Consideration and Enforceable Contracts
Consideration is a bargained-for exchange of something of legal value. “Something of legal value” ranges from a promise to do something or refrain from doing something, an action, or the creation, modification or destruction of a legal relationship. All enforceable contracts must have consideration.
For an example, Abel is need of a loan. Baker promises to lend Abel $1000 if Abel promises to return the $1000 along with $100 in interest. Abel agrees. This is consideration: Baker has promised to loan Abel $1000 as the price for receiving Baker’s $1100 in return and Abel has promised to give Baker $1100 in return for Baker’s promise of a $1000 loan.
In contrast, a promise to make a gift is not enforceable, because there is no exchange of legal value.
Typically, a court will not make a determination of the adequacy of consideration, so a contract will not fail just because one party’s promise is not as valuable as the other’s. This acknowledges the legal maxim that the parties to the contract are in the best position to determine its fairness.
However, contracts can fail based on the outcome of the following consideration issues:
1. Nominal Consideration;
2. Illusory promises; and
3. Pre-existing legal duties.
For example, Charlie promises to give Decker machinery valued at $50,000 in exchange for $1. Neither Charlie nor Decker considers the $1 as payment for machinery. Realizing that a promise to give Decker the machinery for nothing would be unenforceable, they have exchanged a promise for the machinery for a promise for the cash solely as a pretense for consideration. And because neither Charlie nor Decker considers the $1 as the price Decker has to pay for the machinery, this consideration is nominal, and thus fails.
Although nominal consideration will not make all promises enforceable, it may make options (a promise to hold an offer open for a fixed amount of time) and guarantees (a promise to pay another person’s debt or provide performance of a contract in the place of another person) enforceable.
An illusory promise results in a contract where one party has not really made a commitment to perform an obligation and has therefore not exchanged consideration.
For example, where Eric promises to buy all of the lumber he needs from Delta Lumber and in return, Delta Lumber promises to sell all of the lumber it wants to Eric. This promise is illusory because should Eric need lumber he must buy it from Delta, limiting the choices he may make (which is to give up a legal right). In contrast, Delta Lumber has no duty to sell any lumber to Eric unless it “wants” to. Delta’s promise is “illusory.” Therefore, the contract lacks consideration and is unenforceable.
For example, Delta Lumber agrees to sell all of the lumber it owns to Eric. Eric, in return promises to buy all of the lumber he needs from Delta Lumber. However, the contract allows Eric to terminate the contract at any time without notice. Since Eric can terminate any time, he has made no commitment. Therefore, Eric has exchanged no consideration. This contract is void for lack of consideration.
Pre-existing Legal Duties
It is not valid consideration for a person to agree to do that which the person is already obligated to do.
This consideration issue often arises when an employer wants to change the terms of an employee’s employment after that employee has begun that employment.
For example, if a prospective employee agrees to a non-compete restriction when he or she is first hired, employment by itself may be sufficient consideration. But when an existing at-will employee agrees to a non-compete restriction some time after he or she was hired, the restriction is enforceable only if the employer gives the employee independent consideration at the time of their agreement. Such independent consideration in exchange for the employee’s new employment restriction requires the employer to undertake an obligation or promise, other than continuing employment, that it was not previously required to undertake. Examples of independent consideration for a non-compete restriction include increased wages, a promotion, a bonus, or access to protected information. But mere continued employment, without any new promise or benefit by the employer, is not sufficient consideration when an existing employee agrees to a non-compete restriction.
It is important to understand consideration when contemplating making an agreement with someone so you can put yourself in the best position to receive the full extent of the value for which you bargained.
If you want to know more about consideration, contracts, and the limits of contractual language, please comment below or contact us today.