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Include Consideration and Determine Legality

Include Consideration and Determine Legality
We’re now ready to discuss the second key element in creating a contract, which is called consideration. And there are technical legal definitions of consideration. Let me just give you a very practical definition. Which means that for a deal to be binding, both sides have to give up something. Now there are different views of consideration in common law and civil law countries. The general rule is in civil law countries consideration is not necessary. In common law countries it is necessary. However given our global economy and the mixture of legal systems in contract negotiation it’s probably a wise thing always to try to include consideration in contracts, just to be safe.
Let’s try an example, several years ago the dean of the business school where I teach, the Ross School of Business called me and told me that he was involved in an interesting negotiation. One of our graduates was considering making a large gift to the business school. And the gift was complicated because there were tax considerations involved, and so the dean was negotiating not only with the donor, but also with his attorneys. He wanted me to be involved in the negotiation, so I gladly participated in the negotiation. And eventually, the graduate agreed to give the school $30 million, which as that point was the largest gift in history to any business school.
And he structured the gift so that rather than writing a check for $30 million, he agreed to make payments over 20 years. He agreed to write a check for $1.5 million each year over a 20 year period. Now there were no complications with the gift. But let’s assume that over the course of the 20 year period the graduate passed away. And let’s assume that his children didn’t think that this gift was such a great idea and so stopped payment. The question that would arise is is this a legally enforceable promise by the graduate?
Now in this case the graduate signed a five page written agreement with all the details of his promise to make the gift of $1.5 million a year. Let’s just show that if there is a binding contract, death would not change the contractual obligation. So, the only question is, is this a binding gift, when somebody promises to make payments of $1.5 million a year over a 20 year period. Think about that for a second. Press pause if you’d like to, and then reach a conclusion. Would this be a binding contract or not?
The answer depends. And it depends on whether there is consideration or not, at least in common law countries, it depends on whether there is consideration. Clearly, the graduate gave up something. He gave up $30 million, or $1.5 million a year. The consideration question would be, did the business school also give up something in exchange? Now when you look at the five page written agreement the answer to that question would be yes. The business school promised to start an institute with the name of the graduate. They promise to dedicate rooms at the business school for the institute to furnish the rooms, to furnish faculty for the rooms, et cetera.
And so in this case, the promise would be enforceable, even if the children did not want to perform the contract it would be a legally binding contract because there was consideration on both sides. Our next key element in creating a contract, and again these are all elements that should be on your negotiation checklist which should be in your pocket during every negotiation. And the question is is the agreement legal. This can be a fairly obvious element. You can think of very clear and simple situations where the agreement is not legal. For example let’s say that I agree to sell you a truck load of
cocaine and you don’t deliver, so I sue you in court. And the question is, is this a legal contract? Well, of course not. We’ve got an offer and an acceptance, we’ve got an agreement, presumably we have consideration. I agree to give you the cocaine, you agree to pay for it. But the court clearly will not enforce that agreement, because It is not legal. And in fact after throwing us out of court, probably the local prosecuting attorney will grab us and arrest us and we’ll end up in criminal proceedings. But in business dealings, the question of whether something is legal or not is not only important, but it’s more subtle.
So for example, let’s assume that you work for a company and like many companies, this company asks you to sign a non-compete agreement when you are hired by the company. In other words, you sign an agreement that says that for example if you leave the company you cannot work for a competitor for a certain period of time. Let’s say one year. But let’s say that you are an entrepreneur, you want to leave the company and start a competing business or work for a competitor within that one year period. Then the question is will a court enforce your non-compete agreement. And this depends.
It’s a tough decision for a court because no court wants to put you out of work for one year in a business where you have developed expertise. So courts look very closely at these agreements around the world. And they ask for example, well is this agreement too broad in terms of geographical area covered? Or is it too broad in terms of the interest involved? These agreements must be crafted so that they are designed to protect an employer interest. And if they go beyond that then the court might say, well, this agreement is not reasonable and throw it out. So, generally, these agreements are legal. They do not violate public policy.
But if they’re crafted too broadly, then a court will say well, this agreement is not legal. Now, in certain states, notably, California, all of these agreements are considered to be illegal and unenforceable. But in most states and in most countries It would be a question for it to determine whether they are legal or not. So those are some considerations to think about in terms of legality.
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