Is it okay to agree to do something that might be considered illegal as consideration in a contract

In previous blog articles, we talked about Exceptions That Can Void A Contract and How to Get Out of a Contract. Both of these articles touch on a very important aspect of contract law that is often overlooked by small business owners: Consideration.

Definition

Consideration under contract law is defined as a bargained for exchange of value between parties of a contract. Without consideration, a contract cannot be enforced or is otherwise voidable (with only a very few exceptions). The exchange of value is interpreted broadly to not only include money, but property, a promise, doing something, or even not doing something. In broadest sense, if one agrees to do something he or she was not otherwise legally obligated to do, it may be said that he or she has given consideration. Conversely, agreeing to do something that is otherwise legally required, is not adequate consideration to a contract.

Consideration requires (i) a bargain regarding terms of an exchange, (ii) a mutual exchange between the parties (i.e. both parties must get something out of the contract), and (iii) the exchange must be something of value.

If one party was not in a position to properly bargain, either because of fraudulent information provided by the other party, duress (i.e. one party held a gun to the head of the other party), or other circumstance that made it impossible for a party to bargain, then there is no consideration.

Likewise, if one party receives no value whatsoever (i.e. one-sided consideration), this will not be sufficient (in most instances) to establish overall consideration to render the contract valid.

Finally, the value cannot be illusory — it must have actual value. For instance, agreeing to do something that is otherwise legally required, such an agreement is illusory and therefore will not be sufficient consideration to enforce a contract.

Applicability in Business

Usually, consideration is important because one business needs to unilaterally change the terms of a relationship with some other party, such as an employee, contractor or customer. For example, you may have determined it’s important that a particular employee (or contractor) agrees to not compete or solicit customers, years after that employee was hired. Or, you want to change pricing or services for customers. Or, you want to make sure you own the copyrights of the work produced by your contractor, after the project has already started (Read Don’t Get Screwed – Managing Website Vendors).

The fact-pattern is actually complex, and can spell long-term problems for businesses. It goes like this: Your company unilaterally makes a change, either in writing or in practice, and you continue “business as usual” with the other party. Over time, the other party fails to pay or there are some other problems in the relationship and you try to enforce — i.e. you try to get paid or you try to enforce whatever unilateral change you tried to put in place previously.

Without the proper consideration at the time you made a unilateral change to the relationship, your business may be unsuccessful in enforcing that change you tried to put in place previously — Costing your business significant expense, headache, loss of customers or worse.

It’s Critical to Add Consideration to Changes to Existing Relationships / Contracts

When you decide your business needs to change something with an existing relationship, you owe it to the success of your business to think through the issues of consideration. If you’re not sure, I strongly encourage you to talk to a competent business attorney in your local jurisdiction.

Let’s discuss some examples.

Increasing Price for Services

Are you offering a service to your customers, and you want to increase the price for such services? Whether you can do this legally, and enforce the price increase, will depend on the nature of the pre-existing relationship (or contract) with your customers.

For example, do you have a 3-year contract with a customer and you want to change the pricing within the term of the existing contract? Unless you have language in your existing contract that permits you to increase the price, or there is some other pre-existing circumstance and clause you can rely on, your attempts to increase the price of your service will be invalid and cannot be enforced.

Contrast this to a month-to-month customer. With such a customer, you can increase the price with notice to the customer, under the theory that the consideration for an increase in price is the continued provision of service to the customer — and if the customer doesn’t want to pay the increase in price, he or she can terminate the relationship.

Many businesses would like to lock-in customers to long-term contracts. This consideration problem is one of the reasons you may want to be careful about long-term contracts — if you think there’s a chance you may want to increase pricing or change terms later.

Adding Terms to Employment Agreement

Did you hire one or more employees without an employment contract previously, or with a very simple contract, and now you want to add some additional terms to protect company customer lists, intellectual property, trade secrets or more?

Your ability to force existing employees to sign a new, more restrictive employment contract — without something more than merely the right to continued employment — will greatly depend on your state’s laws on this. In general, “at will” states are more forgiving than the rest, but there are a myriad of laws and exceptions for each state, so if you really want to force a new contract on existing employees, this is the one time you really should talk to a competent business or employment lawyer in your local jurisdiction to navigate the proper course.

Even if you pay your employees a bonus to sign a new employment contract, you need to give your employees the option to sign the contract and receive the bonus. Remember that consideration requires a bargain. If you force your employees to sign — even with a bonus — there is no bargain given that employees who don’t sign arguably lose their jobs and therefore the bonus could be viewed as inadequate to establish consideration, and therefore the new contract becomes unenforceable (although the employees would be able to keep their bonuses).

Therefore, your best bet is to (i) make signing the new employment contract optional, AND (ii) providing a cash bonus or pay raise (above-and-beyond what is standard) to sign the new employment contract. Otherwise, you risk the new contract being unenforceable. Again, consult with a competent business or employment lawyer in your local jurisdiction if you want to chart a different course.

