Business Law · English

Consideration in Contract law – Is it just about “legal value” and “bargain-for exchange”?

For several times, I had tried to look up the meaning of the term “consideration” and, those dictionaries did not lead me out of the woods. And for several times, I had tried to find out what “consideration” is, and all I receive is a definition with two “haunted” term, “legal value” and “bargain-for exchange”. That is to say, if you scrutinize “consideration” on the surface, you will get nowhere. If you have no time to do research, don’t let the busyness hold you back, cause by this paper, with analysis on some exceptions of common  law rules , all things have been done for you.

Before we start, I would like to make sure that you have already comprehended the nature of two important types of contract, “bilateral contract” and “unilateral contract” because it is too crucial to forget. Could I remind you briefly right now?

Example for Bilateral Contracts

John says to Bon: “Paint my house and I will pay you $500.”

Bon say: “OK, I will”

In this case, a bilateral contract is formed. Literally, a real contract is formed.

Example for Unilateral Contracts

John emails to Bon: “Paint my house and I will pay you $500.”

Just only by this motion, a unilateral contract is formed. In simple sayings, we can imply that the unilateral contract is similar to “an offer waiting for an act”.

In this case, if then Bon replies to the offer: “OK, I will”, a bilateral contract is formed.

If Bon does not reply to the offer but two days later, he comes and paints the house. Then he has right to collect payment from John.

Now, let’s start with the general view of consideration.

  1. The outline of Consideration

In a bilateral contract, one party’s consideration is the promise and the other’s party consideration is other promise. In a unilateral contract, one party’s consideration is the promise and the other party’s consideration is the act. For a promise to be enforced by the courts, there must be consideration.

But hold on, what is consideration?

It is something of legal value given in exchange for a promise.

Untitled
Consideration in simple.

Again, what is legal value?

It may consist of:

  1. A promise to do something that one has no prior legal duty to do.
  2. The performance of an action that one is otherwise is not obligated to undertake.
  3. The refrain from an action that one has legal right to undertake (forbearance)

Those legal values must be given in exchange or, we often call “bargain-for exchange”.

The diagram below will provide you an outlook on “consideration” before we go further.

Untitled
“The map” of consideration.
  1. Type of consideration

Type of consideration

Example

A benefit to the promisor

A promise to stay in a job until a particular project is complete (this is a benefit to the employer)

A detriment to the promisee A promise to your football coach to refrain from riding your motorcycle during football season even though you love riding it
A promise to do sth A promise to cook diner for your roommate for the next six months
A promise to refrain from doing sth

A promise to stop drinking alcohol during exam week.

  1. Bargain-for exchange and Gift promise

If you look this term up in your dictionary, I am afraid that it will yield no result. But is it too difficult for us to understand? The answer is no.

Actually, it is literally an exchanged agreement that is struck between two parties. A promise “A” by promisor must induce the promisee to offer a return promise, a performance or a forbearance; and that promise, performance or forbearance by promisee must induce the promisor to make the promise “A”.

This helps us distinguish contract from a gift promise (or gratuitous promise). Suppose that John says to Bon, “Today, I am very happy, so, I will give you $5000.” Then John receive a break-up message from his girl friend, so he changes his mind and does not give Bon $5000 as he promised. Can Bon sue John? The answer is no. Indeed, there is no consideration existed in this case because Bon needs not to do anything in order to receive $5000, or in other words, Bon does not need to give John something of legal value in return for John’s promise, and the promise $5000 does not involved a bargain-for exchange.

  1. Enforceable contract without consideration – promissory estoppel and contract under seal

Contract still be valid without consideration? Let’s have a look at these important exceptions.

First exception to the rule requiring consideration is “promissory estoppel”. This occurs when three conditions are met:

  • One party makes a promise knowing the other party will rely on it.
  • The other party does rely on the promise.
  • The only way to avoid injustice is to enforce the promise.

For example, suppose upon graduation from college, Bon receives a job offer across the country. He gives up his apartment, cancels all his other job interviews, and moves all his possessions. Upon arriving, he rents a new apartment and shows up for work. However, Bon is then told there is no job! Under the theory of promissory estoppel, Bon may be able to recover his reliance damages (money he spent in “reliance” on the job offer). Promissory estoppel is not awarded regularly, but in the right case, it can provide a remedy where no other remedy exists.

The second exception to the rule requiring consideration is a contract under seal. A contract under seal is a formal contract which does not require any consideration and has the seal of the signer attached. A contract under seal must be in writing or printed on paper. It is conclusive between the parties when signed, sealed, and delivered.

