Case Study: Letters of Intent and the application of Australian Standards and Fitness for Purpose requirements

 

Tuesday, February 5th, 2019

Navigating Governing Law and potential application of Fitness for Purpose clauses of Contracts.

Background

A client of ours who has been working as the main Contractor on a large offshore project came to us for our interpretation on the Governing Law and potential application of Fitness for Purpose clauses of their contract with the Principal.

To provide context, the Contractor had been working with the Principal since 2017 under a Letter of Intent (LOI). The LOI required the Contractor to ‘undertake the Works in accordance with the relevant provisions of the Draft Contract’ which was based on the conditions set out in the Australian General Conditions of Contract for Design and Construct, AS 4300-1995’.

The LOI stated that the proposed contract arrangement remained in force until the Contractor and the Principal finalised and executed the ‘final Contract’.  The problem for the Contractor was that a final Contract had never been executed and that they were continuing to perform works for the Principal under the original LOI. As a final Contract was never executed, it could be reasonably assumed that the conditions set out in the LOI remained in effect.

The Contractor was getting concerned as the Principal was attempting to enforce standards and requirements which had never formally been communicated and which risked a potential dispute between the Contractor and the Principal, particularly over the timely processing of payments.

As a group of professional project managers and contract administrators who work tirelessly to manage the interface between Principals and their Contractors, coupled with our extensive experience in conducting overseas administration of Australian contracts, Wildara was engaged to undertake an industry professional (but non-legal) assessment of the contract and the application of Fitness for Purpose clauses and Australian Standards.

Letters of Intent (LOI)

Depending on the circumstances and drafting, an LOI may create binding obligations on the parties. The term ‘Letter of Intent’ does not have legal meaning; however, in construction it is typically issued to describe a letter from a Principal to a Contractor indicating the Principal’s; intention to enter into a formal written contract for the Works described in the LOI.

Based on the Contractor’s individual case, it could be demonstrated that the Principals LOI was uncertain as to the key terms and conditions, for instance, the Principal reserved the right to remove, amend or negotiate changes to the provisions of the Draft Contract (AS 4300-1995); hence, based on this provision the LOI could not be legally binding until the final Contract had been executed.

Upon further review of the LOI we also made the following observations which created additional confusion and uncertainty between the parties:  

  • The scope of the works was not clearly identified nor described.
  • Details of matters to be resolved before the contract could be entered were not identified.
  • No Governing Law was identified or stated; however, the Draft Contract AS 4300-1995 states that ‘if the State or Territory is not stated, the law of the State or Territory where the Site is located’ applies (Clause 1). Therefore, it could be reasonably assumed that the local law of overseas site applied to the Works.
  • An amount of consideration was identified; however, it is unclear as to whether this sum included tax (VAT/GST).
  • The LOI did not include a method for dispute resolution.
  • The LOI did not provide clarity that once the contract was finalised it would apply retrospectively and that any payments made under the LOI would be treated as payments against obligations under the main contract.
  • The LOI did not document an expiry date.

Application of Fitness for Purpose to the Contractor’s Works

‘Fitness for purpose’ is a term used to describe the concept that goods or services must be capable of being used for the intended purpose.

Within Construction there are three methods for communicating that works are to be Fit for Purpose as follows:

  • Express terms in the Contract
  • Compliance with common law
  • Compliance with statutory law.

In our assessment to determine the relevance of Fitness for Purpose we reviewed the Draft Contract (AS 4300-1995) which contained an express Fitness for Purpose term under Clause 4.1 (Contractor’s Warranties). This clause warranted the Principal that the Contractor ‘shall execute and complete the work under the Contract in accordance with the Design Documents so that the Works, when completed, shall be fit for their stated purpose’.

Upon our review there was no evidence of any specific or preliminary ‘Design Documents’ (drawings, specifications and other information, samples, models, patterns and the like) issued by the Principal to the Contractor; however, the Principal described a very broad stated purpose of the works within the LOI as follows:

  • Establishment of new accommodation able to accommodate 500 persons
  • Refurbishment of existing buildings to accommodate at least 200 persons.

It would be reasonable to assume that as the Principal did not produce any Design Documentation and that the Draft Contract was of a ‘Design and Construct’ nature that the Contractor would therefore be responsible for producing the Design Documentation and for undertaking the Works in accordance with the Design Documentation. 

As stated, the application of the Fitness for Purpose requirement is also governed by common and statutory law and communicated under AS 4300-1995 Clause 4.1 (Contractor’s Warranties) which warrants to the Principal that the Contractor ‘shall comply with all requirements of the Contract and Legislative Requirements’

As the Governing law of the Contract had been reasonably assumed to be that of the Country in which the works were being undertaken (AS 4300-1995 Clause 1) the applicable legislative requirements for undertaking the construction works overseas inadvertently excluded the application of Australian Standards. 

Summary

Based on our assessment, we concluded that the Fitness for Purpose clause only applied to Works insofar that the Contractor could demonstrate that establishment of the new accommodation could accommodate 500 person and that the refurbishment of the existing buildings could accommodate at least 200 persons.  i.e. confirmation that the Principal’s stated purpose had been satisfied. Furthermore, it was our assessment that the application of Australian Standards applied to the Contract insofar as to the extent they are prescribed within the local Governing law (if at all).

Advice

Letters of Intent should only be used as a temporary strategy to aid the rapid mobilisation and commencement of works. It’s important that LOIs are actively managed between the parties and that clear time limits for execution/abandonment are documented within the LOI. Operating under a Letter of Intent for prolonged period will inevitably lead to a growing disparity of shared meaning between the contacting parties and increase the risk of disputes and poor project outcomes.

For further information on this topic please contact us at www.wildara.com.au

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