Understanding Consideration in Contract Law

In this first lesson of Unit 7, we turn our attention to the topic of consideration. Consideration is generally a requirement for the formation of contracts and also for modification of existing contracts. We'll get to some major exceptions to this requirement later in the course, but for the most part, you should assume, correctly, that consideration is a normal requirement for the formation of a contract. We may have an offer and an acceptance, but if there is no consideration, then there will be no contract. contract. In your casebook, we have an excerpt from the treatise from 1904 called Clark on Contracts that makes a useful distinction in thinking about what consideration means. Professor Clark says, it is undoubtedly true that every man is, by the law of nature, bound to fulfill his engagements. It is equally true that the law of this country supplies no means nor affords any remedy to compel the performance of an agreement made without sufficient consideration. Stop there for a moment and think about the distinction between the law of nature and the law of this country. The law of nature, as referred to here, doesn't require us to get into theories of natural law and such that that exist in various philosophical and faith traditions, but the idea is that there is a moral component to keeping promises. And although morality may require that promises be kept, regardless of whether they were made in exchange or not, the law of this country, that is, contract law that's being referenced here, does not require all promises to be satisfied unless there is consideration, which as we will see is something of value. The last sentence on this screen says that such agreement is, in a Latin phrase, nudum pactum ex quo nor orator actio, a naked promise from which no action can arise. So promises can exist between parties without the existence of a contract. So since we realize that there can be right and wrong, but that doesn't always coincide with what the law requires, we need to know what consideration is, what has to be present for the legal system to enforce a contract. Professor Clark continues, consideration is that which moves from the promisee to the promisor at the express or implied request of the latter. in return for his promise. It may consist either in some right, interest, profit, or benefit accruing to one party, or some forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other. Put more simply, something that has value has to be exchanged. Now, that can be value in a negative sense, such as giving up the legal right to do something. That's what forbearance refers to. And promises often have value because when enforceable, they place restrictions on the legal future of the party making the promise. So we were always going to be... on the lookout for what the thing is of value, including the thing that is contained in a promise. So all of our units on consideration will address this point, and it's one you would do well to keep in mind. Another way to think of this is that formation of a contract, like shown in the picture, requires an offer and acceptance. And that will form a contract only if there is consideration between the parties. So, in this sketch, there's money that's going to one side, and there are goods or merchandise that are going to the other side. Both sides have pledged something of value, and that is enough to support the contract. Now, in contrast to the doctrine of consideration, we might consider Santa Claus. Now, what do I mean by that? Santa gives you based on past performance. If you've been good for the past year, then you may get a gift. But note that it is a gift, and it wasn't negotiated in advance. A gift is the antithesis of a promise made by consideration. So while Santa gives based on past performance, there's no Santa Claus in contract law. Contract law only gives you based on what you have bargained for. The parties who are making promises must pledge and seek something affirmatively from the other. And again, the main import of this is that gift promises, so I made Let's say I made promise to give you a gift for Christmas or some other holiday. That's not enforceable unless there is something that is specifically offered in exchange for that promise. But then, of course, it is no longer a gift. So remember, gift promises are not consideration. The promises must have real substance. The definition of consideration is in Restatement Second of Contracts, Section 71, and Subsection 1 tells us that to constitute consideration, a performance or return promise must be bargained for. Again, it can't be a gratuitous gift. It has to be sought by the party, and that's what the reference to bargain for means. Well, that's elaborated upon in subsection two, where we see that a performance or return promise is bargained for if it is sought by the promisor in exchange for his promise and is given by the promisee in exchange for that promise. Once again, it must be sought. The promise that can constitute consideration may consist of an act other than a promise. So you can pledge to do something. Maybe you actually do do something in a unilateral contract. It may consist of forbearance, that is, not doing something that you would otherwise have a legal right to do. And then a promise could also change the legal relationship between the parties by creating, modifying, or destroying the current status quo of that legal relation. And if you want to know what that means, think of the settlement of a lawsuit. That changes the relationship between the two parties to a lawsuit or a contract maybe that's for the sale of goods over the next year. Perhaps you own a factory and you make a contract that you will sell a certain number of your widgets. That is creating a legal relationship. So all of these things fit within the definition of consideration. But I understand that some of that seems a little bit theoretical or ethereal, so it may help if we have specific examples. Finally, subsection 4 reminds us that a performance or return promise may be given to the promisor or to some other person. It may be given by the promisee or by some other person. In other words, the promise could go to a third party, but it is sought by the first party, that's still good enough. You say, I have no idea what that means. Actually, you do. Think of a life insurance policy where the insured has a contract with the company where the company promises to pay money in the event of death. Well, of course, the insured who dies and is a party to that is not going to get the benefit. Rather, the beneficiaries will, and so that would be an example of some other person who is not a party to the contract but who has the right to a return promise. The case of Ridge Runner Forestry v. Veneman from 2002, a federal contracts case, meaning it involves a contract with the federal government, is a good example for us to see a type of promise that is outside the requirement of consideration, and that is what we call an illusory promise. So stay tuned for what that is. Ridge Runner Forestry provides a variety of services that would be beneficial to the maintenance of a forest. And of course, the Department of Agriculture and its forestry service has need of such services from time to time. And that's what happened here. Ridge Runner Forestry was a fire protection company in the Pacific Northwest. It answered an RFQ, which is a request for quotations, issued by the Forestry Service. when Ridge Runner submitted a proposal and signed a document that was accepted by the Forestry Service, which is under the Department of Agriculture. By the way, if you wonder why is Ann Veneman, the Secretary of Agriculture, the named party here, that is very common that when agencies are sued, they are sued in their official capacity of whoever is leading the agency. Thus, you may hear about suits against the governor, or the president, or the attorney general. It doesn't really