Formation of contracts - Consideration (bargained-for exchange)

Learning Outcomes

This article examines the doctrine of consideration as a requirement for contract formation. It focuses specifically on the concept of a bargained-for exchange, including what constitutes legal value (benefit/detriment) and common issues like preexisting duties and past consideration. After reviewing this material, you will be able to identify the elements of consideration and analyze whether consideration exists in various MBE fact patterns involving contract formation and modification.

MBE Syllabus

For the MBE, you are required to understand the principles governing the formation of enforceable contracts, specifically the requirement of consideration. This involves analysing whether a promise is supported by a bargained-for exchange involving legal value. You should be prepared to:

• Define consideration and its essential elements: bargained-for exchange and legal value.
• Identify legal detriment to the promisee or legal benefit to the promisor.
• Distinguish valid consideration from gift promises, sham consideration, and illusory promises.
• Apply the preexisting duty rule at common law and its exceptions.
• Analyze the effect of past consideration and moral obligation.
• Understand the concept of adequacy of consideration.
• Recognize substitutes for consideration, such as promissory estoppel (though that is covered elsewhere).

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is generally required for a promise to be supported by consideration?
   1. The promise must be in writing and signed by the promisor.
   2. The promisee must suffer an economic detriment.
   3. There must be a bargained-for exchange between the parties.
   4. The value exchanged by the parties must be approximately equal.
2. A homeowner promises a local teenager $50 if the teenager refrains from playing loud music after 10 p.m. for one month. The teenager agrees and refrains. Is the homeowner's promise enforceable?
   1. No, because the teenager received no legal benefit.
   2. No, because refraining from an activity is never consideration.
   3. Yes, because the teenager incurred a legal detriment by refraining from an activity he had a legal right to do.
   4. Yes, but only if the homeowner actually benefited from the quiet.
3. A contractor agrees to build a deck for a homeowner for 5,000.Midwaythroughtheproject,thecontractorrealizeslumbercostsarehigherthanexpectedandtellsthehomeownerhecannotfinishunlessthehomeowneragreestopayanextra5,000. Midway through the project, the contractor realizes lumber costs are higher than expected and tells the homeowner he cannot finish unless the homeowner agrees to pay an extra 5,000.Midwaythroughtheproject,thecontractorrealizeslumbercostsarehigherthanexpectedandtellsthehomeownerhecannotfinishunlessthehomeowneragreestopayanextra1,000. The homeowner agrees. Under the common law preexisting duty rule, is the homeowner's promise to pay the extra 1,000enforceable?a)Yes,becausethehomeowneragreedtothemodification.b)Yes,becausethehigherlumbercostwasanunforeseendifficulty.c)No,becausethecontractorwasalreadyobligatedtobuildthedeckfor1,000 enforceable? a) Yes, because the homeowner agreed to the modification. b) Yes, because the higher lumber cost was an unforeseen difficulty. c) No, because the contractor was already obligated to build the deck for 1,000enforceable?a)Yes,becausethehomeowneragreedtothemodification.b)Yes,becausethehigherlumbercostwasanunforeseendifficulty.c)No,becausethecontractorwasalreadyobligatedtobuildthedeckfor5,000.
   1. No, unless the modification was put in writing.

Introduction

For a promise to be legally enforceable as a contract, it generally must be supported by consideration. Consideration is the "price" of the promise – what one party gives or promises in exchange for what the other party gives or promises. The core concept is that of a bargained-for exchange, where each party's promise or performance induces the other party's promise or performance. This distinguishes legally binding contracts from gratuitous promises (gifts), which are typically unenforceable.

The analysis involves identifying the promise at issue and determining whether the promisee gave something of legal value in return, which was sought by the promisor in exchange for their promise.

Key Term: Consideration The bargained-for exchange of something of legal value between parties; it is what makes a promise legally enforceable as a contract.

Elements of Consideration

Consideration consists of two key elements:

1. Bargained-for exchange: The promise must induce the detriment, and the detriment must induce the promise.
2. Legal value: The detriment must consist of something of legal value, meaning either a benefit to the promisor or, more commonly, a detriment to the promisee.

