Lisa Buckley, Holly Embree, Jennifer Darlington, Laura Hill, Andrew Hansen

Chapter 17: Consideration

Lisa Buckley, Holly Embree, Jennifer Darlington, Laura Hill, Andrew Hansen

Introduction

One of the most important things to understand when working with contract law is that not all agreements are considered enforceable contracts. In order for a social agreement/promise to become an enforceable legal contract both parties must have consideration. In the past the courts used to support contracts involving free promises (a situation in which one side gains nothing while the other side benefits). That, however, is no longer the case. Now both parties must benefit from the contract or have consideration, defined as “legal value, bargained for and given in exchange for an act or a promise.” There are several ways in which consideration can effectively be achieved. However, there are also many agreements originally thought to be enforceable contracts, but in fact are not because they lack consideration. Similarly, there are many exceptions to the rules of consideration the courts have put in place over the years.

I. Elements of Consideration

The concept of consideration is very complex. Though the simple definition was outlined earlier, a more intricate explanation must be given. In order for a contract to be legally enforceable, both parties must gain something of value, often legal value, from the contract. If, for example, the promisee has not given anything of legal value in exchange for the promise of the promisor, then the contract cannot be enforced against either party. The contracts can include consideration as simple as one person paying another for a candy bar or as detailed as a promise to perform a future event for money now. Consideration often protects the promisor from being held liable for contracts in which gratuitous promises were made.

Unfortunately because of that protected liability, the consideration requirement often leads to situations in which the outcome seems unfair. Normally, a gratuitous promise is unenforceable because of a lack of consideration—there is consideration from the person making the promise of a gift but not from the person receiving the promised gift. Some gifts get more complicated.

For example, suppose a long time friend promises to buy you whatever laptop you want as a graduation gift and you find the perfect one and place a nonrefundable down payment on it. If after making the down payment, you find out later that your friend has changed his mind; the question arises of who will pay. According to the rules above, it would seem that you would still have to pay, because there was no consideration given to your friend, but does this seem fair? No, and this is why exceptions to the consideration requirement have been made, such as promissory estoppel. These exceptions will be discussed later in the chapter.

1. Legal Value

Because consideration is such a complex concept, it follows that there are many ways to achieve consideration. In a basic case of consideration, both of the parties must gain something of value from the agreement. In a unilateral contract, consideration can be an act, whereas in a bilateral contract, consideration can be a promise. The most important requirement of consideration is that the promisee gives something of legal value in exchange for the promise of the promisor. The first way that the promisee can give something of legal value is by either agreeing to do, or simply doing, something he had no preexisting duty to do. The second way legal value can be achieved is if the promisee promises not to do something, also known as forbearance. An example of forbearance would be the promise not to smoke for a certain length of time. A particular court case that exemplifies this idea is Hamer v. Sidway.

B. Adequacy of Consideration

The legitimacy of an agreement’s consideration does not rely on the actual value that each party is receiving. This means that each party is free to make their own agreements whether or not they are actually good or bad deals. As long as they are getting what they asked for, consideration is taking place. One must be careful, however, when dealing with inadequacy of consideration. It may give rise to the discussion of fraud, duress, or unconscionability which could render a contract unenforceable and lead to even more legal trouble. Similarly, cases dealing with nominal consideration, ones in which one side is essentially giving a gift to the other, are also questioned by the courts. These agreements are sometimes considered to be gifts (gratuitous promises) and as such are not valid.

For example, years ago Truman State University rented out Ophelia Parrish to a local elementary school for $1. Though it is obvious that the University was not getting the actual value of the cost of renting the building, as long as both sides were receiving something (no matter how much), consideration, and thus an enforceable agreement was present.

Another example of nominal consideration is Bennett v. American Electric Power Service Corp. in which the employees of AEP received $1 in exchange for the Corporation’s rights to the patent for an invention that was discovered while they were working there. The employees sued because they claimed that AEP did not give them the nominal consideration of $1 in exchange for the rights to the patents. The courts ruled in favor of AEP, saying that the patents were very clearly designated to AEP and that even if the nominal consideration of $1 was not paid the contract was still valid.[1]

C. Bargained-For Exchange

Finally, it is important to note that for consideration to be present the terms of the agreement must be expressed and accepted. It is not enough for both sides to be gaining something. Instead, both sides must understand what they are receiving in exchange for the legal value that they are giving up. After that, both sides must agree to the “price” in exchange for the promise of the other party.

