An illusory promise is an oxymoron, as it is not a promise at all. “I will take out the trash” is a promise of sorts. “I will take out the trash if I feel like it” is illusory.
With contracts, I discussed the illusory promise question with regard to terminations for convenience clauses in my November 2009 column, “We Don’t Want You Anymore.” One of the fundamentals of contract law is that there must be mutuality of obligations to have an enforceable agreement. “I will pay you if you build my deck.” One side is obligated to build, one to pay.
In construction, as with most contracts, other elements besides mutual promises are necessary to have a binding agreement. There should be a defined scope of work and a price. If what is being bargained for is unclear, there may not be the requisite mutuality. (See my article, “A Cow, by any Other Status ...”.)
These matters are basic, yet there is a continuing misunderstanding of the rules where letters of intent are involved. So many unintended consequences can arise with their use that many attorneys recommend not using them at all.
What is it, and why have one?
A letter of intent is not a contract. It is an expression of intent to enter into a contract. On its face, it confirms that there is no agreement at present. So why have a letter of intent at all? Good question.
A letter of intent is a written equivalent of a handshake to confirm a desire to work something out. In that regard, it carries some moral suasion. And, it is a commemorative moment indicating that the parties are now serious.
Letters of intent are commonly used where there is a desire to preserve some interim position. A general contractor is saying that it will not negotiate with another electrical subcontractor, or the parties agree to keep their negotiations confidential. Such side agreements may or may not be enforceable, depending on the exact language used.
I have seen letters of intent in construction where the project owner wants the job started but also wants time to complete the full set of contract documents. In these cases, the letter is joined with a real contract for only a small part of the work. For example, the owner will express its intent to sign a contract, and until that time arises, the contractor will proceed with preliminary work or deliveries on the basis of a limited purchase order. On a few rare occasions, I have seen entire projects built by a series of such “not-to-exceed” price purchase orders.
At the heart of these letters of intent/interim purchase order documents is the owner’s right to stop negotiations at any time and not award the full contract. One of the dangers for the contractor is that it gives the owner a low unit price expecting to get the job, but it winds up only doing a part of the work.
Can a letter of intent convert into a contract?
Take the simplest example first. You are negotiating with a building owner for a major electrical upgrade. The general scope of the work is discussed over a period of weeks. But a lot of details are undecided, and design completion will take time. Assume you are not being paid for your design efforts. The owner wants to convince you that he is serious, so he gives you a letter stating, in part: “We have agreed on the layout and the building’s power needs. Final design should be completed by the end of the month. I fully intend to issue a contract for all of this work to you.”
Is there a contract? The answer is no. To have a contract, you need an offer and an acceptance, and the letter contains neither.
What if the letter goes further? Besides expressing his intent, the owner also issues you a work order for underground work and other preliminary installations. Do you now have a contract? Yes, but not because of the “intent.” The contract is the limited work order only.
One step further: All of the design is worked out. What is left is the final draft of the contract, especially the commercial terms and conditions. The owner’s letter says, “I intend to award the contract to you as soon as the final draft is approved by the president of the company. You can begin to set up immediately.” Do you now have a contract? You may. The courts have often ruled that lack of agreement on all terms is not necessary for a binding agreement to be achieved. It depends on the importance of the undefined, outstanding terms.
A case in point
Marathon Oil Co. was planning a project shutdown to perform what was described as “turnaround” work. This type of work in any industry requires close coordination of trades in a compressed time frame.
Marathon negotiated with one contractor over a period of months. Agreement was reached on most of the terms and conditions and that the job would be cost-plus. Unresolved issues included a final job cost estimate and a final scope of work.
At that point, Marathon issued a letter of intent “based on the mutually agreed [time and material] reimbursement terms.” Further, the contractor was authorized to proceed with the project as a whole. Apparently, both sides saw no impediment to reaching an accord on final contract documents. The letter even stated: “This letter of intent shall remain effective until May 28, 2004, by which time a Contract shall be fully executed.”
Was there a contract? The letter of intent contained limitations that prevented it from becoming a full-blown agreement. First, the contractor was advised that Marathon would only pay for the first $50,000 of work until a contract was signed. Second, an extension to this agreement needed to be issued if a contract was not signed by May 28, 2004. Third, the letter stated that an award of the contract was “contingent” on resolving the itemized outstanding issues. Lastly, the owner reserved the right to terminate the agreement at its convenience.
Although the initial $50,000 cap was subsequently modified a number of times so that the work exceeded $2 million, a final agreement was never reached. The only contract that existed prior to termination by Marathon, months after the letter of intent, was the individual not-to-exceed purchase orders.
A letter of intent can have some side benefits. In one of the most costly cases involving a claim of interference with business, the equivalent of a letter of intent exposed an oil company to a multibillion dollar verdict.
Pennzoil was in the final stages of acquiring Getty Oil Co., and the parties exchanged communications indicating their intent to close the deal. While these events were transpiring, Texaco entered the picture and offered Getty a better deal. That interference by Texaco (a third party) was the basis for a very successful lawsuit by Pennzoil.