Bargained-For Exchange

The central idea is that the parties intended to make a deal. The promisor must make their promise in exchange for something specific from the promisee, and the promisee must give that something in exchange for the promisor's promise. It's a reciprocal inducement.

• Distinguishing Bargains from Gifts: A key function of this element is distinguishing enforceable bargains from unenforceable gift promises. If the promisor's intent is merely to make a gift, a condition attached to receiving the gift does not transform it into consideration. Example: "Come to my house and I'll give you my old TV" – going to the house is likely a condition of the gift, not the bargained-for price of the TV.

Key Term: Bargained-For Exchange The mutual inducement element of consideration; each party's promise or performance must be sought by the other party and given in exchange for that other party's promise or performance.

Legal Value

The second element requires that what is bargained for has "legal value." This does not mean it must have economic or monetary value. Instead, it means the promisee must incur a legal detriment or the promisor must receive a legal benefit.

• Legal Detriment: Occurs when the promisee does something they are under no legal obligation to do, or refrains from doing something they have a legal right to do. Example: Promising not to smoke or drink until age 21, when legally permitted to do so, constitutes a legal detriment.
• Legal Benefit: Occurs when the promisor obtains something they were not previously legally entitled to receive.

Key Term: Legal Detriment Incurred by a promisee if they do something they are not legally obligated to do or refrain from doing something they have a legal right to do.

Key Term: Legal Benefit Received by a promisor if they obtain something they were not previously legally entitled to receive.

Adequacy of Consideration

Courts generally do not inquire into the "adequacy" of consideration. As long as there is a bargained-for exchange of something having legal value, the contract is enforceable, even if the values exchanged are unequal.

• Nominal Consideration: A mere pretense of consideration (e.g., "$1 in exchange for a new car") is usually insufficient if it's clear the parties intended a gift.
• Sham Consideration: Recitals of consideration that was never actually paid or intended to be paid are generally insufficient.

Issues Affecting Consideration

Several common scenarios raise questions about the existence or sufficiency of consideration.

Preexisting Duty Rule

At common law, promising to perform (or performing) an act that one is already legally obligated to do (a preexisting duty) is not valid consideration for a new promise.

Key Term: Preexisting Duty Rule The common law principle that a promise to perform an act one is already legally obligated to do does not constitute valid consideration.

• Contract Modifications (Common Law): Under this rule, modifications to existing contracts require new consideration to be enforceable. Example: If a builder agrees to build a house for $200,000, and later the owner promises an extra$10,000 simply for the builder to finish the same work, the promise to pay the extra $10,000 is unenforceable due to the preexisting duty rule.
• Exceptions (Common Law):
  • New or Different Consideration: If the promisee does something in addition to or different from what was originally required, this constitutes valid consideration for the modification.
  • Unforeseen Difficulties: If performance becomes much more burdensome due to unforeseen difficulties not anticipated when the contract was formed, a promise to increase compensation may be enforceable in some jurisdictions (though this exception is narrowly applied).
  • Duty Owed to Third Party: A promise to perform a duty already owed to a third party can be consideration for a new promise (modern view).
  • Honest Dispute: If there is an honest dispute over the scope of the original duty, a modification settling that dispute is valid.
• UCC Modification (§ 2-209): Article 2 abolishes the preexisting duty rule for modifications to contracts for the sale of goods. Modifications under the UCC require no new consideration but must be made in good faith.

Past Consideration

A promise given in exchange for something already done is not bargained for and does not constitute valid consideration. The detriment was not induced by the promise.

• Example: Employer promises Employee a $5,000 bonus at the end of the year "in recognition of your excellent work this past year." This promise is based on past consideration and is generally unenforceable.
• Moral Obligation: Similarly, a promise made out of a sense of moral obligation for past benefits received is typically not enforceable. Exception: Some jurisdictions enforce a subsequent promise to pay for past material benefits received if necessary to prevent injustice (the "material benefit rule").

