Consideration- Module 3 of 5

Module 3: Consideration

The Consideration Principle

Most contracts require “consideration” to be binding. The element of consideration ensures that each party receives something in exchange for his action or promise or, conversely, that each party gives something up in exchange for the other party’s action or promise.[1] 

Consideration means a “bargained for” performance or return promise. To meet this requirement, the performance or return promise must be “sought by the promisor in exchange for his promise,” and “given by the promisee in exchange for that promise.” Consideration is considered “quid pro quo,” Latin for “this for that.” A return promise, as a form of consideration may be given to the promisor or to a third party. 

A performance may include:

·         “An act other than a promise;”

·         “A forbearance;” which means to refrain from acting; or

·         “The creation, modification, or destruction of a legal relation.”[2]

In the case of Hamer v. Sidway, for example, the New York Court of Appeals ruled that refraining from the use of alcohol, tobacco, and other behaviors qualified as valid consideration.[3]  William’s uncle had promised him that if he refrained from drinking, using tobacco, swearing, and gambling until the age of twenty-one, he would pay William five thousand dollars.  The uncle’s estate later claimed that because there was no consideration, the promise was unenforceable.  The court disagreed, finding that William’s forbearance of his legal right to undertake those activities qualified as valid consideration.

As another example, in one case, a student hockey player signed a race registration form to participate in a preseason conditioning program.[4]  The player was then injured during the race and sued for negligence. Citing the release, the sponsor stated the player was prohibited from suing the organization, as indicated in the release form. The hockey player argued there was no consideration to support the contract, but the court disagreed.  The court held that the hockey player agreed not to hold the sponsors responsible for any claims and the sponsors had agreed to let the players run on the course during the event.  Therefore, the consideration given in exchange for allowing the players to run the course was a forbearance of the player’s legal right to sue.

In another New York case, the parties had entered into a seventeen year same-sex relationship.[5] During the relationship, the parties entered into an agreement forming a “partnership and/or joint venture.” The parties agreed that one spouse would forego her full-time employment in order to care after their children and provide other household services.  The parties purchased a house and the other spouse continued working. When the relationship deteriorated, the spouse who was not working sued for a share of the assets and retirement contributions earned by the employed spouse.  The court held that by foregoing her career and maintaining the household, the non-working spouse put forth consideration in exchange for a share of the working spouse’s assets and retirement benefits.[6]

Let’s consider some hypotheticals:

1.    James promises to rake his uncle’s yard in exchange for his uncle’s promise to pay him one hundred dollars. In this exchange, the nephew offers a benefit to his uncle, a tidy yard, as consideration for his uncle’s promise to pay him one hundred dollars.

2.    James may also promise his uncle, who believes motorcycles are dangerous, to refrain from riding his beloved motorcycle for a month in exchange for his uncle’s promise to pay him one hundred dollars. In this example, the nephew is offering a detriment to himself – refraining from riding his motorcycle which he enjoys – as consideration for his uncle’s promise to pay him one hundred dollars.

Courts will not generally consider whether the parties made a good bargain or whether the consideration is fair.[7] However, consideration must be more than just a pretense or false claim that consideration has been exchanged, when – in fact – it has not. 

In the case of Smith v. Riley, Smith and Riley began a romantic relationship with one another.  They opened a joint checking account to which they both contributed. They also had aspirations of purchasing real property. Riley entered a lease with a third party with an option to purchase. Riley transferred a one-half interest in seven personal property items and gave a one-half interest in the lease to Smith. As consideration, the agreement cited Smith’s promising “$1.00” and “other good and valuable consideration” to Riley.[8]

The trial court found that the consideration for the property interest included “society” and “consortium,” essentially that Smith promised to take care of Riley and so forth.  The court stated that it is not necessary for consideration to be equal to what is given in exchange.[9]  In this case, the court found that Smith’s love and affection and the recital of nominal consideration of $1.00 was sufficient consideration.

Mutuality of Consideration

Enforceable contracts also require mutuality of consideration. If only one party is actually bound by the agreement, then the consideration is treated as “illusory” and the contract is unenforceable. 

