Why is Consideration Important in a Contract?
Consideration, or something of value exchanged in a contract, must be adequate in many jurisdictions in order for a contract to be enforceable.4 min read
Why is consideration important in a contract? Consideration, or something of value exchanged in a contract, must be adequate in many jurisdictions in order for a contract to be enforceable.
Role of Consideration in Contracts
Simply stated, the idea behind contracts is to facilitate engagement in mutually beneficial agreements and transactions.
There are three elements of a contract:
- The offer.
Consideration is value or a promise, action, or thing that has value to its recipient. Examples of considerations are:
- A promise to undertake an action.
- A promise to abstain from an action that the party otherwise would have the right to engage in, also called forbearance.
In other words, consideration asks whether the parties to a contract have assumed either an obligation or an act of forbearance. Therefore, certain actions or promises may not qualify as consideration and cannot be incorporated into contract formation. In this type of case, the agreement was illusory, a gift, or possibly an unenforceable agreement due to illegality, for example, blackmail.
What Are the Legal Requirements of Consideration?
Consideration is required to be "adequate," meaning that the exchange in value should be reasonably balanced. A consideration's value is typically determined by the market value of goods and services. While parties to a contract can negotiate as they wish, consideration must at least be deemed reasonable in order to hold up in court.
Under many states' laws, mutual consideration, or the exchange of value between a contract's parties, is a critical component in contract formation. If mutual consideration is not present in a contract, under some circumstances a state may deem the contract to be unenforceable.
For example, if two parties enter a contract in which one party is required to provide a good or service while the other is not required to provide anything of value, the contract lacks consideration.
Other examples of situations in which consideration is lacking include:
- Illusory promises, where an obligation is uncertain
- Past performance, or creating obligations retroactively
For example, if Party A promises to provide Party B a good in exchange for advance payment from Party B, there is sufficient consideration, or exchange of value. Similarly, if Party A pays restitution to Party B in exchange for a promise from Party B that they will not sue for a claimed harm, the promise not to sue can be understood as consideration.
Courts and legislatures typically require consideration in contracts. While in some jurisdictions, the courts do not review the adequacy of consideration, indefinite or vague terms may still in some cases invalidate a contract unless it becomes clear from subsequent actions.
In contracts that are related to trademarks or copyrights, this means that royalties could be discontinued if the contract only grants the right to use the intellectual property and the licensor does not actually have the right to the intellectual property, assuming that the licensor was not aware that the rights were not valid.
If the contract provides that the licensor will discontinue the use of the rights, however, this could constitute forbearance that is adequate for the contract to continue. It is therefore important to evaluate what parties are exchanging when you set up a contract or licensing agreement.
The Differences Between a Contract and a Gift
Without consideration, a contract is really just a gift or unilateral obligation between two parties.
Gifts are when one party promises another something of value without expecting to receive consideration in return. However, a gift may become a contract if the giver stipulates a condition that the recipient of the gift must meet in order to receive it. For example, if a grandparent promises their grandchild a monetary gift to meet college expenses if they are accepted into college, the recipient of the gift is required to meet certain conditions in order to receive the monetary gift.
Illusory promises, where there is no additional or mutual consideration that makes a contract legally binding, are typically unenforceable as contracts. This type of failure of consideration sometimes arises in employment contracts. For example, a contract for continued employment that lays out new terms on behalf of the employer without providing additional benefits to the employee is likely to be unenforceable.
Do Contract Amendments Require Consideration?
As the example above suggests, material modifications of contracts, also known as amendments, usually require new consideration, since one party is already performing a promise they had previously been bound by and therefore are not receiving sufficient consideration. However, under some specific circumstances, contracts may be exempt from this requirement.
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