What Is Consideration in a Contract? Definition, Types & Examples

Contract consideration refers to the value given by one party in exchange for the promise or performance of another party. As stated at the Legal Information Institute of Cornell University Law School, contract consideration involves a "bargained-for exchange," which refers to an item of value which makes the agreement different from a gift or gratuitous promise. This can include money, property, performance, a promise to perform and forbearance of action. Consideration does not have to be of equal value on both sides of the bargain – the courts evaluate its sufficiency, not adequacy. Main principles of validity include (1) it has to be bargained-for (past consideration is invalid, according to Eastwood v Kenyon [1840]), (2) consideration has to have legal value, and (3) performance of pre-existing duty is normally not consideration. Exceptions include promissory estoppel, charitable donations and contracts under seal.

Content

• What is consideration in a contract?
• What constitutes a consideration under contract law?
• What is insufficient consideration?
• What happens when consideration seems disproportionate?
• Are there legal exceptions to the consideration requirement?
• How Does Consideration Affect Contract Management in Practice?
• Conclusion

As discussed in our previous blogs, contracts require certain elements to be legally enforceable.  For any kind of agreement-lease, purchase, or employment—to be valid, there must be an offer, an acceptance, and a consideration. For example, if Person A makes an offer and Person B accepts it, the promise is only imposable by the court if there is an exchange of value.

Hence, whether it’s a car purchase from a friend or leasing of an apartment from a landlord, consideration needs to be involved in order for it to be a legally binding agreement. But what makes a proper consideration? Should it be monetary? And should they have the same value? All this is so complicated for such an essential element of the contract. All will be answered in this blog post.

What is consideration in a contract?

As per Contract Law, consideration is the price the promisor pays in exchange for the promise. It may manifest as a warranted promise, act, concession, or legal asset. Consideration is a legal concept based on “bargained-for exchange.” This implies that each of the parties stands to gain from the contract that they enter into. Therefore, consideration is essentially what you would get or give in return for entering into an agreement. 

In any sales agreement, for example, the seller gains financially while the buyer obtains the good or services purchased. Considerations are such important issues to consider in negotiations that they should be given proper attention. They are an important feature that makes contracts different from gifts and mere promises.

In the definition of Legal Information Institute of Cornell Law School, "consideration is anything of value given by one party to the other". In simple words, consideration is anything that each of the parties will have to give in return for a binding contract.

Types of Consideration at a Glance

What constitutes a consideration under contract law?

In order for the contract to be valid according to law, both the parties should make some form of promise to each other. The terms of the contractual agreement define what each party has promised to the other; it need not be of equal value. Whether the consideration is an undertaking, money, goods, services, or abstinence from action, it should be adequate and lawful. In addition to that, there should be good faith in the making of the contract. If there is proof of fraud, coercion, undue influence, or a mistake about the consideration, then it may affect the validity of the contract.

• Value: Consideration must have some value in the eyes of the law. It doesn't necessarily have to be of equal value, but it must be sufficient to support the contract. For example, a small sum of money or a promise to accomplish anything can be considered valid consideration.
  
  
• Bargained-for-exchange: The consideration must be the product of the parties' bargaining or negotiating. It should not be something given as a gift or a pre-existing obligation.
  
  
• Legal Validity: Consideration must have legal value, meaning it must be something the law recognizes as having some value. Illegal or immoral promises may lack legal validity and render the contract unenforceable.
  
  
• Performance, Forbearance, or Promise: Consideration can take the form of a performance of an act, a promise to perform an act, or a promise to refrain from doing something (forbearance). All three are valid as long as they meet the criteria of being bargained for and having legal value. 

What is insufficient consideration?

Usually, the parties are allowed to bargain on the terms of the contracts they enter into. They are at liberty to fix the value of the performance, products, services or forbearance that they will offer each other. Nevertheless, there are circumstances under which the courts may doubt whether the consideration offered by one party is sufficient or not. This is in situations whereby there is an inequality of value being exchanged among the parties involved in the transaction. These are some examples of insufficient considerations:

• Illusory Promises: Promises that are overly vague or lack commitment may be regarded as illusory and constitute invalid considerations.
  
  
• Past Consideration: Something given or done in the past generally does not qualify as consideration because it lacks the element of a bargain. It typically requires it to coincide with the making of the contract.
  
  
• Illegal Consideration: It is unacceptable to promise anything that would encourage criminal activity or violate public policy. Contracts with unlawful consideration are void.
  
  
• Moral Obligations: Moral or ethical obligations, without a legal duty, are generally not considered valid considerations. Courts are often reluctant to enforce promises based solely on moral considerations.
  
