This recent and well-reasoned decision by Lord Drummond Young in the Scottish Court of Session, provides an interesting analysis of a letter of intent relating to the refurbishment of a school. The letter contained the words “ all direct costs and directly incurred losses", an expression not found in any of the standard forms of contract but which bears some similarity to the well-known phrase “direct loss and/or expense” found in the Joint Contracts Tribunal (JCT) forms.

Background

The defendant, in this case, was a joint venture which had entered into negotiations with the plaintiff contractor for certain refurbishment works at a school in Edinburgh.

The works had to be commenced before the parties had concluded their negotiations. Accordingly, the joint venture wrote to the contractor confirming its intention to enter into a contract and stating that should a formal contract not be entered into then “all direct costs and directly incurred losses shall be underwritten by the Joint Venture'. The letter was limited to a sum of £500,which was subsequently increased to £5million.

The terms of the letter were accepted by the contractor who started work shortly after receipt of the letter. The parties were unable to reach agreement on the formal terms of any contract. Nevertheless, the contractor carried out works and received interim payments.

Once the spending limit of £5million was reached, the contractor was told to stop work. The contractor commenced legal proceedings against the joint venture claiming a further payment of about £850,000.

The Preliminary Issue

As part of its claim, the contractor sought to recover from the joint venture loss of proms and contribution to overheads.

The joint venture contested the contractors entitlement, arguing that the words “all direct costs and directly incurred losses” restricted the recovery by the contractor to costs directly attributable to the construction works. This would include the cost of labour, plant and materials used, but would exclude costs attributable to the contractor's enterprise as a whole, such as head office overheads and any profit element.

The court was invited by the parties to determine, as a preliminary issue, the meaning of these words within the letter of intent.

The Meaning of “Cost” and “Loss”

Whilst the expression “all direct costs and directly incurred losses” is not used in any of the standard forms of building contract ,the judge noted that it nonetheless bears some similarity to the words “ direct loss and/or expense" found in the JCT forms of contract. In each case the expression contains two elements; costs and losses in the letter of intent, and loss and expense in the JCT forms.

The judge said that the words “ cost" and “ expense" are regularly used as synonyms-Both denote sums expended or outlays, and underpin the idea that a claimant is entitled to recover money that he has been compelled to pay in consequence of an event with contractual significance.

Of the words “loss" and “ losses", the judge was also of the view that they correspond to each other. The judge explained the general significance of the word “ loss" as being the idea that a person does not have something that he had or would otherwise have had but for an event with legal significance. ln cases involving breach of contract, the general principle is that the innocent party is entit|ed to be put in the same position as he would have been in if the contract had been performed. The judge said it was obvious that a loss of that nature may include both loss of profit and a contribution to general overheads:

The Use of the Words “Direct” or “Directly”

The judge observed that the meaning of “ cost" and “ loss"(discussed above) are qualified by the use of the words “direct" or “ directly”.

His lordship explained that the significance of the word “ direct" as used in the JCT forms of contract has been the subject of numerous judicial decisions and that two legal propositions can be drawn from the cases:

1. t is concerned with remoteness of loss, not with causation
2. lt denotes that the loss or expense in question must now naturally from the contractual event relied on by the claimant (in accordance with the first rule in Hadley V Baxendale[1854]9Ex 341).

ln the judge's opinion, that same meaning must be accorded to the words “ direct" and “ directly" which appear in the letter of intent. There was nothing in the letter of intent or the surrounding circumstances to persuade the judge that any other meaning was intended.

Conclusion

Disputes of the type addressed by the Court in this case are not uncommon. The case highlights that letters of intent are important documents and that careful attention should be given to their drafting. ln the present case, the letter of intent was the agreement between the parties-Parties would be well advised to seek assistance from their lawyer to ensure that proper and effective contractual arrangements are put in place at the outset.