In the past, contracts were sealed with a piece of soft wax into which an impression was made. Today, sealed contracts are typically identified with the word seal or the letter L.S. (locus sigilli, means “the place for the seal”) at the end. States in the U.S. no longer require that contracts be under seal. However, 10 states still allow a contract without consideration to be enforced if it is under seal.

  1. Adequacy of consideration

Adequacy of consideration involves “how much” consideration is given. Essentially, adequacy of consideration concerns the fairness of the bargain. Under the doctrine of freedom of contract, parties are normally free to bargain as they wish, so the court seldom considers adequacy of consideration. But in some case, the adequacy of consideration will be taken into account when the court believes fraud or undue influence occurred. Suppose that Bon has a house worth $6000 and sells it for $3000. In that such low price, at far below the market value, the court may consider whether the buyer unduly pressure Bon into selling or that John was defrauded. But nothing will happen if John was in a hurry to sell and that the price was legally sufficient.

  1. Illusory promise

Illusory promise, for example, suppose John offers to sell Bon his car for $300. Bon responds, “I will look at them in the morning, and if I like them, I will pay you.” At this point, Bon has not committed to doing anything. In this case, the promise is uncertain and both parties do not actually intend to contract.

But it is not as simple as you thought, so let’s take a look at these following notes.

In an illusory promise, the promisor may retain the right to change his mind, the promise can be vague, the promisor is not clear about what he meant by the word ‘satisfactory’. In some contracts, the promisor may retain the right to terminate or modify the contract as and when he wishes to. This is also an illusory promise, as the party can rescind or modify the contract at any stage. In that case, if there is another clause that requires a reasonable notification (for at least 30 to 60 days), the contract becomes valid and enforceable.

For example, John and Bon sign a contract in which has a provision, “John hire Bon in one year with $5000 per month, reserving the right to cancel the contract at any time.” This provision can be considered an illusory promise because John retain the right to terminate the contract. But if there is a provision of the time for the notice of termination, this is still a valid contract. Suppose it requires John must notice Bon at least a month before the date of termination, in this case, John still has Bon work for him, and in exchange, Bon can collect money for one month work. This is exactly consideration and therefore, the contract is valid.

  1. Past consideration

Past consideration, for example, imagine you graduate from college and get a great job. After five years, your boss says to you, “Because you have done such a great job the last five years, I am going to give you 5 percent of the company stock.” Six months later, you still have not received the stock. May you sue your boss to enforce the promise? The answer is no. For a promise to be enforceable, there must be bargaining and an exchange. Because your work has already been performed, you have given nothing in exchange, and the court will not enforce the promise. A promise cannot be based on consideration provided before the promise was made.

But, there is an exception, under the Restatement (Second) of Contracts (a persuasive, though not binding, authority), promises based on past consideration may be enforceable “to the extent necessary to avoid injustice.” In some cases, if past consideration was given with expectation of future payment, the court may enforce the promise.

  1. Preexisting duty

In preexisting duty rule, there are two parts,

(1) performance of a duty you are obligated to do under the law is not good consideration. For example, part of a police officer’s sworn public duty is catching suspected criminals. If someone offers a reward for the capture of a suspect, the police officer may not collect it, as he or she was already obligated to apprehend the suspect.

(2) performance of an existing contractual duty is not good consideration. For example, John sign a pool built contract with Bon. Under the existing contract, the pool is to be completed by June 1. Then, Bon says that due to a shortage of workers, the completion date cannot be met unless John pay an extra $5000, additional workers could be hired. John told Bon that he would. Then, when the pool is completed on June 1, is John legally obligated to pay extra $5000? The answer is no. The pool contractor (Bon) had a preexisting contractual duty to complete the pool by June 1. John is under no obligation to pay the additional money.

There are exceptions: unforeseen circumstances, additional work and UCC Article 2 (Sale for goods)

In the unforeseen circumstances, suppose Bon has been building pools in John’s neighborhoods for the last 20 years and has never had any problem with rocks – until now. While bulldozing the hole for the pool in John’s backyard, Bon hits solid rock. It will cost additional $5000 to clear to rocks with jackhammers. Bon says unless John agrees to pay him additional money, he will not be able to finish the pool. John agrees to pay. Then, when the work is finished, Bon have right to collect additional money. Even though the contractor is completing only what he was obligated to do under the contract, neither party knew the solid rock. The contractor has given additional consideration (removal of the rock) and John will be held to his promise to pay the additional money.