  
• Pre-existing Duty: A promise to do something that a party is already legally obligated to do may not be considered valid consideration. However, there are exceptions, such as modifications to existing contracts.
  
  Nominal Consideration: Small sums of money may be invalid if they have no genuine economic value.

What Happens When Consideration Seems Disproportionate?

"Adequacy of Consideration" in contract law is the term used for the reasonable or fair value being offered by the contracting parties. The law is not really concerned about the wisdom of the bargain, so as long as the terms of the contract are present, you can have a good deal or a bad one. It makes no difference if you are buying a pencil for $1 or $10 because it does not matter to the legal system, but there are times when adequacy of consideration may be considered.

• Grossly Disproportionate: If the consideration is so grossly inadequate that it shocks the court’s conscience, it might raise concerns. It is rare and typically involves extreme situations.
  
  
• Duress or Undue Influence: If there is evidence that one party used duress or undue influence to force the other into the contract, a court may scrutinize the adequacy of consideration.
  
  
• Unconscionability: In some jurisdictions, a contract can seem unethical if there is a grossly unfair distribution of rights and obligations, which might include disproportionate consideration. Courts may refuse to enforce such contractual agreements.
  
  
• Public Policy Violations: Consideration that goes against public policy may be deemed unenforceable. For instance, a contract that involves illegal activities or is against the general welfare may be invalidated.
  
  
• Fraud: A court may intervene if a party was lured into the contract by fraudulent misrepresentations about the consideration or other fundamental components.

Are There Legal Exceptions to the Consideration Requirement?

While consideration is a fundamental element of a contract, some situations exist where a contract may be enforceable even without traditional consideration. Some of the common exceptions include:

Promissory Estoppel (Detrimental Reliance)

Promissory estoppel prevents a person from reneging on a promise, even without something of value being exchanged between the parties. In other words, if someone makes an unequivocal promise and another party depends on it to their detriment, the promisor may be barred from breaking it. In such cases, consideration isn’t necessary if the promisee suffers harm or loss by relying on the promise.

Charitable Pledges

Donations that are pledged are normally binding despite no presence of consideration. Most courts have lowered the threshold of pledging and donating by making it easy to prove the exchange of values or reliance. The main basis for introducing charity subscriptions is public policy as it is a desirable objective of society.

Contracts under Seal

Deeds or contracts that are made under seal did not need any consideration in order to make the contract valid and binding in the past. The contract would only have to be written, sealed, and delivered for it to be a legally valid contract. The use of a seal signified that there was a more solemn obligation involved in the contract.

Unilateral Contracts

In a unilateral contract, there is a promise or offer from one side which involves an act of performance. Here, the act of performance serves as the acceptance and the consideration. Thus, we have "Performance as Consideration."

Pre-Existing Duty

However, a promise to perform an already existing duty cannot be said to be valid consideration. However, a modification of an existing duty can make the contract valid without any other form of consideration being involved. This is usually due to some unexpected factor.

UCC Note (Good Contracts)

In the UCC article one, modification of a contract for sale of goods does not need new consideration to make the contract enforceable. This is one exception to the preexisting duty doctrine, but it is applicable to contracts for the sale of goods and not for services.

How Does Consideration Affect Contract Management in Practice?

In commercial contract management, consideration clauses require careful drafting. Ambiguous or missing consideration language is one of the leading causes of contract disputes. According to the World Commerce & Contracts research, poor contract management costs companies an average of 9% of their bottom line.

Contract management software such as Dock 365 - built on Microsoft 365 - helps legal teams:

• Use pre-approved templates that include properly drafted consideration clauses
• Track amendments that may modify consideration terms
• Maintain an audit trail of negotiated terms in the event of a dispute
• Automate obligation tracking tied to exchanged consideration

Conclusion

It is the most important factor in establishing enforceable contracts. It is one of the key aspects that make a contract different from simple promises and gratuitous contracts. Therefore, it is crucial to understand the importance and ramifications of consideration for any party making contracts. 

It may vary and include money, goods, services, promises, and forbearance. The flexibility of consideration makes it easy for parties to adjust their agreements according to their specific requirements and business terms. Well-defined contractual terms, mutual agreement, and consideration of value help in making contracts that are enforceable and fair at the same time. This is why businesses need to be careful about drafting their contracts. 

Dock 365 provides the easiest way for the legal team and organizations to create competent legal agreements by using their comprehensive contract management software. There are multiple ways to create enforceable contracts ranging from pre-approved templates and clause library.

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