matter. The idea is that person is the stand-in for the office and is not individually liable. So do understand that Secretary Veneman was not a party to the suit as an individual, but only because she was Secretary of Agriculture. If that job had turned over and someone else came into it during the pendency of the lawsuit, well then the caption of the lawsuit would have changed. So what's going on here? If we have an offer and we have an acceptance, why don't we have an agreement? Let's take a look at the actual terms of the agreement, called the tender agreement. First, award of an interagency equipment rental agreement based on response to this RFQ does not preclude the government from using any agency or cooperator or local EERA resources. so equipment, rental resources. So already something here sounds suspicious that the government is not limiting what it can do. Let's go on. Another provision says award of an inter- agency equipment rental agreement does not guarantee there will be a need for the equipment offered, nor does it guarantee orders will be placed against the awarded agreements. There is no promise here that the government will actually spend any money on anything with Ridge Runner Forestry as a result of the tender agreement. And then finally, as if that weren't enough, the agreement also states, it is mutually agreed that, upon request of the government, the contractor shall furnish the equipment offered herein. But look at the last part. To the extent the contractor is willing and able at the time of the order. Put another way, neither side has to do anything. The government can get out of it for any reason it wants, and Ridge Runner Forestry can get out of it for any reason it wants. wants. So although this document has all the appearance of a contract with promises on both sides, those promises do not withstand scrutiny because any party can get out of it whenever it wants. Students will frequently ask me in connection with this case, then why did the tender agreement even exist? What's the point? And in turn, some students who have experience with the management of government contracts recognize that the tender agreement is a way to set up parties in the system so that it is much easier for the government to use this pre-approved vendor for services. So it isn't a contract, but you might think it is a prelude to a contract. So there is a real reason to have these agreements in place, but they do not form a contract. Despite Ridge Runner Forestry's protests to the contrary, saying, hey, why haven't you used us for a service? Now, the court has some important language about illusory promises. That's what it says the tender agreements are. They are nothing but illusory promise. By the phrase illusory promise is meant words in promissory form that actually promise nothing. They do not purport to put any limitation on the freedom of the alleged promisor, but leave his future actions subject to his own future will, just as it would have been had he said no words at all. Once again, an illusory promise may be stated and presented in the form of a promise or something that looks like a contract, but it's no promise at all because either side has the freedom to get out of it. So a promise to be consideration must put some sort of limitation on the future of the party. making the promise in order for that promise to have value. Now, the court in Ridgerunner gives another case as a point of comparison that also involved a government contract, and this is the Ace Federal Reporters case. That contract provided, except as this contract otherwise provides, the government shall order from the contractor. That would be the court reporter service, all the supplies or services specified in the schedule that are required to be purchased by the government. So far, so good. There is some sort of a requirement here. And the court notes that each contract also included a termination clause that limited government liability should the GSA or government general services administration. choose to cancel any contract. And the court said this was a contract, even though there was a lot of freedom to get out of it. How could that be? Look at the sentence at the bottom. In the earlier case of Ace Federal Reporters, the court held that each time an agency that did not obtain a GSA waiver arranged for services covered under the contract from a non-contract source, that might be. using court reporters other than Ace, then the government did not act within the limited exception and it breached the contract. Put another way, in the earlier Ace Federal case, the government did have some limits on its future freedom. While it's true it had a way to get around that, the fact that it had to do something to get around it meant that there was consideration. This is the first of many examples we'll see in this course where I will tell you consideration doesn't have to be much, but it has to be something. Now, there is a definition of illusory and alternative promises in Section 77 of the Second Restatement, and that section says that a promise or apparent promise is not consideration if by its terms the promisor or purported promisor reserves a choice of alternative performances, meaning you can go one way or the other, unless a. each of the alternative performances would have been consideration, and if it alone had been bargained for. So, in other words, yeah, the party may have a choice to do either one thing or the other, but if each one of those things have value, it doesn't really matter that there is a choice involved. Also, B, one of the alternative promises would have been consideration, and there is, or appears to the parties to be, a substantial possibility that before the promisor exercises his choice, Events may eliminate the alternatives which would not have been consideration. That means we could have a choice that has no value, but we don't know what the future holds, and the future may eliminate that choice. Even that is enough to keep a promise from being illusory. Section 77 of the restatement contains some examples or illustrations of the principle in place, and I think these are helpful for us to look at to see, again, how minimal the consideration requirement is. illustration one is a offers to deliver to b at two dollars a bushel as many bushels of wheat not exceeding five thousand as b may choose to order within the next 30 days and b agrees to buy at that price as much as he shall order from a within that time notice complete choice as to the quantity or whether to order anything at all therefore this first bullet point is an illusory promise. So is the second. A promises B to act as B's agent for three years starting January 1st. So far, so good. But look at the rest. B agrees that A may so act, but reserves the power to terminate the agreement at any time. B has no limits placed on its future where it would be required to use A as its agent. an agent. Therefore, the second bullet is also an illusory promise. But contrast that with our third example. A promises B to act as B's agent for three years. starting January 1st, Bee reserves the power to terminate the agreement on 30 days notice. Put another way, there will at least be a 30-day period where Bee can't get out of it, even if on day one Bee decides to terminate the agency agreement. That does count as consideration, and that is sufficient. Even though, yeah, it's not much because because B still has a lot of power here. Finally, A orders goods from B for shipment within three months. A reserves the right to cancel at any time before shipment. If those last words weren't in there, this would be an illusory promise. But because once B ships the goods, A has no choice. A must accept. the goods. So that would make the promise non-illusory. Once again, consideration doesn't have to be much, but it has to be something. And that brings us to the end of our first lesson on consideration and illusory promises as a method of contrast.

