For a documented business agreement to be legally enforceable, courts generally rule that it must have (among other things) a clearly written contract consideration clause.
While this certainly makes the judge's job easier, it primarily benefits the contracting parties themselves. Unfortunately, poorly constructed consideration clauses continue to be a major cause of expensive disputes, delayed projects, and damaged business relationships.
Without a clear definition of “value exchange” between contracting parties, business agreements are not only prone to misinterpretation but also difficult to enforce in court.
To adequately address this, we'll need to go back to the drawing board, and that's what this guide is about.
Here, we’ll go into detail about what a contract consideration clause is, covering examples, legal requirements for validity, and loopholes you must avoid.
What is the consideration clause in contracts?
Before we explain what a contract consideration clause is, it is important to understand what “consideration” entails.
In legal agreements, consideration refers to the specific benefits each party is entitled to following the execution of a contract. For one party, the consideration can be money (in terms of payment). For the other party, it can be physical goods (like raw materials and equipment) or services (like consultation or infrastructure maintenance).
Beyond these, consideration can be in several other forms, including:
- A pledge to act: Promising to perform a specific action, such as transferring ownership of properties or manufacturing components.
- A pledge NOT to act: Agreeing to refrain from a particular activity, such as not competing with a former employer for a set period.
- Intangible properties: Exchanging things like Intellectual Property (IP) rights, stocks, etc.
Executory vs. executed consideration
Consideration is also categorized as executory or executed.
If classified as executory, it means there is an established obligation for one or both parties to fulfill a promise in the future. This can be at a specified date or upon the occurrence of an event.
In other words, the contract is formed, but the obligations haven't been completed.
For example, let's say your organization agrees to share confidential information with another company as part of an ongoing business partnership, and the partnering company promises to keep that information secret. In this case, both promises remain executory until either party fulfills their part.
On the other hand, executed consideration occurs when one party has already fulfilled its obligation, and the other party now has a responsibility to fulfill its promise. In simpler terms, someone has already done their part, and the other party owes them something in return.
Let’s say you just paid the cashier at a store for a box of printer cartridges. Your payment qualifies as executed consideration. Now, the store has an obligation to give you the cartridges in return.
It is important to note that a contract can involve both executory and executed considerations.
For example, you pay a consultant a retainer fee for their services. The payment (executed) is the consideration for the consultant's future work (executory).
What is a contract consideration clause, and why is it important?
A contract consideration clause is a provision that outlines the exchange of value between the parties involved in a legal agreement. It explicitly describes what one party promises to give or do in return for something else from the other party.
While contract consideration clauses may be a less discussed topic, they are truly the heart of a strong, legally enforceable agreement. Taking the time to craft a clear and comprehensive consideration clause helps in numerous ways:
- Prevention of disputes: Outlining the exchange of value minimizes the chances of misunderstandings and disagreements between partners.
- Dispute resolution: If a dispute does arise, a well-defined clause shows what you are legally entitled to receive.
Also read: Finding Common Ground: How to Resolve Contract Disputes
- Legal enforceability: Judges are more likely to uphold contracts with strong consideration clauses. These clauses provide a solid foundation for demonstrating a meeting of the minds and a valid bargaining process.
- Risk mitigation: A comprehensive consideration clause can help mitigate potential risks by anticipating and addressing potential issues. For example, the clause can specify what happens if there are delays, defects, or unforeseen circumstances.
Also read: Effective Contract Risk Management: Top Tips & Strategies
- Peace of mind: Knowing that a contract has a strong consideration clause can provide peace of mind for both parties. It fosters trust and encourages a collaborative approach to fulfilling the agreement.
Examples of contract consideration clause
The language used in consideration clauses may vary depending on the nature of the contract. But if you understand what a consideration entails, identifying and formulating your own clause will be easy.
Below, we’ve provided examples of basic consideration clauses for various contract forms.
- Simple purchase agreement: "In consideration of $5,000, Seller agrees to transfer ownership of the John Deere 6120M Utility tractor to Buyer. In consideration of the tractor, Buyer agrees to pay Seller $5,000."
- Service contract: "In consideration of Client's payment of the agreed-upon fees totaling $18,000, Consultant agrees to provide the services outlined in this agreement. In consideration of Consultant's services, Client agrees to pay Consultant the agreed-upon fees."
- Non-compete agreement: "In consideration of Employee's access to confidential information, Employee agrees to refrain from competing with Employer for a period of one year following termination of employment. In consideration of Employee's agreement, Employer agrees to provide Employee with severance pay."
- Intellectual Property (IP) licensing agreement: “In consideration of the Licensee's payment of royalties, the Licensor (Company A) grants the Licensee (Company B) a non-exclusive license to use the intellectual property described in this Agreement. In consideration of the Licensor's grant of the license, the Licensee agrees to pay the Licensor royalties at a rate of 5% of net sales of products leveraging the licensed intellectual property."
The above examples provide a simplistic view of what a consideration clause looks like. In reality, a strong consideration clause is much more detailed, as seen in this agreement.
Also read: How to Create an Effective Contract Clause Library
Legal requirements for a valid consideration clause
For a consideration clause to hold up in court, it must generally meet a few standard requirements. Failure to meet these can render the consideration clause void and unenforceable.
