Problems in Consideration - Bargain Promises and the Mutuality Rule
Mutuality of Obligation:
As we mentioned before, a bargain is an exchange of promises, acts or both, in which each party views his promise or performance as the price of the other party’s promise or performance.
The general rule is that, if there is consideration, then the “adequacy of the consideration will not be reviewed”. What this means is that, as long as the contract is not "unconscionable", the courts will not consider whether a bargained for promise or performance is equal in value to the counter promise or performance. Essentially, the courts believe that the parties to the contract are in the best position to determine its fairness. See Batsakis v. Demotsis, 226 S.W. 2D 673 (Tex. 1949). For Example:
Daffy’s family is starving, and Daffy desperately needs a loan in order to feed his children. Daffy goes to Bugs and asks for a loan of $1,000. Bugs promises to lend Daffy $1,000 if Daffy promises to return the $1,000 along with $750 in interest. Daffy agrees. In this situation there is consideration. Bugs has promised to loan Daffy $1,000 as the price for receiving Daffy’s $1750 in return and Daffy has promised to give Bugs $1750 in return for Bugs’ promise of a $1,000 loan. Typically, adequacy of consideration will not be reviewed. However, the courts will review adequacy of consideration if they feel that a contract is unconscionable. It is arguable that a court in this case would review the adequacy of consideration since it is certainly reasonable to say that a contract calling for a borrower to repay a loan along with 75% interest is unconscionable.
In addition to reviewing adequacy of consideration if the terms of the contract seem "unconscionable," courts will also review the adequacy of consideration when the plaintiff is seeking an equitable remedy to the defendant’s breach of contract.
Damages in contracts cases can be paid in two ways. They can be paid as monetary damages or they can be paid as equitable remedies. Monetary damages (or compensatory damages) is money that is meant to put the plaintiff in the financial position he would have been in had the defendant not breached the contract.
Equitable remedies are remedies that the court orders in the name of fairness. Typically, before awarding equitable remedies the court will look to see if there is fairness and substantial equivalence in value in the bargain before granting equitable relief. For example, if two contracting parties work together to design and develop a product, the court can order specific performance, and order one party to deliver the item to the other party.
Although bargains normally constitute consideration and are legally enforceable, there are four kinds of contracts which are unenforceable because the bargain that was made does not constitute "proper" consideration. They are:
- Contracts containing nominal consideration,
- Promises to surrender or forbear from asserting a legal claim that is unreasonable,
- Illusory promises, and
- Bargains in which one party promises to do what he is already legally obligated to do.
We will now examine each of these four types of unenforceable contracts in detail.
A transaction is said to involve nominal consideration when the parties each make promises in the form of a bargain but neither party views their promise as the price they pay for the promise they receive. In other words, nominal consideration looks like a bargain and sounds like a bargain but it isn’t really a bargain. For example:
Michael promises to give his brother Scottie a new $50,000 Mercedes in exchange for $5. Neither Michael nor Scottie considers the $5 as payment for the car. Rather, they have exchanged a promise for the car for a promise for the cash in order to create consideration and make Michael’s promise enforceable. However, because neither Michael nor Scottie considers the $5 as the price Scottie has to pay for the car, this consideration is nominal only.
Please note that if Michael and Scottie had intended to make a bargain so that Michael considers the $5 as actual payment for the car and Scottie considers the car as what he was receiving for his $5, the court will find this to be proper consideration no matter how disproportionate the consideration seems to be.
Although the general rule is that nominal consideration will not make a promise enforceable, it will make options and guarantees enforceable as long as certain conditions are met.
An option is a promise to hold an offer open for a fixed amount of time. Most courts hold that nominal consideration will make an option binding if the option is in writing. For example:
Sunshine Orange Groves offers to sell Squeeze Me Juice Company oranges for $5 a bushel. Sunshine agrees to keep the offer open for thirty days in exchange for Squeeze Me’s promise to pay $5. Sunshine’s promise to hold the offer open for the thirty days is an option and, because nominal consideration makes an option binding, the promise of $5 constitutes consideration. Please note that, pursuant to the UCC, in order for the option to be binding, Sunshine’s promise must be in writing.
A guarantee is a promise to pay another person’s debt or provide performance of a contract in the place of another person. For example:
Michael applies for a $100,000 loan from Chicago’s First National bank. Scottie promises to pay Michael’s outstanding debt to the bank if Michael defaults on his loan in return for a promise to receive $5. Such a promise is a guarantee and, as with options, the general rule under the UCC is that nominal consideration will make a guarantee binding as long as the guarantee is in writing.
The idea behind allowing nominal consideration to make options and guarantees binding is that options and guarantees are usually not promises to make a gift. Rather they are promises designed to facilitate a bargain. In this respect, they serve an important commercial purpose, and are likely to be relied on. Therefore, the law is willing to enforce such promises even though they are not bargained for.
