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Friday, September 6, 2013

A Recital of Consideration

I start my first year contracts course with consideration.  For the first time, I’m also teaching a contracts drafting course.  Based upon the contracts drafting texts that I reviewed, the general consensus seems to be that recitals of consideration are basically pointless.  While I think that’s somewhat true in that they don’t contain performance obligations, it’s misleading, too.  Courts not only consider recitals in construing clauses and the parties’ intent, a recital of consideration may create a rebuttable presumption or may estop a party from claiming lack of consideration.  In other words, in some cases, it can save a party from a claim that consideration was insufficient.

A recent case involving a patent assignment, Network Protection Sciences v. Fortinet, 2013 WL 4479336 (N.D. Cal 2013), seemed to go even further when the court, applying Texas law, held that a recital was conclusive.  The recital in question stated that the patent was assigned “for good and valuable consideration, the receipt of which is hereby acknowledged.”  The party contesting the assignment argued that it was invalid because it was “beyond dispute” that no consideration was paid for it.  The court, applying Texas law, rejected that argument finding the recital conclusive and that “(e)ven if no actual consideration were paid…NPS’s agreement to be bound by the choice-of-law provision would be deemed adequate consideration.”  In other words, according to the court, the recital is conclusive with respect to the issue of whether there was consideration for the assignment but even if it weren’t, agreeing to the choice of law provision was sufficient consideration.  Is this the law in Texas, is it unique to Texas, or did the judge make new law? Any contracts profs care to weigh in?

In any event, it seems that consideration wasn't the way to go anyway because (although the parties didn't raise the issue)  the assignment seems to fall under Restatement section 332 regarding gratuitous assignments that are irrevocable if signed and delivered to the assignor.  This makes sense to me because a written assignment can affect third parties who rely upon it. 

The case is also noteworthy because it opens with a quote from a recent NYT oped, coauthored by Santa Clara law prof Colleen Chien, which discusses the problem of “patent trolls” (companies that buy up patents with the intent to sue for infringement, rather than to practice the patented invention).  The court’s decision denying the defendant's motion to dismiss the patent infringement action was a bit disappointing given the way it began its opinion and the less-than-admirable behavior of the plaintiffs and their trollish behavior in pursuing the action.  Where are the activist judges when you need them?

 

[Nancy Kim]

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Comments

I’m one of those who says that the traditional recital of consideration is a waste of space. Sure, in some jurisdictions it establishes a rebuttable presumption, but who cares! It shouldn’t be a mystery whether there was consideration, so the presumption is worth very little.

I’m pleased to learn of that California case—I can add it to those opinions in which the judge displays drastic ignorance of basic contract law regarding consideration. For another example of that, see the following blog post: http://www.adamsdrafting.com/the-illinois-appellate-courts-problematic-take/.

It would be very odd for drafters to reinsert the traditional recital of consideration to take advantage of such anomalous caselaw. You’d have to say to yourself, “I’m going to include a traditional recital of consideration, so that if (1) I do a deal where there’s no consideration, (2) I chose to dispute that fact, and (3) the dispute ends up in front of a clueless judge, I’ll be golden!” As an approach to dealmaking, that seems particularly unhelpful.

