Consideration

Consideration

In general, a contract is not enforceable if it is not supported by legal consideration on both sides
of the contract. Consideration is present only when the parties to a contract exchange (bargain
for) something of value (legally sufficient) in the eyes of the law.

1. Legal sufficiency of consideration: Legal sufficiency refers to a situation where both parties
change their legal positions. What this means is that the parties must exchange something of
legal value. Legal value can take the form of a legal detriment or legal benefit.

a. Legal detriment: Legal detriment refers to a situation where a party—pursuant to the
contract—agrees to do something that he or she was under no obligation to do or to
refrain from doing something that he or she would otherwise have a right to do.

b. Legal benefit: Legal benefit is the reverse of legal detriment. It is the right to receive
something of legal value or the right to prevent the other party from doing something he
or she would otherwise have the right to do.

c. Adequacy of consideration: Generally, the courts will not review the consideration
given by each party to a contract to see if they are of equal value. It is enough that
consideration exists on both sides of the agreement.

2. Illusory promises: A promise is illusory if it imposes no obligation on the other party to do
or not to do something.

Example: Jean signs a contract with Zack in which she promises to buy Zack’s house if she
feels like it. This is an illusory promise because Jean is under no legal obligation to do
anything. Jean may or may or may not purchase the house. An agreement to perform a
promise that is illusory cannot serve as consideration.

There are a number of situations where a promise is made, but legal consideration does not
result from that promise.

a. Pre-existing obligation: If a party is already under a legal obligation to do something, a
contractual promise to do the same thing would not constitute consideration. The
promisor is agreeing to do something that he or she was already obligated to do.

Example: Vincent signed a contract to play baseball for the S.F. Giants for $500,000 per
year for the next three years. At the end of the first two years, Vincent’s performance was
much better than anyone could have hoped. Before the beginning of the third year,
Vincent asks for a salary of $1,000,000 per year for the remaining years of his contract.
Even if the S.F. Giants agree, the team is under no legal obligation to pay the additional
salary. Vincent is already obligated to play for the Giants for $500,000 per year and his
new agreement lacks legal consideration. He is not promising to do anything more than
what he has already agreed to do.

What could Vincent have done? A contract requires consideration on both sides.
Vincent wanted more money from the S.F. Giants. If the Giants were willing to increase
Vincent’s salary, this would be a detriment to them (promise to do something they would
not be obligated to do). To make this promise enforceable, Vincent must now give new
consideration on his side. This could take the form of promising to give speeches before
various community groups on behalf of the Giants. This is something that Vincent is not currently obligated to do. This would be a new legal detriment to him. With consideration
now present on both the Giant’s side and Vincent’s, the new agreement would be
enforceable.

Substituted contracts: Parties to an existing contract are always free to renegotiate.
They can rescind the existing agreement and replace it with a new one as Vincent did in
the above example. The agreement will have to be supported by consideration on both
sides, but the UCC is moving away from requiring new consideration. If the new
contract is fair in light of new circumstances, new consideration is not required.

b. Settlement of an undisputed debt: Bill owes Paul $2,000. If Bill offers to pay $1,500 in
full settlement of his debt, and Paul agrees, is the debt settled after the $1,500 payment is
made? The answer is no. In the new contract, Bill is agreeing to pay less than the amount
he was originally obligated to pay. To be allowed to do this, Bill must give up something
in return (consideration). If he or she does not, the new agreement is unenforceable.
Example: Michael borrowed $90,000 from the Bank of America at 10% for one year.
Under the terms of the loan, Michael must repay B of A $99,000 on July 1, 1998.
Michael went to B of A and asked whether he could repay $97,000? B of A
reluctantly agreed.