Please note that according to the UCC, Section 2-205, a written offer by a merchant to buy or sell goods is irrevocable for the period of time stated in the offer even if there is no consideration. In other words, according to the UCC an option contract requires no consideration whatsoever to be enforceable.
Promises to Surrender or Forbear from Asserting a Legal Claim that is Unreasonable:
A bargained for promise to surrender or forbear from asserting a claim that is reasonable and held in good faith constitutes consideration.
For example, where Jerry crashes into Edy’s front porch and promises to pay her $1000 in exchange for Edy’s promise not to sue Jerry, her promise, along with Jerry’s promise, will constitute consideration because Edy’s legal claim is reasonable and held in good faith.
However, problems arise when a claim is not reasonable or held in good faith (for example, a promise not to sue when a law suit would be frivolous in the first place).
The general rule is that a promise to surrender or forbear from asserting a claim is consideration if the promisor’s belief in the validity of the claim is either reasonable or held in good faith.
An illusory promise, like nominal consideration, looks like a contract and sounds like a contract, but it is not a contract because one of the parties is not bound.
As we said in the last chapter, in order for a bilateral contract to be enforceable it must have mutuality of obligation.
Because an illusory promise forms a contract in which only one party is required to perform, an illusory promise is not valid consideration and neither party to a contract containing an illusory promise is bound by the contract. The illusory promisor is not bound because he has not made any kind of commitment (nothing he has promised actually limits his future options). The real promisor is not bound because he has received an illusory promise in exchange for his real promise and, since an illusory promise is not consideration, no enforceable contract has been forged. The general rule is that if one party makes an illusory promise in exchange for someone else’s real promise neither party is bound.
There are two kinds of illusory promises. The first is where the promisor promises to do something only if he wants to. For example:
- Sunshine Orange Groves and Squeeze Me Juice Company enter a contract where Squeeze Me will buy all of the oranges it needs from Sunshine and Sunshine will sell all of the oranges it wants to to Squeeze Me. This promise is illusory because, while Squeeze Me is bound, Sunshine is not. Squeeze Me is bound because although nothing in the contract stipulates that Squeeze Me must buy oranges, if they choose to buy oranges they must buy the oranges from Sunshine. Thus, Squeeze Me has limited its future options. However, Sunshine has promised to sell as many oranges as it wants to to Squeeze Me. Thus, if Sunshine decides they don’t want to sell any oranges to Squeeze Me they don’t have to and they can sell oranges to whomever they want. Sunshine has not limited their future options and is thus not bound by anything. Therefore this contract is not enforceable.
- Sunshine Orange Groves and Squeeze Me Juice Company enter into a contract in which Squeeze Me promises to buy all of the oranges it needs from Sunshine and Sunshine promises to sell all of the oranges it grows to Squeeze Me. Now we have a valid contract because both parties are bound. Although nothing in the contract stipulates that Squeeze Me must buy oranges, if they buy oranges they must buy them from Sunshine. and although nothing in the contract stipulates that Sunshine must grow oranges, if they grow oranges they must sell them to Squeeze Me.
The other kind of illusory promise is contained in contracts that allow a party to terminate the contract at will and without any notice to the other party. For example:
Sunshine Orange Groves agrees to sell all of the oranges it grows to the Squeeze Me Juice Company. Squeeze Me in turn promises to buy all of the oranges it needs from Sunshine. However, the contract allows Squeeze Me to terminate the contract at any time without any notice. This contract is void. The fact that Squeeze Me can terminate the contract at any time and without any notice basically means that they have not limited their options for the future. Thus, their promise is illusory. Had the contract required that Squeeze Me give Sunshine thirty days notice before terminating the contract, then the contract would be enforceable. In that case, Squeeze Me would have to buy oranges from Sunshine for at least a month. That being the case, Squeeze Me’s options would be limited and this contract would be enforceable.
UCC section 2-309 requires that reasonable notification be given before termination of a contract and that any contract that does not require notification to be given is invalid if its enforcement would be unconscionable. Please see UCC section 2-309.
The language of a contract is vitally important to establishing whether or not the contract is valid, so pay close attention to a contract's wording. Also, when trying to decide whether or not a contract is illusory, always ask yourself if the parties have limited their future options and how. If both parties have limited their future options, there is a valid contract. However, if either of the parties has not limited his or her future actions, then his or her promise is illusory and the contract is unenforceable.
Bargains in Which One Party Promises to Do What He or She is Already Legally Obligated to Do:
A bargain in which one party promises to do what he or she is already legally obligated to do looks like an ordinary bargain but it is not enforceable because the obligated party is not required to do anything new under the contract. We will discuss this in more detail when we discuss the legal duty rule in future lessons.