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Formation of contracts | Consideration

Overview

ConsiderationConsideration is the price that is asked by the promisor in exchange for their promise – the price for a promise.

In many jurisdictions consideration is not an essential element of a contract – it is sufficient that parties have reached a binding agreement.  However, the common law requires that (subject to limited exceptioins), for an agreement to be binding, the promisee (or promisees) must provide consideration (payment of some kind) for the promise they have received. 

As a result, gratuitous promises are generally not enforceable.

 

General rules

Consideration as the price for the promise

Consideration is the price stipulated by the promisor (person making the promise) for the promise made. This requires two things. First, that there be some 'price' (in the form of a benefit to the promisor or detriment to the promisee) and that this price be given in exchange for the promise (as a 'quid pro quo' for the promise to which it relates).

Price - benefit/detriment

Price is used in a broad sense; it need not be monetary or even of monetary value. It may involve a 'detriment' on the part of the promisee in the form of giving up a freedom otherwise enjoyed (such as promising to stop smoking or to study every Saturday night) - it is not necessary that the promisor receive any tangible benefit. In Carlill, for example the Court said that it would be sufficient if Mrs Carlill suffered the detriment from using the smoke ball as directed even if the Carbolic Smoke Ball Co received no benefit (this was obiter as the Court concluded that the company did in fact receive a benefit).

It follows from this that consideration must move from the promisee but need move to the promisor. For example, if promisor (A) asks promisee (B) to pay (C) a sum of money as consideration for A's promise to B, that will be good consideration. However, if promisor (A) asks (C) to provide a payment as consideration for A's promise to B, that will not constitute good consideration (there is no detriment to B in such as case). In the case of joint promisees, it is sufficient if consideration moves from one of the parties.

  • Coulls v Bagots (High Court, 1967)
    (where promise made to joint promisees, sufficient if consideration moves from only one of them)

Quid pro quo

It is not sufficient that there be a benefit or detriment. Additionally, it must be the case that that benefit is given or detriment is suffered as the price for the promise - that is, it is part of a bargained for exchange. It is not sufficient consideration for the promisee to merely act in reliance on a promise, if that act was not part of a bargained for exchange.

  • Australian Woollen Mills (High Court, 1954)
    (Australian Government promised subsidy if wool purchased for Australian use. Subsidy later discontinued. Held that the purchase of wool was a condition necessary for the subsidy but was not the price for the promise of a subsidy - it was not part of a bargained for exchange/quid pro quo and therefore was not good consideration)
  • Beaton v McDivitt (NSWSC 1987)
    (Discussed requirement for 'bargain' and not mere 'reliance' to constitute consideration)

Consideration can be anything stipulated by the promisor

It is for the promisor to stipulate the consideration for his/her promise (directly or indirectly), not for the promisee to proffer something and call it consideration - however, as indicated above, provided the consideration stipulated it legal, it can take virtually any form and, importantly, need not be of comparable value to the promise for which it is provided.

The most famous case regarding the nature of consideration is Chappell v Nestle in which Lord Somervell of Harrow expressed the view that a 'peppercorn' could constitute valuable consideration (if stipulated by the promisor) even if the promisor was not fond of peppers and would discard the corn (note, however, that adequacy of consideration may be relevant in other respects; in particular, it may be evidence of duress or unconscionable conduct which may render the contract voidable. Other key cases discussing consideration include:

  • Chappel v Nestle in which Lord Somervell famously observed that a 'peppercorn' could be good consideration.
  • Carlill in which the inconvenience associated with using the smoke ball was held to constitute consideration.
  • Dunton v Dunton in which giving up a freedom constituted good consideration
  • Wigan v Edwards in which giving up a legal right was held to be good consideration (bona fide compromise).

 

Special rules and situations

Consideration can be anything stipulated by the promisor, provided it is not illegal. The consideration must, however, have 'value' in the eyes of the law - that is to say, it must exist! Consequently, an illusionary undertaking (I promise to give you my car if you pay me whatever sum of money you choose (which may be nothing)) cannot be good consideration.

  • Biotechnology v Pace (NSWCA, 1988)
    (Illusory and uncertain - option to participate in staff equity sharing scheme not yet established)

Past consideration not good consideration

The consideration must come into existence either at the same time or after the promise. Where the stipulated consideration pre-dates the promise, it will not be considered 'good' consideration (eg, a promise by A to transfer ownership of a car to B in exchange for assistance B provided to A the previous month).

This was discussed in, Roscola v Thomas, where the promise was not binding because the only “consideration” provided for a promise about the soundness of a horse was entering into the original contract - this had occurred before the promise was made.

  • Roscola v Thomas (UK, 1842)
    (Promise that horse was sound made after contract of sale was not supported by good consideration)
  • Harrington v Taylor (USA, SC of North Carolina, 1945)
    (Promise to pay damages made to P after P came to D's aid, not supported by good consideration)

Exception

Past consideration can be good consideration if (a) provided at the request of the promisor (b) the parties understood that the act would be remunerated and (c) had the promise occurred in advance of the act it would have been enforceable.