Revising Terms with a Contractor

Unilateral changes to an existing contract between an employer and contractor could be unenforceable without proper consideration, and therefore (the lack of) consideration can help or hurt your business, depending on which side of the fence you sit for any particular issue.

If you want changes, the best bet is to seek mutual agreement with the contractor, but make sure consideration is adequate given the previous contract and the new agreement. Otherwise, you could end up paying money, releasing confidential information or not properly assigning intellectual property to your company’s detriment.

If the contractor is forcing changes on your business that you don’t agree to, the lack of consideration for the changes may provide salvation for your business — but be careful of “promissory estoppel” (i.e. a legal principle that a promise is enforceable by law, even if made without formal consideration, when a promisor has made a promise to a promisee who then relies on that promise to his subsequent detriment.). We told you this can be complicated.

Law 4 Small Business, P.C. (L4SB). A little law now can save a lot later. A Slingshot company.

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ELEMENTS OF CONSIDERATION [4316]

•    Consideration, which must be given in order to make a contract legally binding, is legally sufficient and bargained-for value, given by the promisor in return for the promisee performing or refraining from performing some act which results in a detriment to the promisee and/or a benefit to the promisor. “ A bargained for exchange in which there is a legal determinant to the promisor or legal benefit to the promise.”

•     Legally Sufficient Value may be established by: [4316.08]

(1)   promising to do something that the promisor has no prior legal duty to do (e.g., promising to pay money for the promisor’s goods);

(2)   performing an action that the promisor is not otherwise obligated to undertake; or

(3)   refraining from exercising a legal right which the promisor is otherwise entitled to exercise.

•     In a bargained-for exchange, the consideration given by the promisor must induce the promisee to incur a legal detriment and/or provide a legal benefit to the promisor, either or both of which are sufficient to induce the promisor to make the promise.

INSUFFICIENT CONSIDERATION [4316.07]

•    Pre-Existing Legal Duty: Under most circumstances, a promise to do (or refrain from doing) what one already has a legal duty to do (or refrain from doing) does not constitute legally sufficient consideration.

•     A commonly-recognized exception to the foregoing rule is the so-called “unforeseen difficulties” doctrine, which permits an existing contract to be modified to account for unforeseen difficulties that arise during the course of performance.

•     Past Consideration: Promises made in return for acts or events that have already taken place are unenforceable for lack of sufficient consideration.

•     Illusory Promises: If the terms of a contract call for performance in such uncertain terms that the promisor has not definitely promised to dQ (or refrain from doing) anything, the promise is unenforceable for lack of sufficient consideration.

·        Moral obligation: while you may feel morally obligated, it doesn’t mean there is a legal obligation….

RESCISSION AND NOVATION

•      The unmaking of an existing contract and making of a new contract between the same parties (e.g., to account for unforeseen difficulties) are known, respectively, as rescission and novation.

•     Rescission: Canceling an existing contract, and returning the parties to their pre-contract states (i.e., stopping it before it goes further and going back to where you were before the contract.)

•     Novation: Replacing an existing contract with a new, superseding contract between the same partie (continuing)

ACCORD AND SATISFACTION 4326.06

•      Accord and Satisfaction: An agreement between an obligor (debtor) and obligee (creditor), by which the obligor agrees to pay the obligee some amount owed under the contract (generally less than the amount in dispute) in exchange for a discharge of all obligations owed by the obligor to the obligee.

•     For accord and satisfaction to occur, the amount of the obligor’s debt to the obligee must be in dispute, or unliquidated.

•      Liquidated Debt: A debt whose amount has been ascertained, fixed, agreed on, settled, or exactly determined.

•      Unliquidated Debt: A debt whose amount may be disagreed on by reasonable persons.

RELEASES AND COVENANTS NOT TO SUE 4326.08/.09

•     Release: An agreement whereby one party forfeits its rights to pursue a legal claim against another party.

•     Releases are generally binding if they are:

(1)   given in good faith,

(2)   stated in writing, and

(3)   accompanied by consideration.

•     Covenant Not to Sue: An agreement to substitute a contractual obligation for some other type of legal action based on a valid claim.

PROMISSORY ESTOPPEL

•       Promissory Estoppel: When a promisor makes a clear and definite promise on which the promisee justifiably relies, the promisor is bound by the promise, even if it was insufficient to form the basis of a valid, legally binding contract.  This is equitable relief.

•     For the doctrine of promissory estoppel to be applied, the following elements must be established:

(1)   the promise was clear and definite;

(2)   the promisee justifiably relied on the promise;

(3)   the promisee’s reliance was substantial and of a definite character; and

(4)   enforcing the promise will serve the best interests of justice.

•     Other Promises Enforceable Without Consideration:

Courts may also enforce, despite the lack of consideration,

(1)   promises to pay a debt, otherwise barred by limitations, made after limitations have run, and, in rare cases,

(2)   promises to charitable institutions.