What is Consideration in Contract Law?
The special word “consideration” in contract law refers to something that has value in the eyes of the law.
- is an essential element to make a contract
- must be provided for a contract to be legally binding.
In contract law, it is said that "consideration must move from the promisee".
Drawing out the subtlety of this statement:
- If there is "a promisee", there must already be a promisor
- The promisor has already made a promise to the promisee, which is sufficient to form a contract (but it's not formed at this point)
- The promisee must give something back to the promisor - a promise
- When the promisee promises to do something - gives consideration (and it doesn't have to be given to the promisor) - a legally binding contract is formed, provided the other elements have been satisfied
Types of Consideration in Contract Law
A promise - ie consideration - can be:
- a promise to do something, such as to:
- transfer ownership in property, such as intellectual property, a car or house
- create an art work
- develop software
- grant a licence to intellectual property rights
- pay money
- a promise to refrain from doing something (known as a restrictive covenant):
- not work with another employer of a particular description for a period of time after employment ceases.
- not to build property over a specified height
- not take ownership of shares in another business
- a promise to pay money to the other contracting party, or to someone else
Consideration is classified as one of two types:
- executed: when the promise has been performed within the meaning of the contract, or
- executory: when the promise has not been performed.
Sufficiency of Consideration
Consideration is able to be minimal, such as £1.00.
Contracts supported by small consideration are enforceable, because Courts will look for consideration for a promise, rather than examine the commercial merits of the contract.
Courts are reluctant to interfere with contracts which are freely made between contracting parties. If the promises to be performed at a later date or at the time the contract is made, it is sufficient.
The law looks for some of value in an economic sense - even minuscule.
For this reason, consideration may be inadequate from a commercial perspective, but for legal purposes:
- it is "sufficient",
- and sufficient to form a legally binding contract.
What is the purpose of contractual consideration?
Reciprocity of consideration is fundamental to contract law.
The exchange of consideration creates a benefit and a burden for each party entering into a contract.
The consideration which is the benefit of the contract for one party (say, receiving money) is the burden of the other (say, paying money).
Without consideration being given by each party to the contract, the contract can't legally binding.
Accordingly, gratuities are not enforceable in law. For example, this is a gratuity:
A person promises to pay you £10.
You do not offer to do anything in response.
It's a gratuitous promise. One person promises to do something but the other (you) does not promise anything. The promise to pay the £10 is not enforceable.
In legal language, "the offer to pay the £10 is not supported by consideration" or consider does not move from the promisee.
As there is no consideration provided by one party, there is no contract.
Exception to requirement for Consideration: Deeds
The exception to this, is use of a Deed.
- are written contracts
- must state that they are a Deed
- must be "signed, sealed and delivered" by both of the parties.
Those words have a technical meaning which we don't cover here
- are not required to be supported by consideration to be legally binding
- have other special requirements which prevent them from being abused.
Let's put that exception to the general rule to one side.
What sort of consideration is required to properly form a legally binding contract?
The Essential Characteristic of Consideration
There's an essential characteristic of consideration which must exist to form a contract.
Above, 3 types of consideration were listed:
- a promise to do something
- a promise not to do something, and
- a promise to pay money.
There's another requirement.
The consideration must be fresh consideration.
What is fresh consideration?
It's consideration which has not:
- been given, provided or delivered by one party already
- already been promised, which the party is already bound to perform
Let me explain.
Once a contract is signed, consideration can be either:
- Executed consideration, which is consideration which has been provided by the party promising it.
For example, money which has been promised to be paid under a contract which has been paid is executed consideration.
- Executory consideration is consideration has been promised but not yet performed or delivered to the other party.
It may be products yet to be delivered or services yet to be performed.
So when is this essential characteristic not present?
Absence of Fresh Consideration
1. Past Consideration:
When contracting parties are already contracted with one another, a promise to do something that they have already contracted to do can't be "fresh" consideration.
It's consideration which has been provided in the past, and not at the time of formation of the contract.
For example, a buyer of goods who paid £10 in the past. It is not good consideration for supply of new goods, so as to form a new contract.
2. Existing Obligation or Duty:
Likewise, if a party is already required to do something by law, then that also can't be fresh consideration.
The usual forms of these are:
- an existing obligation to perform a contract
A promise to perform an existing contractual obligation in an existing contract is something which the person is already legally bound to do.
However if a party promises a superior performance of the requirement, that might be sufficient.
Nevertheless, the fresh consideration must be offered freely and not under threat, and the receiving party receives a benefit from increase in standard of performance of the existing contract.
- an obligation imposed under the general law, such as performance of a public duty or a duty imposed by statute.
For instance, companies are required to file tax returns. Suppose a company was to promise to file its tax return in return for the supply of goods from a supplier.
Filing the tax return isn't good consideration to form a contract.
However, where the consideration offered exceeds the requirements of the duty, then that may well be good consideration and sufficient to form a contract.
3. Lack or absence of economic value:
Informal gratuitous promises, charitable gifts, or promises of sentimental or moral value.
Consideration must be real or sufficient in the sense that it has economic value.
4. Part Payment of Debts:
A promise to pay part of a debt is not adequate consideration to discharge a larger debt. That's because there is no fresh consideration for the payment of a smaller sum of money.
The principle is of longstanding authority, derived from Foakes v Beer (1884).
The principle is explained as follows:
- "It is a well established principle that a promise to pay a sum which the debtor is already bound by law to pay to the promisee does not afford any consideration to support the contract.": Vanbergen v St. Edmunds Properties Ltd (1933)
- Foakes v Beer "settled definitely the rule of law that payment of a lesser sum than the amount of a debt due cannot be a satisfaction of the debt, unless there is some benefit to the creditor added so that there is an accord and satisfaction.": D & C Builders Ltd v Rees (1966)
As a consequence, a creditor is entitled to sue to the debtor for the balance of the debt after payment of the smaller sum.
Part payment of Debts: Fresh Consideration
Fresh consideration however may exist where:
- early payment is made, and the creditor has provided fresh consideration that the debt will be discharged. See below for an example.
- part payment has been made on the date due at a different place, at the request of the creditor and for the convenience of the creditor.
- the debtor transfers ownership of an asset of a lesser value than the money owed to the creditor, coupled with a promise from the creditor that the debt will be treated as discharged
- the debtor is insolvent, and the creditor accepts a smaller sum to discharge the entire debt
- the creditor agrees to accept a lesser sum from a third party in exchange for a promise to discharge the debt
When payments of smaller sums are combined with mutual releases to discharge one another from legal claims that a debtor and creditor may have against one another, those mutual releases may well:
- amount to fresh consideration, and/or
- be enough to give rise to a binding agreement.