Illusory Promises

If one party's promise is illusory, meaning they have not actually committed to do anything, there is no consideration, and the agreement lacks mutuality of obligation. An illusory promise leaves performance entirely within the promisor's discretion.

• Example: "I promise to buy all the widgets I want to buy from you next year." This is illusory because the promisor has not committed to buying anything.
• Valid Promises vs. Illusory:
  • Requirements and Output Contracts (UCC § 2-306): Promises to buy all one requires or sell all one produces are not illusory. Good faith limits the parties' discretion.
  • Conditional Promises: Valid unless the condition is entirely within the promisor's control (e.g., "I'll pay if I feel like it").
  • Satisfaction Clauses: Promises conditioned on satisfaction are generally not illusory, as they are subject to a standard of good faith (subjective satisfaction) or reasonableness (objective satisfaction).

Worked Example 1.1

Builder agreed in a written contract to construct a house for Owner for $300,000 by September 1st. Due to unexpected labor shortages causing delays, Builder informed Owner in July that he could not complete the project by the deadline unless Owner agreed to pay an additional$20,000. Owner, needing the house finished quickly, orally agreed to the extra payment. Builder completed the house by September 1st. Owner paid $300,000 but refused to pay the additional$20,000. Builder sued Owner for the $20,000. Will Builder likely prevail?

Answer: No. Under the common law preexisting duty rule, Builder was already legally obligated to construct the house for $300,000 by September 1st. His promise to complete the work he was already bound to do is not valid consideration for Owner's promise to pay an additional$20,000. While unforeseen difficulties can sometimes be an exception, typical labor shortages are usually considered risks assumed by the contractor and not sufficiently "unforeseen" to bypass the rule. Therefore, Owner's promise to pay the extra $20,000 is likely unenforceable for lack of consideration.

Worked Example 1.2

Aunt promised her 19-year-old Nephew $5,000 if he would "refrain from drinking alcohol and using tobacco" until his 21st birthday. Nephew, who occasionally drank alcohol but did not use tobacco, agreed and fully complied. On Nephew's 21st birthday, Aunt refused to pay. Nephew sued. Is Aunt's promise enforceable?

Answer: Yes. Nephew incurred a legal detriment by refraining from activities he had a legal right to engage in (drinking alcohol, as he was over 18/19 depending on local law, though perhaps not universally 21). This detriment was bargained for by Aunt in exchange for her promise to pay $5,000. The fact that refraining might have also benefited Nephew's health is irrelevant to whether he suffered a legal detriment. There was a bargained-for exchange of legal value.

Exam Warning

Be careful not to confuse conditional gifts with bargained-for consideration. If the promisor's primary intent is to make a gift, an act required of the promisee merely to receive the gift (e.g., "come to my office to pick up the check") is a condition, not consideration. The test is whether the act benefits the promisor or was the "price" of the promise.

Key Point Checklist

This article has covered the following key knowledge points:

• Consideration is required for most promises to be enforceable as contracts.
• Consideration consists of (1) a bargained-for exchange and (2) legal value.
• Bargained-for exchange means the promise induces the detriment and the detriment induces the promise.
• Legal value means either a legal benefit to the promisor or a legal detriment to the promisee.
• Legal detriment involves doing something one is not obligated to do or refraining from something one has a legal right to do.
• Courts generally do not examine the adequacy of consideration, only its sufficiency (legal value).
• The preexisting duty rule (common law) states that performing or promising to perform an existing legal duty is not consideration.
• Exceptions to the preexisting duty rule exist (e.g., new/different consideration, settlement of honest dispute, unforeseen difficulties).
• UCC § 2-209 abolishes the preexisting duty rule for sales of goods modifications (good faith required).
• Past consideration (a promise based on something already done) is generally not valid consideration.
• Illusory promises (where one party is not actually bound) lack consideration and mutuality.

Key Terms and Concepts

• Consideration
• Bargained-For Exchange
• Legal Detriment
• Legal Benefit
• Preexisting Duty Rule