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Case Update – letters of intent: yet more problems!

The Supreme Court in RTS Flexible Systems Limited v Molkerei Alois Müller Gmbh & Company [2010] UKSC 14 overturned the decisions of the lower courts and found that after the expiry of a letter of intent, although the parties never signed a formal written agreement and regardless of the fact that the agreement was said to be subject to contract, the agreement was binding on the parties.

Dispute

In brief, the facts of the case were that RTS agreed to supply a packaging system to Müller. The work began on the basis of a four week letter of intent whilst the parties negotiated the terms of the final contract. A draft contract was drawn up incorporating the amended MF/1 terms but the contract was not signed. The letter of intent expired but RTS continued work and the parties continued to negotiate the terms of the contract. As at 5 July 2005 the parties had reached agreement on all major terms of the contract save for the liquidated damages provisions. The draft contract contained a provision stating that the contract would not become effective until each party had executed a counterpart and exchanged it. This never happened. The project ran into difficulties which meant that RTS were unable to meet the original programme. The parties therefore met on 25 August 2005 to vary the project delivery plan. On a claim for payment by RTS the question of whether a contract had been entered into and, if so, upon what terms was referred to the court as a preliminary issue.

Decision

The matter ended up with the Supreme Court who held that the parties had reached a binding agreement on or around 25 August 2005 on the terms agreed on or before 5 July 2005 (as subsequently varied on 25 August 2005). The Court held that the parties had effectively agreed to waive the provision that the contract was not effective until executed and so the binding agreement was not “subject to contract”.

In reaching its decision, the Supreme Court stated that it was unrealistic to suppose that the parties had not intended to create legal relations. Once the letter of intent had expired, the contract containing the price must have been contained in another agreement. The parties had treated the agreement reached on 25 August as a variation of the agreement that they had reached by 5 July 2005. It was not until the parties were in dispute that the suggestion that there was no contract arose.

The Supreme Court further stated that, in a case where a contract is being negotiated subject to contract and work begins before the formal contract is executed, it would be too simplistic and dogmatic an approach to say that there would always, or even usually, be a contract on the terms that were agreed subject to contract. The Court would not impose binding contracts which the parties had not themselves agreed. All decisions would depend on the circumstances of each case. It was necessary to consider (amongst other facts): whether the parties intended to be legally bound by what was agreed; whether further essential terms were necessary in order for the contract to be enforceable; and whether the parties had departed from their understanding that the contract being negotiated was “subject to contract”, in other words not binding until signed.

Advice

As Lord Clarke stated in his judgment, this case highlights the perils of beginning work without agreeing the precise basis upon which the work is to be done. This case reinforces our view (now supported by Lord Clarke!) that letters of intent should be avoided and a formal contract executed before work begins.