Analysis: In this case, since Michael did not give new consideration for the change in the
terms of the agreement, B of A is not bound by the new agreement. Michael must still
repay $99,000. What could Michael have done? In order to make the new agreement
binding, Michael must give something (consideration) in return. He could, for example,
have agreed to repay the loan two months earlier. In this event, B of A’s legal position
changed (accepted less money) and Michael’s legal position changed (repay the loan
earlier). Since the new agreement was supported by consideration on both sides, it would
be enforceable. What if Michael agreed to repay the loan two days earlier? While this
would not be an advantageous bargain for B of A, it would be acceptable. The courts,
generally, do not review the adequacy of consideration, only that it be present.

c. Settlement of a disputed debt: United Commercial Enterprises buys $1,000,000 worth
of computers from IBM with the understanding that it will receive a 3% discount if the
amount is paid within 30 days. United is under the assumption that it has 30 working
days (38 days in total). IBM is working on the assumption that the debt must be repaid
within 30 days. In this case, there is a genuine misunderstanding. If the two parties agree
on a settlement whereby United will repay the debt within 34 total days and receive a 2%
discount, this agreement would be enforceable. United is willing to repay the loan 4 days
earlier than it believed was necessary and will accept 1% less in discount. IBM will give
United four days longer than it believed was required under the deal, but will need to pay
1% less in discount. There is consideration on both sides to support the new deal.

d. Promises to give a gift: When a person makes a promise to give a gift, he or she is
promising to do something he or she was not required to do. This would be a legal
detriment and will constitute consideration on the donor’s side. The recipient, however,
has not done anything and is not expected to do anything. There is no consideration on
his or her end. For this reason, a promise to make a gift is generally not enforceable. e. Past consideration: Very often, promises to do something or compensate someone are
made on the basis of something that was done in the past. These promises are generally
not enforceable.

Example: Lonny is walking along Fisherman’s Wharf when he hears a scream coming
from beneath the pier. He looks down and sees a drowning man. He instantly dives into
the water and saves the man’s life. The man promises to give Lonny a cash reward.
Analysis: The man is under no legal obligation to keep his promise. He agreed to reward
Lonny for something that was already done. So his promise to do something is not
matched by a corresponding consideration on Lonny’s end.

3. Contracts that are enforceable without consideration: There are several exceptions to the
rule that consideration must exist on both sides in order to be enforceable.

a. Prior unenforceable obligations: Some debts and promises may become unenforceable
because they were discharged in bankruptcy or because there was a time limit for the
collection of the debt and this deadline has passed. In these cases, if the original debtor
promises to repay a debt that has been discharged, the debt will be reinstated even though
there is no consideration on the other side.

Example: Jake files for bankruptcy and discharges all of his existing debt including a
debt of $300 to the local grocery store. One day, Jake is walking in the neighborhood
when he runs into Mr. Lee, the owner of the store. Jake, out of a feeling of guilt,
apologizes to Mr. Lee and promises to repay him $200.

Analysis: Mr. Lee did not give anything (no consideration) in return for Jake’s promise
to repay $200 of the $300 he owed. Jake’s promise, however, is enough to revive his debt
to Mr. Lee to the extent of $200.

b. Promissory estoppel: In some cases, courts will enforce promises made without a
corresponding consideration in order to prevent an unjust situation. Promissory estoppel
is invoked in situations where it would be reasonable for the other party to rely on a
promise, they did rely, and expended time and money in the expectation that the promise
would be kept so that it would be unjust not to do so.

1) Situation of hardship: Just because a party changes his or her position in reliance
upon a promise is not enough to invoke promissory estoppel. The change in the
party’s position must be such that significant hardships would result unless the
promise was kept.

Example: Betty, a successful doctor in San Francisco, promises to give her recently
unemployed sister, Veronica, her country house in Sonoma County. In reliance upon
this promise, Veronica moves from San Francisco to Sonoma County, spends a great
deal of her savings in order to repair the country home, and finds a new job in
Petaluma. When Betty sees the wonderful transformation in the house, she revokes
her gift.

Analysis: Even though the offer to give her country home was a gift that was not
supported by consideration on Veronica’s end, the promise is enforceable. Was it
reasonable for Veronica to rely on Betty’s promise? A court would probably say yes.

It is clear that Veronica did rely on the promise and expended quite a bit of money and effort. At this point, if Veronica is not allowed to keep the house, a grave
injustice would result. For this reason, a court would invoke promissory estoppel to
compel Betty to give the house to her sister.