We may have an offer and an acceptance, but if there is no consideration, then there will be no contract. contract. In your casebook, we have an excerpt from the treatise from 1904 called Clark on Contracts that makes a useful distinction in thinking about what consideration means.

Professor Clark says, it is undoubtedly true that every man is, by the law of nature, bound to fulfill his engagements. It is equally true that the law of this country supplies no means nor affords any remedy to compel the performance of an agreement made without sufficient consideration. Stop there for a moment and think about the distinction between the law of nature and the law of this country.

The law of nature, as referred to here, doesn't require us to get into theories of natural law and such that that exist in various philosophical and faith traditions, but the idea is that there is a moral component to keeping promises. And although morality may require that promises be kept, regardless of whether they were made in exchange or not, the law of this country, that is, contract law that's being referenced here, does not require all promises to be satisfied unless there is consideration, which as we will see is something of value. The last sentence on this screen says that such agreement is, in a Latin phrase, nudum pactum ex quo nor orator actio, a naked promise from which no action can arise. So promises can exist between parties without the existence of a contract.

So since we realize that there can be right and wrong, but that doesn't always coincide with what the law requires, we need to know what consideration is, what has to be present for the legal system to enforce a contract. Professor Clark continues, consideration is that which moves from the promisee to the promisor at the express or implied request of the latter. in return for his promise. It may consist either in some right, interest, profit, or benefit accruing to one party, or some forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other. Put more simply, something that has value has to be exchanged.

Now, that can be value in a negative sense, such as giving up the legal right to do something. That's what forbearance refers to. And promises often have value because when enforceable, they place restrictions on the legal future of the party making the promise.

So we were always going to be... on the lookout for what the thing is of value, including the thing that is contained in a promise. So all of our units on consideration will address this point, and it's one you would do well to keep in mind. Another way to think of this is that formation of a contract, like shown in the picture, requires an offer and acceptance.

And that will form a contract only if there is consideration between the parties. So, in this sketch, there's money that's going to one side, and there are goods or merchandise that are going to the other side. Both sides have pledged something of value, and that is enough to support the contract. Now, in contrast to the doctrine of consideration, we might consider Santa Claus.

