We all know that business deals involve careful consideration of company finances, risk, and potential gain. But the contracts underlying those deals involve another form of consideration—something that demonstrates each party has a stake in the outcome. In fact, contracts are only legally binding if there is consideration (along with an offer and acceptance, as discussed in previous blogs). In contract law, consideration is defined as something (an act, forbearance, or return promise) that is bargained for and received by a promisor from a promisee and that motivates a person to so something. While the term and even definition of consideration is obscure, the (somewhat cynical) reasoning behind it actually makes sense: why would a person enter into a contract if they have nothing to gain from it?
A Valuable Exchange
Consideration can take many forms. In the classic 1891 Hamer v. Sidway case, the New York Court of Appeals found consideration—and thus a legally enforceable contract—when an uncle promised to pay his nephew $5,000 in exchange for the nephew’s promise that he would refrain from smoking, drinking, and gambling until he reached the age of 21. The takeaway from Hamer is that both parties were motivated by a promise or act of forbearance: the uncle was happy—and found value—in seeing his nephew refrain from smoking, alcohol and gambling, and the nephew’s forbearance from those activities came with a (valuable) payment of $5,000 down the road. Of course, had it been illegal to smoke, drink alcohol, or gamble in New York before the age of 21, there would have been no consideration. This gets us to some important nuances of consideration in contracts.
Pre-existing Legal Duties
Consideration is not found when a contracting part has a pre-existing legal duty. In the Hamer case above, the nephew would have had a pre-existing legal duty not to drink alcohol if it had been illegal to drink alcohol before the age of 21. In a business context, a pre-existing legal duty is found if a party already had an obligation to perform under a contract. For example, say your company entered into a contract with a consultant to prepare a marketing report for a new product launch. The contract stipulates a flat $1,500 fee to be paid once the report is submitted. Halfway through the project, the consultant calls to say the marketing report entails more work than he anticipated, and he needs to increase the price from $1,500 to $2,500. In this case, even if the contract is amended to increase the price, your company is still only on the hook for the initial $1,500. The consultant had a preexisting obligation to prepare the report for $1,500.
Consideration in contracts can create useful options. You can think of an option contract as an agreement to keep an offer open for a certain amount of time in exchange for something of value—usually money. Say your business is expanding and you are in search of space to lease for a new retail location. You come across a space for lease for $1,000 per month that’s in a pretty good location, but you want to keep searching in case you find something better. But what if you don’t find anything better, you wonder? An option contract is a great interim solution. In this scenario, you could offer the property owner a small payment of, say, $1,000 in exchange for her promise to not lease the property to anyone else for the next month along with a right of first refusal after that month. Your consideration of $1,000 in exchange for the property owner’s forbearance makes the option contract legally enforceable.
The consideration element of legally binding contracts can be as straightforward as an exchange of money for goods, or it can become obscure and nuanced when it comes to complex, long-term contracts with multiple amendments. Let us help ensure your business has legally enforceable contracts in place.
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Law 4 Small Business, P.C. (L4SB). A little law now can save a lot later. A Slingshot company.