            Promises are illusory if performance is so indefinite that it cannot be enforced or if it is “entirely optional.”  Even though the promisor may make a promise for performance, if performance is not required in a meaningful way -- then there is no contract.[10]

            In one Tenth Circuit case, employees of a golf course owned by Paradise Hills were required to complete and sign several agreements as a condition of employment.[11] One agreement included the requirement that any claims for discrimination, harassment, or wrongful discharge be brought exclusively through arbitration. The employee handbook, however, allowed the employer to change, delete, modify, or add additional terms to any of the provisions contained in the handbook at its own discretion. A few years later, Dumais filed an employment discrimination claim, and Paradise Hills attempted to compel arbitration.[12] The court held the employees’ promise to submit to arbitration was illusory because it gave the employer the “unfettered right” to change the arbitration agreement’s scope and even its very existence.  

In another case arising out of Texas, though, the court held the promise to arbitrate was not illusory when some claims required arbitration while others did not, but the designation was not entirely within the control of one party.[13] 

Output contracts and requirements contracts are two types of contracts that are seemingly illusory but are nevertheless enforceable. In a requirements contract, the seller promises the buyer that he will sell goods to the buyer in any quantity that the buyer requires. In an output contract, the buyer promises to purchase everything the seller can produce. These contracts are seemingly illlusory because they lacked any definite promise to perform.  In a requirements contract the buyer may not require any goods, whereas under an output contract, the seller may not produce any goods. Under the Uniform Commercial Code, however, both types of contracts are enforceable.[14] The UCC also requires that that the parties act in good faith. So, for example if the buyer in a requirements contract claims that he needs none of the goods produced by the seller, this may be considered a breach of contract.

The Legal Duty Rule

Consideration cannot be in the form of something a party is already legally bound or obligated to perform. In a 1902 Ninth Circuit case, a group of employees agreed to participate in a fishermen’s trip from San Francisco to Alaska.[15]  The employees agreed to earn fifty dollars for the fishing season and an additional two cents for each red salmon they caught. Once they arrived, and upon learning another crew was receiving a higher wage, the employees refused to continue working unless they were paid additional money. The superintendent agreed and negotiated a new contract with the employees. When the employees returned, the company refused to honor the new contract, and the court agreed.  The court held that when one party is legally bound to perform some action, undertaking that action cannot qualify as consideration for a new agreement.[16] Since the employees were already obligated to perform under the initial contract, the later agreement was void for lack of valid consideration.

As another example, William Glisson entered into a covenant not to compete with his employer, Global Security Services, with whom he had a two-year employment contract.[17] About eighteen months into that contract, Global asked Glisson to sign another noncompetition agreement, and Glisson signed the new agreement, which specified that Glisson could not compete with Global in certain additional countries for two years after his employment ended.[18] Glisson resigned a few months later.[19]

After Glisson started his own security business, Global sued Glisson to enforce the second noncompetition agreement.[20] The Georgia Court of Appeals, however, found that the newly-signed noncompetition agreement lacked valid consideration because Global was already obligated to employ Glisson through the initial two-year employment contract period. Upon the signing of the second noncompetition agreement, Global provided nothing of value besides what they had already promised as consideration for Glisson signing the first agreement.[21]

Partial Payment Checks

The partial payment check rule is a corollary to the pre-existing duty rule. In some situations, a customer may mark a payment with a notation such as “payment in full,” when, in fact, the check does not cover the entire outstanding balance. What happens when a seller deposits a check with one of these notations?

Under the rule, accepting the check or form of payment does not remove the customer’s duty to pay the outstanding balance.[22] This is because the customer had a pre-existing duty to pay the full amount and there is no new consideration for accepting the partial payment.

However, if there was a good faith dispute as to the validity of the debt and the partial payment could reasonably be considered a settlement offer, then giving up the claim that the debt is invalid could be consideration for the creditor’s acceptance of less than the full amount. Also, the creditor and debtor could agree on a “mutual rescission” of the original agreement and replace it with a new (lower) debt amount that the buyer agrees to pay immediately. This is valid because mutual rescission does not require consideration.

Past Consideration

            Under the traditional rule, a contract cannot be supported by past consideration. Past consideration is something given before the promise is made. Past consideration is not sufficient because, by definition, you cannot “bargain for” something that already happened.

            In an older Massachusetts case, a man’s son became extremely ill in a foreign country.[23] The plaintiff, a good Samaritan, cared for the son until he died.  After learning that the good Samaritan cared for his son, the father promised to pay the man for his services and time.  The court held there was no consideration because the services were performed before the promise was made. Any moral obligation that the father may have felt could not serve as valid consideration.