Now, what do I mean by that? Santa gives you based on past performance. If you've been good for the past year, then you may get a gift. But note that it is a gift, and it wasn't negotiated in advance.

A gift is the antithesis of a promise made by consideration. So while Santa gives based on past performance, there's no Santa Claus in contract law. Contract law only gives you based on what you have bargained for. The parties who are making promises must pledge and seek something affirmatively from the other. And again, the main import of this is that gift promises, so I made Let's say I made promise to give you a gift for Christmas or some other holiday.

That's not enforceable unless there is something that is specifically offered in exchange for that promise. But then, of course, it is no longer a gift. So remember, gift promises are not consideration.

The promises must have real substance. The definition of consideration is in Restatement Second of Contracts, Section 71, and Subsection 1 tells us that to constitute consideration, a performance or return promise must be bargained for. Again, it can't be a gratuitous gift.

It has to be sought by the party, and that's what the reference to bargain for means. Well, that's elaborated upon in subsection two, where we see that a performance or return promise is bargained for if it is sought by the promisor in exchange for his promise and is given by the promisee in exchange for that promise. Once again, it must be sought. The promise that can constitute consideration may consist of an act other than a promise. So you can pledge to do something.

Maybe you actually do do something in a unilateral contract. It may consist of forbearance, that is, not doing something that you would otherwise have a legal right to do. And then a promise could also change the legal relationship between the parties by creating, modifying, or destroying the current status quo of that legal relation. And if you want to know what that means, think of the settlement of a lawsuit. That changes the relationship between the two parties to a lawsuit or a contract maybe that's for the sale of goods over the next year.

Perhaps you own a factory and you make a contract that you will sell a certain number of your widgets. That is creating a legal relationship. So all of these things fit within the definition of consideration. But I understand that some of that seems a little bit theoretical or ethereal, so it may help if we have specific examples.

Finally, subsection 4 reminds us that a performance or return promise may be given to the promisor or to some other person. It may be given by the promisee or by some other person. In other words, the promise could go to a third party, but it is sought by the first party, that's still good enough.

You say, I have no idea what that means. Actually, you do. Think of a life insurance policy where the insured has a contract with the company where the company promises to pay money in the event of death.

Well, of course, the insured who dies and is a party to that is not going to get the benefit. Rather, the beneficiaries will, and so that would be an example of some other person who is not a party to the contract but who has the right to a return promise. The case of Ridge Runner Forestry v. Veneman from 2002, a federal contracts case, meaning it involves a contract with the federal government, is a good example for us to see a type of promise that is outside the requirement of consideration, and that is what we call an illusory promise. So stay tuned for what that is. Ridge Runner Forestry provides a variety of services that would be beneficial to the maintenance of a forest.

And of course, the Department of Agriculture and its forestry service has need of such services from time to time. And that's what happened here. Ridge Runner Forestry was a fire protection company in the Pacific Northwest. It answered an RFQ, which is a request for quotations, issued by the Forestry Service. when Ridge Runner submitted a proposal and signed a document that was accepted by the Forestry Service, which is under the Department of Agriculture.

By the way, if you wonder why is Ann Veneman, the Secretary of Agriculture, the named party here, that is very common that when agencies are sued, they are sued in their official capacity of whoever is leading the agency. Thus, you may hear about suits against the governor, or the president, or the attorney general. It doesn't really matter.

The idea is that person is the stand-in for the office and is not individually liable. So do understand that Secretary Veneman was not a party to the suit as an individual, but only because she was Secretary of Agriculture. If that job had turned over and someone else came into it during the pendency of the lawsuit, well then the caption of the lawsuit would have changed.

So what's going on here? If we have an offer and we have an acceptance, why don't we have an agreement? Let's take a look at the actual terms of the agreement, called the tender agreement. First, award of an interagency equipment rental agreement based on response to this RFQ does not preclude the government from using any agency or cooperator or local EERA resources.

so equipment, rental resources. So already something here sounds suspicious that the government is not limiting what it can do. Let's go on. Another provision says award of an inter- agency equipment rental agreement does not guarantee there will be a need for the equipment offered, nor does it guarantee orders will be placed against the awarded agreements. There is no promise here that the government will actually spend any money on anything with Ridge Runner Forestry as a result of the tender agreement.

And then finally, as if that weren't enough, the agreement also states, it is mutually agreed that, upon request of the government, the contractor shall furnish the equipment offered herein. But look at the last part. To the extent the contractor is willing and able at the time of the order. Put another way, neither side has to do anything. The government can get out of it for any reason it wants, and Ridge Runner Forestry can get out of it for any reason it wants.

wants. So although this document has all the appearance of a contract with promises on both sides, those promises do not withstand scrutiny because any party can get out of it whenever it wants. Students will frequently ask me in connection with this case, then why did the tender agreement even exist?