Under UCC 2-209:

  • An agreement modifying a contract within this Article needs no consideration to be binding.
  • A signed agreement that excludes modification or rescission except by a signed writing cannot be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party.
  1. Requirement and output contract

A requirement contract is an agreement whereby the buyer agrees to purchase all his or her goods from one seller. No quantity is stated in the contract. Under common law, it would be void because the buyer has made no commitment and therefore, there is no consideration. An output contract is an agreement whereby the seller guarantees to sell everything he or she produces to one buyer. Once again, no quantity is stated, and under common law, consideration is lacking. Because such contracts are valued by merchants, however, under the UCC both are valid, with the limitation that the output or requirement must be made in “good faith”. The consideration, then, is that the parties act in good faith. Neither may take advantage of the other by requiring or producing more than expected when the deal was signed.

  1. Partial payment of debt – Accord and satisfaction

Partial payment of debt may or may not be valid consideration, depending on whether the debt is liquidated or unliquidated. In a liquidated debt, there is no dispute that money is owed or how much. For example, Bon says that he is a poor student and cannot afford to pay the entire $3000 he owes. The school agrees to accept $2000 as payment in full. The following month, Bon receives his new credit card showing he owes the remaining $1000. May the school collect the additional $1000? The answer is yes. A creditor’s promise to accept less than owed, when the debtor is already obligated to pay a full amount, is not binding.

The exception in this case occurs when the debtor offers different performance. Suppose, Bon offer the school his car in full settlement of $3000 debt. If the school accepts, regardless of the value of the car, the debt is paid in full and the school may not sue Bon for any additional money.

In an unliquidated debt, the parties either disagree about whether money is owed or dispute the amount. They can settle for less than the full amount if they enter into an “accord and satisfaction” (accord is new agreement in order to replace the unclear  or disputed previous contract, satisfaction is the performance of accord), which must meet three requirements to be enforceable:

  1. The debt is unliquidated (the amount or existence of the debt is in dispute)
  2. The creditor agrees to accept as full payment less than it claims is owed.
  3. The debtor pays the amount they have agreed on.

Debtors sometimes attempt to create an accord and satisfaction by sending the creditor a check with “paid in full” written on it. Under the common law, in many states, this did create an accord and satisfaction, and if the creditor cashed the check, he or she was bound to accept the lesser amount as payment in full. However, the UCC has two exception.

  1. Business organization can receive thousands of checks each day. To protect themselves, they may notify their debtor that any offer to settle a claim for less than the amount owed must be sent to a particular address or/and person.
  2. If a business does inadvertently cash a “paid-in-full” check, it has 90 days to offer the debtor repayment in the same amount. For example, if John owed company $3000 and sent a $2000 check marked “paid-in-full” to the correct address and person, the company has 90 days to offer to repay John $2000. Once the business has made that offer, no accord and satisfaction exists.

Accord and satisfaction summary

Debt dispute?

Status of debt Payment? Create and accord?

Create a satisfaction?

Yes – amount of debt in dispute Unliquidated Debtor offers to pay less money than creditor believes is owed as full payment, and creditor agrees. Yes Yes. Once debtor pays the money agreed to, the debt is satisfied and the creditor may not collect any addition money
Yes – existence of debt in dispute Unliquidated Debtor offers to pay a sum of money as full payment when debtor does not believe anything is owed, and creditor agrees. Yes Yes. Once the debtor pays money agreed to, the debt is satisfied and the creditor may not collect any additional money
No dispute over amount of debt of existence of debt Liquidated Debtor offer to pay less money than is owed as full payment and creditor agrees. No No. even if the debtor pays the money agreed to, the creditor may still sue for the balance it believe is owed.
No dispute over amount of debt of existence of debt Liquidated Debtor offers a different payment (e.g., her car) as full payment. Yes Yes. Once the debtor makes a different payment, the debt is satisfied and the creditor may not collect anything else.
Authorities

Frank Cross, Roger Miller (2008), The Legal Environment of Business: Text and Cases — Ethical, Regulatory, Global, and E-Commerce Issues, Cengage Learning.

Nancy Kubasek and M. Neil Browne and Linda Barkacs and Daniel Herron and Carrie Williamson and Lucien Dhooge (2015), Dynamic Business Law, 3rd Edition.

Steven J. Burton (2012), Burton’s Principles of Contract Law, 4th Edition,  West Academic Publishing.

Henry Cheeseman (2010), Business law, 7th Edition, Pearson Education.

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