter itself does not qualify as a binding legal contract. The legal doctrine "quantum meruit" provides for the recovery of the reasonable value of services provided when no contract exists between two parties. Generally, you would need to prove the following to recover costs incurred as a result of relying on a letter of intent: you provided services to the general contractor; the services were accepted by the general contractor; you had the expectation of being compensated for the services; and the reasonable value of the services. Assuming these elements can be proven, you would be entitled to compensation for the reasonable value of the work provided.