Risks of accidental contracting
01 December 2016
Interim documents, such as letters of intent, may be necessary to launch works on projects. However, these must include certain clauses to handle the eventuality of later concluding the final contract and of not concluding it, says STUART JORDAN*.
Making construction contracts can be a messy business. In other, more organised (and less interesting) industries, the parties like to agree their contract terms in full, write it up, sign it and then start to perform it.
That isn’t how we do it in construction. In our more exciting world, there is usually a frantic pre-contract period in which every part of the deal – technical, financial and legal – is still moving. There will be tender clarifications, engineering and change management workshops, scopes of works still coming together and negotiations running on price, programme and contract conditions.
Into this fray comes the news that, to maintain programme, works need to begin immediately! Everyone starts thinking about how to cover that. The solution is some sort of interim document, usually a Letter of Intent.
The main danger, and the one so frequently ignored in fast-moving situations, is accidental contracting: the inadvertent creation of a contract covering all of the project works. The most common mistake is simply to create a short letter of intent telling the contractor that he has won the job, that the parties will agree the final detail of the contract later on but asking the contractor to mobilise straight away.
Even without this imperative to start work, parties are sometimes tempted to set out their part-deal in a Letter of Award, Heads of Terms, Memorandum of Understanding or similar. There can be good reasons for this, for instance a memorandum to provide a route map for the negotiation. There are also bad reasons: for instance where – as often happens – the parties simply lose momentum on the road towards agreeing the full contract, so they produce a letter of award as a stop-gap solution. Of course, it is not a solution. If there are difficulties in producing final contract terms, it will be because of incomplete data or real disagreement on the terms – precisely the time to address those issues and not to make an incorrect or incomplete record.
In doing these things, employers believe that they are protected against the accidental award of the whole works, simply by mentioning the as-yet unagreed final contract. This is the principle of “nothing is agreed until everything is agreed”. This approach always has risks, no matter where you are working, but there are particular dangers in the Middle East.
One common risk is that the interim document records at least the essentials of the deal as agreed. The UAE Civil Code Article 141 states that if the parties agree the essential elements of a contract but leave the matters of detail to be agreed upon afterwards, and without stipulating that the contract shall not be binding without agreement on that detail, the contract shall be deemed to have been made. The court can effectively insert that detail “in accordance with the nature of the transaction and the provisions of the law”.
This is not too different from the common law principle that certainty on deal essentials (in our case: specification, price and programme) is enough to create a contract. The solution, of course, is to refer to these partially-agreed terms as being not binding pending the final contract.
The added risk in the Middle East, however, derives from the concept of good faith. Employers and contractors do not necessarily see these interim documents in the same way. Whilst employers might be intending just to record the position, leaving everything open for discussion, contractors might see the broad points as “banked”, that is, closed and committed to. Their expectation, even in a “non-binding” document, might be that the parties will proceed in good faith to flesh out the detail in those points but not depart from the principles. Also, an interim document might create an expectation that the parties will continue to negotiate the other points as well, maybe to do so for a reasonable amount of time and to reach a reasonable position.
The common law perspective is, of course, different: an “agreement-to-agree” is legally without force, and the concept of ‘good faith’ is essentially unrecognised in English Law, but Article 246 of the UAE Civil Code requires contracts “to be performed in a manner consistent with the requirements of good faith”.
Depending always on the specific terms of an interim document, the parties might conceivably be held both to any broad points which are stated to be agreed, and possibly to an obligation to continue to agree full terms, or to make certain effort to do so. To avoid the danger of accidental contracting, both issues should be addressed specifically.
If an interim document cannot be avoided – for instance works need to commence pre-contract – the best approach is to state clearly what is and what is not happening in relation to the works as a whole. That means a letter of intent which can handle the eventuality of later concluding the final contract and of not concluding it. The letter should include the following features:
• This is not an award of the whole works. That might happen if a final contract is agreed but there is no obligation on either party to conclude a contract or to make any particular effort to bring that about.
• This is a limited authorisation to do certain works for a fixed or maximum sum.
• These limited works are subject to specified contract terms, referenced. If these works are not subsumed into the full contract works, these terms will continue to apply.
In construction, we know that every element in project delivery is price and programme-sensitive. That makes agreement on full contract terms sometimes difficult to achieve, but the best approach to contract formation is still ‘all or nothing’.
* Stuart Jordan is a partner in the Global Projects group of Baker Botts, a leading international law firm. Jordan’s practice focuses on the oil, gas, power, transport, petrochemical, nuclear and construction industries. He has extensive experience in the Middle East, Russia and the UK.