II. Applications of Consideration

A. Illusory Promises

An illusory promise is “a contract into which parties enter, but one or both of the parties can choose not to perform their contractual obligations. Thus the contract lacks consideration[2].” Sometimes it is difficult to determine whether or not the promisee is getting anything of legal value in exchange for their promise. In order for consideration to take place in a bilateral contract, the promisee must promise to do something, or not to do something, at the request of the promisor. Once that condition is met, as long as there is legal value present, there is no question as to the enforceability of the contract. However, if there is a lack of mutual obligation present in the agreement, the contract is considered illusory and is therefore unenforceable.

For example, if Bill promises to shovel Kyle’s driveway “if Bill wants to”, that would not count as mutual consideration. The promise is indefinite; one does not know whether Bill will actually shovel Kyle’s driveway. Because he has not promised anything of legal value, the contract is not enforceable. In conclusion, an illusory promise is one in which the promisee is not bound to do something, or to refrain from something, and so lacks mutuality of obligation.

B. Terminable at Will

If a contract is terminable at will, it can be canceled by either party at any given time. These contracts are not necessarily illusory and can be good because while the contract can end at any time during the time of the contract, both sides have obligations. For example, if limitations do exist, such as the requirement of a tenant or landlord to notify each other within 30 days of termination, then the contract would no longer be considered illusory. The reasoning behind this is that each party has bound themselves to do something in exchange for the execution of the other’s promise. In this example, they are each promising to give each other 30 days’ notice in exchange for the other’s promise to do the same. In addition, both the landlord and tenant have obligations during the time of the lease.

C. Effect of Output and Requirements Contracts

Additional subjects of dispute in regards to illusory promises are output and requirements contracts. An output contract is a contract in which one party agrees to buy all of a company’s output for a certain period of time. A requirement contract is when one party agrees to buy all of a particular product they need from a certain company for a designated period of time. Before the Uniform Commercial Code (which only applies to goods) was put into effect, there were questions as to whether or not output and requirements contracts fell under the illusory category. These contracts do not specify the quantity of goods purchased and it was feared that the terms were too vague. However, the UCC now says that these contracts are enforceable as long as the demands in the contract occur in good faith and the quantities involved are reasonable. This also helps ward off exploitation by any party involved.

D. Preexisting Duties

In order for consideration to be present in an agreement, the promisee must promise to do something they had no prior legal duty to do, or had not previously agreed to do, through a contract. One cannot make an agreement to obey the law because every member of society has a preexisting duty to follow the law. Suppose that a woman’s house catches on fire and once she is outside she realizes that her son is still inside the burning building. She offers $1,000,000 to anyone who will go inside and save her son. A fireman arrives on the scene and saves her child. He is not, however, entitled to the promised reward because he had a preexisting duty, as a public official, to save anyone who would have been trapped inside that building.

Furthermore, in the case of Denney v. Reppert, a bank was robbed and offered a reward for the capture of the robber. The robber was captured by several police officers (two within their jurisdiction, one not) with the help of the descriptions made by some employees of the bank, the question arose as to who was entitled to receive the reward. The two policemen within their jurisdiction could not claim the reward because they had a pre-existing to protect the community. Likewise, the employees of the bank were also subject to the preexisting duty rule as they had a duty to act in the best interests of the bank. Additionally, public officials such as policemen or firemen have a preexisting duty to do their job. However, the third policeman (who was outside of his jurisdiction) was entitled to all of the reward because he had no preexisting duty in that jurisdiction.[3]

a. Modifications of Contracts under the Common Law

Many preexisting duty cases involve the modification of contractual agreements. Generally, in order for the modifications to be considered binding, they must involve new consideration by both parties. Suppose a city makes a contract with a contractor to build a bridge within two years for the price of $1,000,000. After one year of work, the contractor realizes that he will not be able to finish within the remaining year and says that in exchange for extra payment he will work harder and pay his workers overtime in order to finish on time. The city accepts this offer, but due to the contractor’s preexisting duty to complete the job within two years, they do not have to pay, even after accepting. There was no new consideration for the city. However, if the contractor were to move the due date up at least one day or promise to throw in something extra, such as a streetlamp to light the bridge, then new consideration exists and the contract would be enforceable due to modification of contracts under common law.

A case that exemplifies this idea even further is Alaska Packers Assn v. Domenico, in which Domenico and a group of other fishermen went on strike, demanding that the Alaska Packers Association increase their wages. Since there was no new consideration for the APA (the fishermen already had a preexisting duty to complete their job at the salary they were being paid), the modification could not be made.[4]Once again, in order for a modification to be made to an already existing contract, new consideration must be present.

