CONTRACT MODIFICATIONS, CONSIDERATION AND MORAL HAZARD

• Citation: (2005) 17 SAcLJ 566
• Date: 01 December 2005
• Published date: 01 December 2005

The doctrine of consideration, which under its broad rubric fulfils a number of different functions, has always excited debate among academics and jurists. To some, the extension of the doctrine beyond the formation of contracts to areas such as contract modifications has been unwise. In this article, it is asserted that the legal duty rule in the doctrine of consideration ought not to prevent enforcement of agreements to modify contracts where such agreements were entered into seriously, without any coercive or unfair conduct, on the part of the party who seeks to rely on the contract as modified.

I. Introduction

1 Generally, human beings are free agents who may conduct their affairs in any way they see fit. The state and the legal system should not interfere with the private affairs of individuals unless there is a compelling reason to do so. Yet, on the issue of whether bare promises made are binding on the promisor, the common law adopts what has sometimes been referred to as a paternalistic attitude by presumptively not enforcing such promises. Under traditional contract doctrine, a promise is not, as a general rule, binding unless it is supported by something called consideration that moves from the promisee to the promisor. Consideration is usually described as giving something of value in return for the promise. This may be some benefit the promisee gives the promisor, or some detriment the promisee has incurred for the promise. In synallagmatic contracts, each party’s promise or obligation is the consideration for the other party’s promise or obligation. However, at common law not every promise made or obligation incurred constitutes valid consideration. Consideration must involve something of value in the eyes of the law. Thus, where a party is already under a legal obligation to perform an act, promising to do so does not, as a general rule, constitute valid consideration. The law draws a distinction between a legal benefit or detriment and a factual benefit or detriment. Generally the former must be conferred or incurred for there to be such consideration as can support a contract. The mere fact that a benefit may have been conferred or a detriment incurred will not generally constitute

consideration if the promisee was already under a legal obligation to confer that benefit or incur that detriment. This is commonly referred to as the legal duty rule.

2 Intuitively, once one accepts the notion of consideration as involving a bargain, there is much to commend this approach. For example, A may be under a contractual obligation to perform a service to B. The performance of this service will obviously benefit B as a matter of fact. If A does not perform the service contracted for, B may have remedies against A but this may be time-consuming and B will have to look for a substitute. The performance of A’s obligation therefore confers a benefit on B. However, since this was only what B was entitled to, why should B’s promise to pay more to A be enforceable when this was what A had already promised to do? In fact, why would B even promise this unless perhaps there was some sharp practice on the part of A?1

3 Accordingly, where there is an existing contract and the parties wish to modify it, the general rule is that the modification(s) must be supported by fresh consideration. The modified contract is in essence a new contract and must therefore, as a general principle, be supported by fresh consideration from all the parties. In addition, if the modification is one that imposes fresh obligations or burdens on one of the parties only, it will mean that the other party is only doing what she or he was already under an obligation to do under the contract in its original form. Since there was a pre-existing contractual duty to perform those acts, the mere promise to do so or the performance of those acts cannot constitute good consideration for the new promises that the other party has agreed to pursuant to the modified contract.

4 This general approach to contract modifications has been eroded considerably in many Commonwealth countries although the basis for such erosion is still controversial and unclear. In the US, the approach is more clearly stated. Section 89(a) of the Restatement (Second) of Contracts (1981) (hereinafter “Restatement”) states, inter alia, that a promise modifying a duty under a contract not fully performed on either side is binding if the modification is fair and equitable in view of circumstances not anticipated by the parties when the contract was made. In this article, it will be suggested that where the parties are already in a contractual

relationship, the rules relating to consideration can be relaxed as some of the policy considerations underlying the requirement for consideration are less compelling in such circumstances. A better approach would be to ask if the parties seriously intended to make the promises leading to the modified contract coming into existence.2 Before embarking on a fuller discussion of this, it will be useful first to consider briefly the functions played by the doctrine of consideration. It will be argued that there must be good reasons for adopting a paternalistic attitude towards promissory liability since promises principally operate in the private realm and there ought to be compelling reasons before limiting private autonomy.

II. Functions performed by the doctrine of consideration

5 In the 18th century, Lord Mansfield attempted, unsuccessfully, to limit the doctrine of consideration by arguing that it was intended to serve an evidentiary function because of the danger of false or mistaken testimony should bare promises be enforceable.3 In the 20th century, the English Law Revision Committee in 1937 proposed that consideration should serve an evidentiary role of showing a serious intention to contract,4 a view that has not been taken up.5 Nevertheless, that consideration does have a formal evidentiary aspect is undoubted. The doctrine appears to have originated in the 16th century, perhaps as a means of filtering serious promises that were enforceable from those that were not. Thus, consideration would exist where there was a reason or purpose for the making of the promise. The existence of a reason or purpose for the promise would tend to show that it was made and

intended seriously, and the jury could therefore with more confidence award damages for breach.6

6 The doctrine of consideration in fact plays a number of different roles. It has been stated that the doctrine of consideration has a formal aspect, in that it can perform an evidentiary function, a cautionary function and a channelling function.7 The evidentiary function of consideration is to provide evidence of the existence and substance of the contract.8 The cautionary function, which is probably the most important formal function played by the doctrine, ensures deliberation before the contract is entered into; it minimises the prospect of a foolish or casual promise being made. Sometimes such promises may be made in the heat of the moment, only to be regretted later. The requirement of consideration, insofar as it stipulates the need for something of value from the promisee and the acceptance by the promisor of this something of value, has the effect of encouraging some degree of deliberation.9 Consideration also serves a channelling function in that “it furnishes a simple and external test of enforceability”; “it offers channels for the legally effective expression of intention”.10 A person who wishes to make his or another person’s promise binding can use consideration as a means to accomplish this objective.11

7 In contract law, consideration is not the only device capable of playing these formal functions. The seal is an example of another such device. The existence of the rule relating to seals, namely that a promise made under seal is binding without more, also attests to the formal role played by consideration. The affixing of a seal to what would otherwise be a gratuitous promise signifies the seriousness of intent of the promisor. It also provides the setting for deliberation and clearly serves a channelling function. This is the reason why the seal is an alternative to consideration in giving rise to valid and enforceable promises.12

8 While consideration has a formal aspect to it, consideration also plays a substantive function in that it embodies policy considerations against the enforcement of certain types of promises.13 It is often said that the doctrine of consideration prevents the enforcement of gratuitous promises. This may be because society does not have an interest in the enforcement of such promises since they do not have the same potential as bargained for promises to create new value. In the latter a mutual exchange takes place that is conducive to the production of real value; the former, by comparison, are “sterile” transactions.14 Nevertheless, it is debatable how important this apparent policy really is.15 As already indicated, the doctrine does not apply to gratuitous promises made under

seal. If the non-enforcement of gratuitous promises was of fundamental importance to society, it is hard to see why promises made under seal should be enforceable. And, as will be discussed in greater detail later, the law does not look to the adequacy of consideration which means that a gift can effectively be made for nominal consideration. Furthermore, the law does support executed gifts in that an action to recover property that has been conveyed gratuitously will be dismissed regardless of whether there was any reliance or change of position on the part of the recipient. It is clear therefore that the applications of the doctrine of consideration are not the logical consequences of requiring a bargain.16 Perhaps we are on safer ground if we say that from an economic point of view, the enforcement of gratuitous promises could be...