Under basic principles of contract law, consideration is the answer to the question, "Why are you entering this contract?" or "What are you receiving for being a party to this contract?"
In order for any agreement to be deemed legally binding, it must include consideration on the part of every person or company that enters the contract. This article covers the basics of the consideration requirement, including real-world examples of consideration. (To learn more about what else goes into a legally binding contract, check out Nolo's article Contracts: The Basics.)
What Is Consideration?
Consideration is the benefit that each party gets or expects to get from the contractual deal -- for example, Victoria's Secret gets your money; you get the cashmere robe.
In order for consideration to provide a valid basis for a contract -- and remember that every valid contract must have consideration -- each party must make a change in their "position." Consideration is usually either the result of:
- a promise to do something you're not legally obligated to do, or
- a promise not to do something you have the right to do (often, this means a promise not to file a lawsuit).
Sometimes this change in position is also called a "bargained-for detriment."
How does consideration work in the real world? Let's say you backed into your neighbor's golf cart and damaged it. Your neighbor is legally permitted to sue you for the damage but instead agrees not to sue you if you pay him $1,000. This agreement provides adequate consideration for the contract, because each party is giving up something in the exchange -- you're giving up some of your money while your neighbor is giving up the right to sue you.
When a Contract Lacks Consideration
In some situations, courts will step in and declare that a contract is unenforceable because it lacks consideration. Let's look at some of these scenarios.
One of the parties was already legally obligated to perform. For example, a police officer cannot claim the reward for capturing a wanted suspect, because the officer is already legally obligated to capture and arrest people who break the law.
The promise amounts to a gift, not a contract. If your rich uncle promises to give you money to buy a house, without any strings attached, that is a promise to make a gift. If he changes his mind, you can't force him to come up with the cash because his promise was one-sided; you have not done or promised to do anything in exchange.
On the other hand, if you make a down payment on a house in reliance on his promise, and your uncle knows about it, a court may enforce his original promise. Although it still isn't a true contract, the law recognizes that it's necessary to hold people to their promises once others take action on the assumption that the promise will be kept. This legal theory -- called "promissory estoppel"-- treats promises as contracts if the promise was reasonably relied upon.
The exchange is for "past consideration." When someone promises to give you something in return for something you've already done -- "I'm going to pay you $500 because you quit smoking last year" -- a court will not enforce the promise to make the payment because the performance (quitting smoking) wasn't bargained for. You did it without knowing that someone would come along later and offer to pay for it.
The bargained-for promise is illusory. For example, the laws in Maria's state prohibit firing an employee for refusing to sign a noncompete agreement. Maria signs one anyway, under threat of losing her job. The agreement is unenforceable because Maria's employer cannot do what it promised (or threatened) to do. A better approach would have been to provide Maria with some benefit or compensation if she signed the agreement, rather than threatening to fire her if she didn't.
For more information on unenforceable contracts, check out Nolo's article Unenforceable Contracts: What to Watch Out For.
What if the Consideration Seems Disproportionate?
In hindsight, many deals seem unfair ("You paid how much for that dress?"). However, courts rarely pass judgment on the value of the consideration exchanged unless the two promises are so disproportionate in value as to demonstrate bad faith (or "unconscionability") in the bargaining process. If a court does judge the consideration to be unfair, the contract will probably fall apart not because of a lack of consideration, but because the consideration is so disproportionate that it indicates that one party acted unfairly or concealed information that might have made the deal a fair one. Unless this type of bad faith exists, however, courts generally don't want to get into judging the relative value of particular promises or items. After all, what's worth a lot of money to one person may be worth very little to another; that's what bargaining is all about.
Do You Need the Word "Consideration" in Your Contract?
Many contracts provide a recital (a statement at the beginning of the contract) that the contract is being entered into "for good and valuable consideration, the sufficiency of which is acknowledged," or something to that effect. The writers of these contracts mistakenly believe that simply stating that consideration exists actually fulfills the requirement of contractual consideration. In a majority of states, however, this is not the case; such recitals don't prove anything. In other words, saying there is consideration doesn't necessarily mean there is consideration.
Legal scholars agree that generally, a contract doesn't need to include anything other than a statement that "the parties agree." The exception is for contracts that only one party signs, such as assignments, option agreements, or promissory notes. In these contracts, a recital that the consideration is sufficient should be included, because it's not self-evident that a bargained-for exchange has taken place.
For more tips on putting your agreement in writing, check out Nolo's article Contracts 101: Make a Legally Valid Contract. If you're looking for a practical A to Z guide to everything you need to know about contracts, get Nolo's new book Contracts: The Essential Business Desk Reference, by attorney Rich Stim.