            In another older case, a husband’s deceased wife had wanted to leave her relatives two hundred dollars each upon her death. At the time of death, she owned no property. Rather, the property was owned by her husband. After her death, the husband attempted to contract with the third parties to whom the wife wished to leave the money. As consideration, the third parties paid one cent to the husband. Also cited as consideration was his love and respect for his deceased wife. The court held that consideration of one cent could not qualify as consideration because it was merely nominal – as in, worthless and a form of an illusory promise. Regarding the moral consideration, the love and affection for his wife, the court also held this was invalid. The wife was already deceased and thus her past love and affection was not consideration.

            Many modern courts, though, have shown willingness to enforce a promise based on past consideration when there was a material benefit conferred to the promisor and the promise is to compensate the promisee for the benefit she conferred.[24] In one Alabama case, an employee at a lumber company was responsible for cleaning the upper floor of a mill belonging to the company. During this process, he was required to release a large, heavy block to allow it to fall to the lower level. However, during this process he realized a man named McGowin was standing directly below, where the block would land. To avoid causing McGowin serious injury or death, the man held the block and, in the process, fell with it to the lower level, successfully preventing it from killing McGowin, but severely injuring himself in the process.

            Afterwards, McGowin agreed to pay fifteen dollars every two weeks for the remainder of the man’s life. The court held this was sufficient consideration although it was for services already received, because McGowin had previously received a material benefit in exchange for the payment.[25]

Promissory Estoppel

            Courts can apply contract-like principles to enforce a promise that is not supported by consideration under the theory of promissory estoppel.[26]  Promissory estoppel applies when one party is induced to perform some act or forbearance in reliance on a promise. Although unsupported by consideration, enforcement of the agreement may be necessary to prevent injustice.

Promissory estoppel requires the following:

·         The promisor made a clear and definite promise to the promisee

·         The promisee relied on that promise to her detriment

·         The promisee’s reliance was expected and foreseeable[27]

It should be noted, though, that the courts may not enforce the entire extent of the promise and may instead require the promisor to pay only the amount that the promisee suffered because of the reliance on the promise.

Let’s look at an example:

Susan is considering going to law school but is worried about carrying too much student debt. Knowing this, Susan’s mother promises her that she will pay her undergraduate loans. Susan goes to law school in reliance on her mother’s promise, believing that she can afford it financially because of her mother’s assistance. After graduating law school, Susan’s mother refuses to pay off her undergraduate debt. Susan’s mother may be bound by the promise because she should have expected that Susan would believe her, Susan did in fact believe her and the only way to avoid the injustice is to require Susan’s mother to pay the undergraduate debt that Susan sustained.

            In a Seventh Circuit case, Meyer had entered two previous loan agreements with Firestone Financial Corporation.[28]  Meyer claimed that he was told by a representative that Firestone Financial Corporation would fund its 2013 purchases under the same terms as its first two loan agreements. Meyer therefore purchased equipment to continue its business operations. Firestone then declined to renew Mr. Meyer’s loan under the same terms and he defaulted on his equipment purchases.  The court concluded promissory estoppel applied because there was a clear promise, upon which Meyer had relied, and an injury that resulted. Therefore, Firestone Financial Corporation was bound to its promise despite the lack of consideration. Note that the remedy could be limited to what Meyer spent in reliance of the agreement. He could not compel the company to grant him the full loan that he was promised.

            In another case, from California, a general contractor was preparing a bid for a job in the Lancaster school district.[29] The general contractor would typically review bids submitted by subcontractors and use those bids to make his general bid for the job. He received over fifty subcontractor bids.  The contractor was required to list the names of the subcontractors working on the job and provide a bidder’s bond to bid on the school district job. The contractor received a bid for a little over seven thousand dollars from a Hoon, a potential subcontractor.  Since this was the lowest bid for paving, the contractor accepted the bid and used it to compute his own bid accordingly.  Afterwards, the subcontractor refused to do the paving work for less than fifteen thousand and stated the bid was a mistake.

            The California court held that the subcontractor’s bid was a promise, and he had reason to expect that the bid would be used by the contractor in computing his bid. Since this action adversely affected the contractor – he needed to find a new subcontractor which cost approximately $10,000 – promissory estoppel applied. He was responsible for the $3,000 difference – the amount necessary to prevent injustice.

            Now that we have covered the steps necessary to form a binding agreement, our next module looks at defenses against the enforcement of otherwise binding agreements.