Performing existing duty not good consideration

Where the promisee is already contractually bound to the promisor, the general rule is that performance of an existing contractual obligation will not be good consideration unless some additional benefit is conferred.  However, it is sometimes difficult to determine whether an additional benefit is conferred; in particular, a benefit may exist if performance of the existing duty avoids problems that are associated with non-performance (and the benefit of that exceeds the detriment likely to have been suffered by non-performance: Musumeci)

  • Stilk v Myrick (UK 1809)
    (Perfomance of existing duty not good consideration for promise of additional payment)
  • Williams v Roffey (UK, 1991)
    (Performance of existing duty can be good consideration for promise of additional benefit if it confers additional benefit or obviates disbenefit and is not given as a result of duress/fraud)
  • Musumeci (NSWSC, 1994)
    (Promise to accept less rent enforceable (practical benefit obtained) - performance of existing duty can be good consideration for promise of additional benefit if it confers additional benefit or obviates disbenefit (and that is valued more highly than the likely remedy for breach) and is not given as a result of duress/fraud)
  • Popiw v Popiw (VR, 1959)
    (Where 'duty' is not binding in law then a promise to perform that 'duty' (in this case cohabitation) can be good consideration for a promise made)

The position is different where the promisee contractually bound to a 3rd party to perform the obligation. In a case where the promisee’s contractual duty is owed to a third party, performing (or promising to perform) that duty is good consideration for the promisor’s promise.

  • Pao On (UK Privy Council, 1979)

Where a duty is imposed by law to perform a certain task mere performance of that task is not good consideration.  This seeks to prevent corruption - public officials extorting money from the public for performing tasks they are already required to perform. However, if the promisor does more than merely perform an existing duty this will be good consideration.

  • Glasbrook v Glamorgan County Council (UK CA, 1925)
    (Promise to pay Council for special policy protection - performance of public duty not good consideration unless it involves more than what is required by public duty)

Part payment of a debt: the rule in Pinnel's case

As a general rule part payment of a debt is not good consideration for the creditor’s promise to forgo the balance. In paying part of the debt the promisee is doing no more than performing an existing contractual duty owed to the promisor.

This rule, that payment of a lesser sum on the day cannot be satisfaction for the whole – known as the rule in Pinnels case – was finally established by Foakes v Beer.

  • Foakes v Beer (UK CA 1884)
    (Agreement to pay sum of money in part satisfaction of a judgment debt followed by later instalments not good consideration for promise not to take action on the debt)

There are, however, exceptions; part payment will be good consideration where

(a) Earlier payment is made

Receiving the lesser sum earlier is good consideration.

(b) Payment is made with something else

The additional factor provides consideration. This is one of the sources of criticism of the general rule: payment of $999 out of $1,000 will not be good consideration for a promise to forgo the $1 balance. However, payment of $10 plus book worth $5 will be good consideration (provided stipulated by the promisor) for the promise to forgo the balance of $990)

(c) Where it arises from a composition Agreements

Where a debtor agrees with all his creditors and they agree to accept a dividend, payment will discharge the debtor from further liability to the creditors. This is to prevent fraud between the other debtors.

(d) Where payment is made by a third party

This exception is explained on the basis that it would be a fraud on the 3rd party to allow the creditor’s claim

(e) Where the claim is unqualified

The rule does not apply to unliquidated or disputed claims.

Executed versus executory consideration

Consideration is sometimes classified into 'executed' and 'executory' consideration; either is sufficient. Executed consideration takes the form of performing an act rather than a promise of performance.  Executory consideration consists of a promise to do something. Most contracts take the form of executory consideration; thus they comprise of initial promises (eg, promise to buy and sell, even if payment and exchange of property occurs almost immediately).

Distinguishing consideration and conditions

The act requested by the promisor will only be consideration if it was regarded as the price to be paid for the promise. The test is the attitude of the reasonable person. If the act is regarded as a condition then it is something that must be performed before entitlement to the promise arises, but performance (absent separate consideration) does not allow the promisee to enforce the promise.

  • Australian Woollen Mills (High Court, 1954)
    (Purchasing wool for domestic use was a condition required to obtain government subsidy; it was not consideration (no bargain/quid pro quo)

 

Exceptions

There are two exceptions to the need for consideration

(a) promises under seal (deeds)

(b) where the doctrine of promissory estoppel operates (this is not strictly speaking an exception; the doctrine is designed to enforce promises in limited circumstances where it would be inequitable not to do so - but it is not a true substitute for consideration). See further below.

Promises under seal (deeds)

Promises made under seal (deeds) do not require consideration. These are referred to as 'formal' contracts, but that designation can be misleading. Deeds do not need to involve complex contracts and many (indeed most) complex written contracts will not be 'formal' contracts in this sense.

Promissory estoppel

Promissory estoppel is equitable in nature (often called ‘equitable estoppel’) and operates when it would be inequitable for the promisor not to be held to the promise – the modern doctrine developed with the judgment of Denning LJ in Central London v High Trees.

There were, however, important limitations to the doctrine -

(a) It applied only where the parties were already in an existing contractual relationship; and

(b) It provided only a defence to a claim made by the promisor in violation of the promise – it could not found a claim.

In Australia, the doctrine has developed beyond those restrictions following the High Court’s decision in Walton Stores. This case establishes the following pre-conditions for promissory estoppel:

The preconditions to estoppel operating in this context remain significant.

(1) Defendant must make a promise of some kind

(2) Defendant must also create or encourage an assumption on Plaintiffs part that promise will be performed

(3) Plaintiff must rely upon this to its detriment; and

(4) It must be unconscionable, having regard to the Defendant's conduct, for the Defendant to be free to ignore the promise.

For a (relatively) recent High Court discussion of this issue see:

 

Further reading