#1 The consideration must be something of value
The consideration described must have some recognizable value in the eyes of the law. This doesn't mean it has to be perfectly equal, but it can't be entirely one-sided. Also, it doesn't have to be money. A valid consideration can be goods, services, promises, or even the forbearance of a legal right.
#2 There must be sufficient negotiation involved
To be legally binding, the consideration should be the result of a bargained-for exchange. This means that both parties must have had the opportunity to negotiate the terms of exchange and come to an agreement. It can't be something one party offers unilaterally out of generosity or without expecting something in return.
Also, if one party is coerced or under duress, the court may invalidate the consideration.
Also read: 5 Most Negotiated Terms and Clauses in a Contract
#3 Consideration must not comprise pre-existing duties
An agreement to do something you are already legally obligated to do does not constitute valid consideration. For instance, a firefighter can't demand extra payment for rescuing a citizen from a burning building, as it's already part of their job duties.
#4 Consideration cannot promote illegality
A consideration clause cannot include an agreement to do something illegal. For example, a contract to supply illicit drugs would be unenforceable because its core purpose is unlawful.
Best Practices for drafting a robust consideration clause
Having a consideration clause in your contract is not enough. You must ensure the clause leaves no room for misinterpretation, effectively communicating the bargained-for exchange between your organization and its contracting partners.
Here, we've detailed some crucial steps you can take to ensure your consideration clause maintains its validity.
#1 Start with clarity: always define the exchange upfront
Before diving into the legal jargon, take a step back. Outline exactly what each party is bringing to the table. What good or service is being provided? What is the expected outcome or deliverable? Etc.
This initial clarity will guide the drafting process and prevent ambiguity in the final clause.
#2 Be specific in drafting the details of what’s being exchanged
Don't settle for generic terms like "goods" or "services." Always be specific about what each party is obligated to bring to the table. For services, specify the scope and nature of work. If goods are involved, define quality standards, quantity, and delivery terms.
Additionally, clearly state the amount of money involved in the contract if applicable.
Specificity ensures there’s no room for ambiguity and that all parties know exactly what to expect.
#3 Contingent conditions and escalations: plan for potential scenarios
“It’s difficult to be part of any business and not hear about “risk.” It’s everywhere. Risk is the new black.”
~Sterling Miller, CEO and Senior Counsel, Hilgers Graben PLLC
Ten Things: Spotting, Analyzing And Managing “Risk”
No contract, as carefully written as it might be, exists in a vacuum. Things change, and circumstances can throw a wrench into the best-laid plans.
Your consideration clause is the perfect place to introduce contingencies. Clearly state what happens if certain milestones aren't met, prices fluctuate unexpectedly, or force majeure events (like natural disasters) occur.
Can deadlines be adjusted? Will there be a need for renegotiation upon the occurrence of certain events?
Having a plan for these scenarios embedded in your consideration clause fosters stability and reduces risk.
#4 Take advantage of modern technology
“If legal teams don't figure out technology, they're going to get left behind. Their jobs might get replaced, if not by AI, it'll be by the lawyer who figures out how to use AI.”
~Kathy Zhu, Co-founder & CEO, Streamline AI
From DoorDash AGC to Entrepreneur
Drafting a comprehensive contract consideration clause takes time and effort. However, with the right technology tools, you can become more efficient, generating more thorough and reliable provisions in less time than usual.
Take SpotDraft (a Contract Lifecycle Management (CLM) platform), for example. Its ecosystem of tools is designed to help you streamline every aspect of your contract lifecycle, from drafting and negotiation to execution and compliance.
It offers a variety of templates for different contracts, all enriched with the right legal guardrails. These templates are auto-filled with details you provide for your contract, helping you cut through the tedious brainstorming process associated with drafting clauses from scratch. All you have to do is review the generated output (with its AI component) and put your own spin on it to ensure no stones are left unturned.
Additionally, its central repository can be very crucial during legal proceedings. It securely preserves your contracts and offers a comprehensive audit trail your legal team can utilize to demonstrate the validity of your agreements.
“I have seen a demo of SpotDraft’s CLM technology and they should be on your short list of vendors to talk to about a contract management system.
~Sterling Miller, CEO and Senior Counsel for Hilgers Graben PLLC
Ten Things: “Cool Tech” For In-House Counsel (2022 Edition)
#5 Regularly review and update your provisions overtime
“If you think that you're doing everything perfectly, you're not going to grow. There's always an opportunity for improvement.”
~Doug Luftman, ex-DGC, DocuSign
The Key to Success as an In-House Legal Counsel & Leader
Laws change, business strategies shift, and best practices evolve. To ensure your consideration clause doesn’t get outdated, you must keep it as flexible as possible.
Establish a regular schedule for checking your consideration clauses (and contracts in general). This might be annually, quarterly, or even more frequently for high-risk or rapidly evolving areas of your business.
The goal is to ensure your contracts remain aligned with your organization's objectives and compliant with constantly changing regulations.
Additionally, it is also crucial to keep a clear record of the history of your consideration clauses, detailing when they were changed and why. This is useful if future disputes arise, showing a pattern of good faith adaptation.
Ready for change?
A consideration clause is a mission-critical component of an enforceable contract. Its presence can be the difference between a smooth, legally binding agreement and a recipe for future disputes.
This guide provided insights into what a contract consideration clause entails, best practices for implementation, and how CLM technology can help you get even more efficient.
If you’re ready to explore the world of CLMs, click here to check out our 2024 CLM Buyer’s Guide.
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