Posted by: Ken Adams | Sep 6, 2013 1:33:20 PM

Ken, I find your comments particularly interesting in light of the Macaulay symposium that's been going on here. As Gillian Hadfield's post indicates (http://lawprofessors.typepad.com/contractsprof_blog/2013/08/revisiting-the-contracts-scholarship-of-stewart-macaulay-post-v-gillian-hadfield.html), while Macaulay's research indicated that businesspeople rarely pay much attention to contracts, in certain contexts, contracts serve relational purposes that would not be served by litigation.
In light of the scholarship alluded to in Professor Hadfield's post, it seems to me that recitals of consideration serve the same purpose as the rest of contracts. One's thought process in reciting consideration is nothing like what you describe. First, one recites consideration (especially in a context in which it might not be obvious that anything of value has been exchanged) in order to protect one's client from a troublesome issue that, in the absence of a rebuttable presumption, would be very expensive to litigate because it goes to the intent of the parties and thus requires extensive discovery.
Second, recitals of consideration clarify that the parties' purpose is to form a legally binding agreement (what Fuller called the evidentiary function); provide a mechanism for testing their commitment to that purpose (Fuller's cautionary function); and help a court figure out what the document is supposed to be (Fuller's channeling function).
Given all of these justifications for recitals, and given the fact that including them is much easier (and thus less expensive) than any alternative mechanisms for achieving the same goals, I cannot imagine counseling a contract drafter to leave out recitals of consideration.

Posted by: Jeremy Telman | Sep 6, 2013 4:22:20 PM

Ken,
I agree with Jeremy and I disagree with your characterization of how this would arise. Of course, the body of the agreement should contain the substance of the consideration, i.e. the promises, performances and payment. But in some cases, it’s not clear what the bargain is. For example, in the situation I described – a patent assignment – the assignor wasn’t receiving any money from the assignee. Another typical situation is a guaranty – the guarantor is guaranteeing the debt of a third party and it’s not clear what she is getting in return. In both those situations, it would be foolish to omit a recital of even nominal consideration. It’s even more foolish in a jurisdiction where recitals provide rebuttable (or conclusive!) evidence of consideration.
I also think it would be unwise to ignore case law simply because you disagree with a judge’s analysis, especially if you are in the same jurisdiction. It’s still precedent whether you agree with it or not – and it’s something that you should take into account when drafting a contract. One of the most important things a lawyer can do for her client in drafting a contract is minimize the client’s risk exposure – when you know there’s a potential risk and you can protect against it by drafting, why wouldn’t you do it?

Posted by: Nancy Kim | Sep 6, 2013 5:23:09 PM

As an author of one of the contract drafting textbooks, my views differ from Ken's. Whether a statement of consideration is necessary and its contents depends on the contract and context. A plain vanilla contract with reciprocal covenants doesn't gain much from the traditional statement of consideration: Now, therefore, in consideration of $10 paid in hand and other good and valuable consideration, the receipt of which is hereby acknowledged, the parties hereto hereby agree as follows:

This statement of consideration has two parts: first, the statement of the "purported" consideration and second, a statement that the parties agree to the terms of the contract. The latter is essential. It evidences the parties' agreement to the terms of the contract. (I believe this evidentiary function is sufficiently important that the concluding paragraph before the signature lines should reiterate that the parties agree.)

As to the former, a plain vanilla credit agreement can probably suffice merely with the statement of the parties' agreement. If the choice of law is that of the state which gives presumptive evidence of consideration, based on a statement of consideration, a simple statement of consideration is appropriate:
"In consideration of the mutual promises stated in this Agreement, the parties agree as follows:" But even this can be tricky. For example, some security agreements are so one-sided, that the bank makes no promises at all. These agreements should be redrafted so that the bank has several obligations: to care for the collateral, to return the collateral and to sign the necessary UCC– 3 statements. The bank may be required by law to do these things anyhow, but to assure reciprocal consideration, I always negotiated for these covenants when representing the borrower.

Options, guarantees and real estate contracts in specific states require more. The real estate contract may require a statement of a dollar amount of consideration. With respect to options and guarantees, the drafter should not rely alone on the statement of consideration. Instead, the recitals take on a critical role. That is the place to explain how the guarantor, for example, is deriving benefit from the guaranty it is giving. The statement of consideration should then tie into those recitals.

Context and reducing the risk of litigation should be salient. I once did a deal where a bankruptcy partner and I spent an entire afternoon drafting recitals to demonstrate how a complex series of related transactions in fact provided consideration when in one of those transactions the consideration appeared to be flowing only one way.

I had hoped that my textbook explained at least most of these nuances, but perhaps I had better work on the proofs of the second edition.

