Consideration: Every Contract Needs It

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.

What Is Contract Consideration?

Consideration is the benefit that each party gets or expects to get from the contractual deal—for example, Volvo gets your money; your business gets the excavator.

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 legal detriment."

How does consideration work in the real world? Suppose a customer visiting your store is browsing your inventory when one of the display shelves gives way and falls on top of them, dislocating their shoulder. Your customer is legally permitted to sue you for their injury but instead agrees not to sue you if you pay them $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 customer is giving up the right to sue you.

When Does a Contract Lack 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 can't 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 start your business, without any strings attached or promised stake in the business, that's 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 haven't done or promised to do anything in exchange.

The exchange is for "past consideration." When someone promises to give you something in return for something you've already done, a court will not enforce the promise to give you something because the performance wasn't bargained for. For example, suppose a client promises to give you $500 to celebrate your first full year in business. A court probably wouldn't make your client give you $500 because staying in business for a year wasn't bargained for. You did the action without knowing that someone would come along later and offer to pay for it.

The bargained-for promise is illusory. For example, suppose 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 can't 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.

What If the Consideration Seems Disproportionate?

In hindsight, many deals seem unfair ("You paid how much for that espresso machine?"). 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 might 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 isn't the case; such recitals don't prove anything. In other words, saying there's 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 to this rule is for contracts that only one party signs, such as:

• assignments
• option agreements, and
• 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.

Talking to a Business Lawyer

Every contract, with very few exceptions, needs consideration. While it might be a long road to negotiate the appropriate consideration, including it in your contract is relatively simple. You can probably work out the terms for consideration in your business agreement with the other side yourself. But if you have legal questions on whether consideration is required or adequate in your situation or you've hit a snag in contract negotiations, you should talk to a business attorney. They can help you negotiate your business agreement and advise you on how your consideration can affect the rest of the contract terms.

If you're interested in further education and a practical A to Z guide to contracts, see Contracts: The Essential Business Desk Reference, by Richard Stim (Nolo).