What's the point? And in turn, some students who have experience with the management of government contracts recognize that the tender agreement is a way to set up parties in the system so that it is much easier for the government to use this pre-approved vendor for services. So it isn't a contract, but you might think it is a prelude to a contract. So there is a real reason to have these agreements in place, but they do not form a contract. Despite Ridge Runner Forestry's protests to the contrary, saying, hey, why haven't you used us for a service?

Now, the court has some important language about illusory promises. That's what it says the tender agreements are. They are nothing but illusory promise.

By the phrase illusory promise is meant words in promissory form that actually promise nothing. They do not purport to put any limitation on the freedom of the alleged promisor, but leave his future actions subject to his own future will, just as it would have been had he said no words at all. Once again, an illusory promise may be stated and presented in the form of a promise or something that looks like a contract, but it's no promise at all because either side has the freedom to get out of it. So a promise to be consideration must put some sort of limitation on the future of the party.

making the promise in order for that promise to have value. Now, the court in Ridgerunner gives another case as a point of comparison that also involved a government contract, and this is the Ace Federal Reporters case. That contract provided, except as this contract otherwise provides, the government shall order from the contractor. That would be the court reporter service, all the supplies or services specified in the schedule that are required to be purchased by the government. So far, so good.

There is some sort of a requirement here. And the court notes that each contract also included a termination clause that limited government liability should the GSA or government general services administration. choose to cancel any contract.

And the court said this was a contract, even though there was a lot of freedom to get out of it. How could that be? Look at the sentence at the bottom.

In the earlier case of Ace Federal Reporters, the court held that each time an agency that did not obtain a GSA waiver arranged for services covered under the contract from a non-contract source, that might be. using court reporters other than Ace, then the government did not act within the limited exception and it breached the contract. Put another way, in the earlier Ace Federal case, the government did have some limits on its future freedom. While it's true it had a way to get around that, the fact that it had to do something to get around it meant that there was consideration.

This is the first of many examples we'll see in this course where I will tell you consideration doesn't have to be much, but it has to be something. Now, there is a definition of illusory and alternative promises in Section 77 of the Second Restatement, and that section says that a promise or apparent promise is not consideration if by its terms the promisor or purported promisor reserves a choice of alternative performances, meaning you can go one way or the other, unless a. each of the alternative performances would have been consideration, and if it alone had been bargained for. So, in other words, yeah, the party may have a choice to do either one thing or the other, but if each one of those things have value, it doesn't really matter that there is a choice involved. Also, B, one of the alternative promises would have been consideration, and there is, or appears to the parties to be, a substantial possibility that before the promisor exercises his choice, Events may eliminate the alternatives which would not have been consideration.

That means we could have a choice that has no value, but we don't know what the future holds, and the future may eliminate that choice. Even that is enough to keep a promise from being illusory. Section 77 of the restatement contains some examples or illustrations of the principle in place, and I think these are helpful for us to look at to see, again, how minimal the consideration requirement is. illustration one is a offers to deliver to b at two dollars a bushel as many bushels of wheat not exceeding five thousand as b may choose to order within the next 30 days and b agrees to buy at that price as much as he shall order from a within that time notice complete choice as to the quantity or whether to order anything at all therefore this first bullet point is an illusory promise.

So is the second. A promises B to act as B's agent for three years starting January 1st. So far, so good.

But look at the rest. B agrees that A may so act, but reserves the power to terminate the agreement at any time. B has no limits placed on its future where it would be required to use A as its agent. an agent. Therefore, the second bullet is also an illusory promise.

But contrast that with our third example. A promises B to act as B's agent for three years. starting January 1st, Bee reserves the power to terminate the agreement on 30 days notice. Put another way, there will at least be a 30-day period where Bee can't get out of it, even if on day one Bee decides to terminate the agency agreement.

That does count as consideration, and that is sufficient. Even though, yeah, it's not much because because B still has a lot of power here. Finally, A orders goods from B for shipment within three months.

A reserves the right to cancel at any time before shipment. If those last words weren't in there, this would be an illusory promise. But because once B ships the goods, A has no choice. A must accept. the goods.

So that would make the promise non-illusory. Once again, consideration doesn't have to be much, but it has to be something. And that brings us to the end of our first lesson on consideration and illusory promises as a method of contrast.

Transcript for:Understanding Consideration in Contract Law

Transcript for:
Understanding Consideration in Contract Law