Recent cases decided by the Court of Appeal highlight the risks in commencing work under a letter of intent or interim agreement before a contract has been finalised.

Traditionally, the law considers that a contract is formed through an offer made by one party followed by acceptance of the offer by another party. Parties who plan to enter into a formal agreement will generally negotiate the terms of the agreement on a "subject to contract" basis. Until they enter into the formal contract, those "subject to contract" negotiations are not legally binding. Sometimes, however, commercial pressures will mean that a party starts work on the basis of what had been agreed in a letter of intent or interim agreement before a final and written agreement is concluded.

If there is then an issue resulting in litigation, the Court will have to decide whether a contract had been formed and/or the amount due to be paid to the party who performed the services.

We discuss below two recent examples of cases dealing with this question. Although they involved parties in the distribution and manufacturing industries, the issues raised are equally applicable to all businesses.

No contract where work undertaken under Letter of Intent

In Whittle Movers Limited v Hollywood Express Limited [2009] EWCA Civ 1189 the Court of Appeal decided that the High Court had been wrong to find that the parties had entered into a contract evidenced by an interim agreement and "subject to contract" negotiations. Hollywood (a subsidiary of a cinema group undertaking distribution and warehousing services) selected Whittle Movers to be its subcontractor for the distribution services. The tender process was "subject to contract" and contemplated the execution of a formal long-term contract.

Hollywood sent a letter of intent to Whittle in November 2005 which stated "The contract will be on the terms of the draft contract attached to [Hollywood's] invitation to tender, amended to take into account the commercial details agreed during the tender process .." In December 2005, the parties entered into an "interim agreement". By January 2006, the parties had not concluded the formal contract but the period for the supply of Whittle's services under the proposed formal contract commenced. Whittle started performing services and invoiced Hollywood. Hollywood paid Whittle for the work.

No formal contract was drawn up as Hollywood's owners (Odeon/UCI) decided to put it up for sale by autumn 2006. Hollywood gave Whittle six months' notice of its intention to terminate the interim agreement. Whittle argued that the parties had actually entered into a long term contract (by Hollywood's conduct in accepting the distribution services) and that the parties were bound by that.

The High Court decided that the parties had, by conduct, concluded an interim contract which had been varied by agreement to reflect changes in pricing and services. Both parties appealed the decision and the matter went to the Court of Appeal. Lord Justice Waller decided that the High Court had been wrong to find that there was a contract and said that, if important terms were still under negotiation, the proper answer was that there was no contract. He did, however, decide that there ought to be an inquiry as to whether Hollywood had been unjustly enriched (i.e. received an unjust benefit) as it had received services from Whittle for a short period at a price only appropriate for a long term contract.

No contract because of counterparts clause

In another recent case, RTS Flexible Systems Limited v Molkerei Alois Müller GmbH & Co KG [2009] EWCA Civ 26, the issue of whether or not the parties had entered into a contract after termination of a letter of intent is about to be decided by the Supreme Court. The case involved RTS (a manufacturer specialising in automated machines for packaging and handling) successfully tendering for a contract to supply Müller with an automated system for packaging yoghurt pots. The parties agreed that RTS would start work on the basis of a letter of intent while the parties negotiated the terms of a final contract. The final contract was to be based on industry model standard conditions (MF/1) amended to reflect the project between the parties. Clause 48 of the MF/1 conditions stated that:

"This 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".

A draft contract was prepared but was never signed by the parties. After the expiry of the letter of intent, RTS continued to work on the project. A dispute then arose as RTS did not carry out the site acceptance testing stipulated in the tender document and Müller made partial payment (but refused to pay the outstanding balance).

The Judge in the High Court found that, after the expiry of the letter of intent, a new contract had come into existence which incorporated the obligations under the schedules to the draft contract (but which did not incorporate the MF/1 conditions including the counterparts clause). RTS appealed to the Court of Appeal who disagreed with the High Court's finding. The Court of Appeal held that the definition of "Contract" in the counterparts clause covered the schedules to the draft contract. This prevented any contract coming into existence until the parties had entered into a written agreement (by executing separate copies of the agreement before exchanging). Therefore, no contract had come into existence post termination of the letter of intent.

The amount due to RTS was to be decided on a quantum meruit basis (i.e. consideration of what was a reasonable sum for the work undertaken). Müller's appeal of the decision was dealt with by the Supreme Court in December 2009 and the judgment should be published shortly.

Points to consider

It will be interesting to see what the Supreme Court decides in the RTS v Müller case. The decisions do, however, highlight the inherent risks in a party carrying out work under a letter of intent until a formal contract has been agreed. If a dispute arises, the Court will be required to look at the circumstances of the agreement to determine what was intended by the parties and whether a contract does, in fact, exist. If a party is under pressure to commence work before a contract is concluded, it should ensure that critical terms are properly set out in the letter of intent and the final contract is concluded as soon as possible.

Rebekah Richards