Tina Stark

Posted by: Tina Stark | Sep 7, 2013 12:32:16 PM

Tina,
Thanks for commenting. You provide good examples of what I was referring to in my comment to Ken. I especially agree with your statement that "context and reducing the risk of litigation should be salient." I might even substitute "paramount" for "salient."

Posted by: Nancy Kim | Sep 8, 2013 10:29:29 AM

Hmm. Evidently I should have been clearer. Here’s a summary of my position:

For the following four reasons, it’s unhelpful to include a generic recital of consideration as a matter of course in all contracts:

First, in the overwhelming majority of contracts (considering multi-contract transactions as a whole), it’s clear that the contract is supported by consideration. (If it isn’t readily apparent what the consideration is, then consider spelling it out in the recitals. That sort of specific information is very different from a generic recital of consideration.)

Second, it’s well established that a recital of consideration cannot transform into valid consideration something that cannot be consideration, and a false recital of consideration cannot create consideration where there was none. So anyone who thinks that including a generic recital of consideration in a contract would address a lack of consideration could be in for an unpleasant surprise. (That the odd court fails to recognize that precedent is neither here nor there.) Yes, a generic recital of consideration might establish a rebuttable presumption of consideration, depending on the jurisdiction, but that would be of little value—determining whether there was in fact consideration should be easy enough to establish. And relying on the presumption is a distant second to address the issue head on.

Third, saying by rote the same thing in every contract is functionally equivalent of saying nothing.

And fourth, even if in a given contract a generic recital of consideration is simply unnecessary, it would still be best to omit it, as it clutters up the lead-in, usually with dysfunctional traditional language (“NOW THEREFORE, in consideration of the premises,” etc.) that also serves to alienate readers.

So instead of lumbering each contract with a generic recital of consideration, drafters should instead determine whether there’s a risk that the contract isn’t supported by consideration. If that risk does exist, the drafter has choices. Here are four:

First, you could restructure the transaction to provide for consideration.

Second, you could have the performing party waive consideration and acknowledge that the other party will be relying on that waiver, although anyone tempted to adopt that approach should probably do some research to see how the relevant courts might respond.

Third, depending on the jurisdiction and the kind of contract, it might be that a sham recital of consideration would be sufficient to support consideration. (Option contracts governed by Texas law come to mind.) But even in such cases, I wouldn’t use a generic recital of consideration; I’ll do a blog post about that.

And fourth, depending on the law in the relevant jurisdiction, you could hold your nose and make the contract one “under seal.”

So that’s why I recommend omitting a generic recital of consideration from the lead-in to contracts, and why I recommend that drafters take more specific steps to address a potential lack of consideration. I see nothing in the earlier comments that brings that approach into question. And yes, I'm exquisitely aware of the need to avoid risk—that's a fundamental part of what I do.

By the way, Nancy, it’s generally held that the consideration supporting the principal obligation also supports the guarantee—if Acme guarantees that it will pay back Widgetco’s bank loan, the fact that the bank is lending Widgetco money is consideration for Acme’s acting as guarantor. The reporter’s notes to section 88 of the Restatement (Second) of Contracts cite only one decision of uncertain significance to the contrary.

Posted by: Ken Adams | Sep 9, 2013 8:04:06 AM

"I cannot imagine counseling a contract drafter to leave out recitals of consideration."
"when you know there’s a potential risk and you can protect against it by drafting, why wouldn’t you do it?"

I'm with Ken on this one. I'm an English, rather than a US lawyer, so may be disqualified from commenting, but like Tina I have written a book on boilerplate clauses.

I don't agree with the above-quoted statements. That way madness lies. It won't be just the consideration issue, there will be other points that you can just cover off with a sentence or two based on some maverick judge's comment on a Friday afternoon. You end up with lots of additional legal verbiage that contributes nothing practical to the agreement. And you do it based not on considered judgments by appellate courts but on what comes across as convenient excuses to dispose of an issue by a hack court.

