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Why is Consideration Necessary for Every Commercial Contract?

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A business contract establishes and manages the obligations between you and other involved parties. Clarity in this contract is vital to define your commercial ties and maintain their effective operation. This article will assist you in navigating consideration and why it is necessary for commercial contracts in New Zealand.  

Elements of a Binding Commercial Contract 

For a contract to be valid, there must be four elements present, as per below:

OfferTo demonstrate an offer, it needs to be in the form of a sign, statement or action with clear and specific terms alongside showcasing an intention to be legally bound. 
Acceptance For a contract to form, the offeree must accept the offer in the form they were offered for it to constitute acceptance. 
Certainty and Intention A legally binding contract must include certainty and intention from the parties. In commercial contexts, this is particularly important to ensure parties can choose to enter risky agreements that they demonstrate an intention to enter.
Consideration Consideration is a key element of a legally enforceable contract. It is the price paid by a party in exchange for a promise made by another party. 

The question to ask is whether there has been sufficient consideration. However, the adequacy of the consideration will generally not impact your contract’s enforceability. 

What is Consideration?

Consideration is the value exchanged between parties in a contract, either in the form of a benefit or detriment received in exchange for the promise. For consideration to be valid, it usually requires both parties to undergo a change in position, often through a commitment to either perform or refrain from certain actions. 

Consideration in Practice

The general rule is that contracts lacking consideration are unenforceable. This emphasises the importance of exchanging value through a contract. Consideration can vary as there is no requirement for it to be equal between the contractual parties. It will be sufficient as long as both parties agree. 

Consider a situation where a company has asked a marketing agency to develop an advertising campaign costing $5,000. Payment for the agency’s services serves as consideration, establishing the binding nature of the contract. Alternatively, if the agency breaches a confidentiality clause, agreeing not to sue in exchange for $8,000, this also qualifies as consideration due to the mutual exchange. 

Although non-monetary consideration is less common, it can also be sufficient for a valid commercial contract. This is only if the consideration constitutes exchanging something of value between parties. For example, working at a hotel reception in exchange for accommodation at the hotel can be an acceptable form of consideration.

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Types of Consideration 

In commercial contracts, consideration can take various forms, including monetary payments or exchanges that do not involve money. There are a few main types of consideration, as follows.

Executed Consideration

This is where your performance is the mode of acceptance and consideration simultaneously. For example, you have returned a lost laptop for a prize. In that case, you accept the contract for monetary prize payment, and the laptop is the consideration you are providing in exchange.  

Executory Consideration 

Executory consideration is something not yet done, like a promise given by one party to perform a specific act in the future in exchange for the other party’s promise to perform another act.

For example, you have hired a software company to develop a custom software application for your business. You promise to pay $15,000 upon successful software delivery. In exchange, the software company promises to develop and deliver the software. Your payment is contingent on the software company fulfilling its promise to deliver the software.

Until both parties fulfil their respective promises, the consideration remains executory. 

Past Consideration 

Past consideration is the type of act performed before contract formation.

Generally, past consideration will not constitute sufficient consideration as it does not demonstrate the true intention of parties to enter legal relations. 

What Happens if There is No Consideration?

If consideration does not exist in a commercial contract, it will be deemed invalid and unenforceable. Therefore, you need to exchange consideration with the other party in the early stages of contract drafting. 

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Key Takeaways

To make a commercial contract enforceable, it is crucial to incorporate all necessary elements, including the element of consideration. Consideration involves value exchanged between parties. There are a few things to keep in mind about consideration, which include that it can be monetary or non-monetary and can make a contract legally binding and enforceable.

If you need assistance with your commercial contracts, our experienced contract lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers who can answer your questions and draft and review your documents for a low monthly fee. Call us today at 0800 005 570 or visit our membership page.

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