One exception to this rule occurs when unforeseen circumstances arise. In the bridge example above, if abnormal rock formations were found when trying to secure a foundation for the bridge, then the contractor could reasonably ask for more money. The unforeseen circumstances must make the job much more costly and time-consuming than was originally thought. Therefore, if there was simply bad weather for a few days during construction of the bridge, this exception would not apply.

b. Contract Modification under the UCC

Another exception to this rule exists under the Uniform Commercial Code and contracts dealing with goods. Under the UCC, the initial contract must have consideration going both ways, but a modification of that contract can be made in good faith even if consideration does not exist for both parties. This can come about in regards to quantity or price. It is to be noted that if one of the parties does not agree to this modification, it is not enforceable.

For example, suppose that a furniture company initially contracts to purchase 500 tables from a manufacturing company for $60 each. Two weeks after the contract was made, the furniture company realizes that they can only store 450 tables in their inventory. Even though consideration does not exist for the manufacturing company in this new contract, as long as they agree to it in good faith (meaning it is not malicious in nature), the contract will still be considered valid.

c. Agreements to Settle Debts

The preexisting duty rule also applies to settling debts, liquidated or unliquidated. A liquidated debt is one in which there is no reasonable dispute over the existence or amount of the debt. Suppose Lisa borrowed $100 from Amanda and agreed to pay her back within one year. After one year had passed, and Lisa had yet to pay her debt, she offered to give Amanda $50 instead, along with the promise that Amanda would not sue her for the remaining amount. Even if Amanda agrees to this, she can still sue Lisa for the remaining amount based on the preexisting duty rule. Because of the original contract, there is no new consideration for Amanda if Lisa offers to give her less money than was originally owed to her.

An unliquidated debt is one in which there is a reasonable dispute over the existence or amount of the debt. For example, suppose Tony did not turn on his blinker, causing Rhonda to crash into him on the highway while switching lanes. There is a dispute over the amount of the damages to the cars. Because the cost of the damage to Rhonda’s car is not clear, there is an unliquidated debt, meaning it is subjective (different mechanics could come up with different amounts of damages). At the time of the crash, Rhonda offers not to sue if Tony pays her $3,000 and Tony accepts. Both sides think that they are getting the better deal and are taking that risk. If Tony later realizes that the damages are only $1,000 he cannot sue for money he lost because contracts dealing with unliquidated debts are binding.

E. Past Consideration

Past consideration occurs when a current promise is made in exchange for actions that have already been completed. If past consideration exists, then the contract is not valid. One cannot make a promise based on something that happened in the past. In order for a valid contract to be made, newconsideration must be present.

III. Exceptions to Consideration

Because consideration is a tricky concept, there are several exceptions to the requirement that the courts have come up with over the years. Though several have already been discussed (the Uniform Commercial Code, firm offer, and contract modification rules), there are a few more exceptions that also pertain to the consideration requirements.

A. Promissory Estoppel

Promissory Estoppel originated as a way to attain fair outcomes when dealing with donative promises that cause the promisee to act in reliance on that promise. A donative promise is a promise to make a gift or donation to an individual or an institution. In the past, donative promises were not legally enforceable because the promisor had no consideration in the agreement. However, in cases where substantial performance was made by the promisee resulting from reliance on the promise, then the agreement can become enforceable.

For example, suppose that a grandfather promised to give his grandson a car for his 18th birthday. The grandson then went out and signed a contract to purchase a Corvette. Several days later, the grandfather decided to revoke his offer and the grandson was left to pay for the car himself. Because the grandson relied on the grandfather’s promise and then acted on it by signing the contract for the car, this case falls under promissory estoppel, which would take the place of consideration in this situation. In cases where promissory estoppel applies, the contract would be legally enforceable.

B. Debts Barred by a Statute of Limitations

In all states, creditors are required to sue within a specified time period to recover debts under the statute of limitations. The statute of limitations bars recovery of the debt if the creditor does not sue within the specified period. If a debtor promises to pay a previous debt, even though the statute of limitations bars recovery, there is an enforceable promise which needs no consideration (although some states require that the promise is in writing). This promise extends the limitations period and the creditor can sue to recover either the whole debt or the amount promised. The promise may be implied if the debtor acknowledges the barred debt by making a partial payment.[5]