The cited case was about a patent assignment. That can be viewed as a transfer of property rather than a contract, and as such doesn't need consideration. So it's a bad case to use as a justification for more legal mumbo jumbo in contracts.

And I don't buy the argument that putting it in the contract helps even if it doesn't go to court, because businessmen are persuaded not to take a point. The question of consideration is so far removed from non-lawyers' perspective that they are likely to treat it as a highly technical point for lawyers rather than something that they can form a view on.

While I place (I think) far more weight on winning in court as a basis for contract drafting than Ken does, I wouldn't generally include recitals of consideration in my contracts, nor would I teach others to do so.

Posted by: Mark Anderson | Sep 9, 2013 9:17:23 AM

Mark,

Thanks for commenting. It's not just one "maverick" judge - it's pretty well established precedent in several jurisdictions that a recital of consideration creates a rebuttable presumption (the case I referenced was unusual because the presumption was conclusive). Recitals can also be useful to help indicate what the parties intended, i.e. to provide context. I find it puzzling that you think this is not worth the few extra lines to make the case clearer for your client. (And again, I am obviously not saying you should include the consideration provisions in the recitals in lieu of putting the consideration provisions in the body of the agreement, nor am I saying that you should include them in all contracts). But in cases where there might be some doubt about parties' intent, why wouldn't you clarify that intent in the recitals ?

Posted by: Nancy Kim | Sep 11, 2013 6:43:06 PM

I think it is always going to be easier for English lawyers (I am one) to discard recitals of consideration than it is for US lawyers, as the English case law on the point is clearer and more consistent - perhaps simply because of the many and varied state jurisdictions in the US. So I do have some sympathy for the US lawyers here.

However, even if courts have sometimes given value to generic recitals of consideration, I don't believe such recitals can or should be relied on. While the judges may not be “maverick”, their arguments in support of the principles – either than they are conclusive or create a rebuttable presumption - seem a little shaky to me. Moreover, giving full effect to such recitals, as the Texas court did, effectively removes the requirement for consideration entirely – do we think the courts really want to do that? Or did a judge want a particular result in one particular case? This isn’t an academic point – there seems a good chance that at some point a higher court will put a lower court right, and the recital of consideration will fail. And as not all jurisdictions support this interpretation of the recital, it isn’t a generally-applicable solution to anything even now.

I think there are always better ways to address consideration. Firstly, the consideration is usually perfectly clear from the contract. Secondly, if there is consideration but it isn’t clear in the contract, the actual consideration can be referred to more specifically in the recitals. (This is where a recital is certainly useful, though like Ken I think this is a very different idea to a generic recital in every contract.) If there is no consideration, or any doubt about consideration, the contract should be executed as a deed (or by whatever the equivalent process is to render a bare promise enforceable in the relevant jurisdiction). If these steps are followed, a generic recital of consideration doesn’t really seem to add anything further. For that reason, I would never propose it as my solution to a consideration problem, or use it as standard in all my contracts.

Posted by: Art Markham | Sep 12, 2013 8:46:27 AM

Hi Art,
Welcome to the blog. I’m pleased that the post has generated so many comments.
I don’t think there is a huge disagreement here but there are some misconceptions/misunderstanding -- whether they are due to the differences between UK and US law, I'm not sure. I thought I made it very clear that recitals should not be relied upon and that the consideration provisions should be in the body of the agreement whenever possible. I also don’t recommend a recital in every contract. My post referenced the general notion in many contract drafting texts (although not Stark’s which does discuss the role of recitals as long as they are not overdone) that recitals of consideration are pointless. They are not. Although they are not required or necessary in every contract, they can be useful in many situations, to establish intent or a rebuttable presumption of consideration. For example, while nominal consideration is typically not sufficient, a recital of consideration will often suffice if the agreement is an option or guaranty. These comments only underscore what my original post was about – that there is a misconception that recitals of consideration are always pointless. Even a generic recital can be quite useful in many situations. If a lawyer were drafting an agreement for one of those situations (e.g. involving an option contract), s/he would be wise to include a recital of consideration. Far from being "madness" as a previous commenter noted, it is prudent - what's a lawyer (and a contract) for if not to reduce risk for the client? A recital may defeat or keep out the other party's argument that consideration was never received so that the case is dismissed rather than litigated extensively (cost savings to the client). Sure, many courts won't accept a mere recital to establish the receipt of consideration but many do and I don't see how it can hurt to include it (again, to be clear, not saying it should substitute for the consideration provisions in the body of the agreement, but in addition to them). Given all the confusion, I will likely write another post about this or maybe even a law review article categorizing the different types of situations, so stay tuned….

Posted by: Nancy Kim | Sep 12, 2013 10:03:00 PM

Nancy, thanks for your response. I think there is a more general point about including text in contracts that is designed for other lawyers and judges to understand, but which is not really part of the commercial deal. My impression is that English judges are inclined to ignore such wording as self-serving, and that we don't have such a keenly developed sense of what Chancellor Skrine, in Delaware, called the "contractarian" approach. Other examples include:
- stating in NDAs that damages are not an adequate remedy and that a party is entitled to an injunction
- stating in liquidated damages clauses that the clause is a "genuine pre-estimate" of the anticipated loss (this one may be encountered more in the UK than the US)
- stating in non-compete clauses that the parties agree that the restriction is reasonable

There are no doubt other examples that people can think of. In all these cases, the drafter is trying to persuade the court to apply legal principles in a particular way. It is a private conversation between drafter and judge in which the commercial client is not really involved. It is also a conversation about points "at the margin", trying to squeeze an advantage.

In my view this goes against the modern idea that contracts should be written for non-lawyers to understand wherever possible.

Posted by: Mark Anderson | Sep 13, 2013 10:02:56 AM

Mark,
I agree with you that these clauses are most unhelpful to non-lawyers and they are pretty standard in US contracts, too. Strategically, I wouldn’t exclude them. US courts really take seriously this view that they should enforce the “intent of the parties.” Although courts are not obligated to abide by these clauses, often they do as they see their role as determining the intent of the parties. My “belt and suspenders” approach to drafting may not move the cause of better written contracts forward, but it may put my client in a better position in the event the contract ends up in court. The “modern idea that contracts should be written for non-lawyers to understand whenever possible” is a good one, but should not replace the idea that a lawyer’s job is to reduce risk for clients. I hold firm to the belief that it is poor lawyering for one to disregard precedent dealing with these issues simply because one would have ruled otherwise. You are drafting the contract to protect your client, not to make law. A lawyer is not the judge.
Another point that I think is too often ignored is that contracts are useful not only to help win a case at trial -- they are useful in avoiding litigation. I’ve worked on many transactions where litigation was avoided by pointing out contract clauses that may not have been necessary for performance purposes, but were quite helpful in resolving a dispute and re-setting expectations.
Thanks again for commenting – it is interesting and helpful to hear how things may be different in UK courts.

Posted by: Nancy Kim | Sep 13, 2013 2:49:23 PM

I know it's an old blog post, but I thought I would add a quick note. My initial thoughts were that you don't need to recite consideration in a property conveyance. However, the final paragraph of 35 USC 261, which governs patent assignments, requires "valuable consideration" to overcome a prior conflicting assignee that did not record their assignment. For that reason, it would seem prudent to systematically include a recital of consideration in patent assignments.

Posted by: Aaron Weiss | Aug 4, 2014 9:09:33 AM

Aaron,

That's exactly right - - the 'valuable consideration' issue comes up in real property, too. I am in the midst of researching that issue now for a book on contract clauses. Stay tuned!

Posted by: Nancy | Aug 5, 2014 6:40:11 PM

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