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Contract Modifications: The Consideration Problem

For any contract in Tennessee to be valid, it must be supported by mutual consideration.  What does mutual consideration mean?  Very generally speaking, it means that both parties to the contract must have agreed to pay something, give something, do something, refrain from doing something, or assumed some obligation.

The requirement of mutual consideration applies not only to original contracts, but also, to modifications of original contracts.  In Tennessee, if a contract is modified such that a new obligation is imposed on one of the parties, the modification will not be valid unless the other party also assumed some new obligation.  This rule is sometimes referred to as the preexisting duty rule.

Here is the quintessential example of a contract modification that would not be valid because of a lack of consideration on the part of one party.  Contractor agreed to remodel a structure for Owner.  Contractor and Owner entered into a written contract with a specified scope of work and price.  Three fourths of the way through the remodel, at a time the Contractor knows that Owner is vulnerable because Owner needs the remodel to be completed, Contractor informs Owner that he needs more money because the remodel was more work than he thought it would be.  Owner balks, but Contractor informs Owner that he will walk off the job leaving the work unfinished which, of course, would force Owner to find another contractor to complete the job and would delay completion.  Owner then agrees to pay ten percent (10%) more than he originally agreed to pay.

Under the above scenario, Owner would not owe Contractor for the additional ten percent (10%).  Contractor gave no new or additional consideration for the promise of the Owner to pay ten percent (10%) more.  To put it another way, the only obligation assumed by Contractor in the modification was an obligation which he had a preexisting duty to perform – – – complete the construction.

Bear in mind that, in a lot of Tennessee breach of contract cases, whether the modification is not valid because it was not supported by reciprocal consideration is not so clear.

There are exceptions to the rule requiring mutual consideration for a valid modification.  An informative case which discusses the exceptions to the rule that a modification requires reciprocal consideration is Guesthouse International, LLC v. Shoney’s (Tenn. Ct. App. 2009).

The Guesthouse case noted one exception to the rule occurs when the parties have an honest dispute about the interpretation of the existing contract and agree to modify it to settle that dispute.  Here is how that exception might work tweaking the facts of the above example with the Contractor and Owner.  Contractor understood that the Owner wanted the remodel finished within three months, but understood the three months to start from the date Contractor began construction.  Owner understood the three months to start from the date the contract was signed, which was one month before work began.  To resolve their differences, Owner and Contractor agree that Contractor will be paid ten percent (10%) more and will finish within three months of the date the original contract was signed.  This modification will probably be upheld.

As noted in Guesthouse, a second exception occurs when one party encounters unforeseen difficulties, and, under the circumstances, it is fair to allow a modification.  Let’s go back to the Contractor and Owner example to illustrate a situation in which that exception might apply.

Three fourths of the way through the remodel job, Contractor discovers that there is asbestos behind walls in the structure in places where most contractors would not expect to find asbestos.  Removing it will increase Contractor’s cost by twenty percent (20%).  Removal of the asbestos is technically within the scope of work Contractor agreed to perform because, while he did not specifically agree to remove asbestos, he agreed to remove the walls within which it was found. Owner agrees to pay Contractor an additional thirty percent (30%) if he will complete the job.  Even though there was no new consideration given by Contractor, this modification would probably be upheld by a Tennessee court.

Keep in mind that, apart from a modification, sometimes parties will agree to cancel or to rescind a contract and to replace it with a new one.  This would not be considered a modification, and the new contract would be valid even if it contained terms which placed new obligations on one party while the other party just had the very same obligations which it had under the old contract.

Assume that halfway through the remodel job, Contractor tells Owner that he needs to cancel the old contract and agree to a new one pursuant to which Contractor performs the same scope of work, but is paid ten percent (10%) more. If Owner agrees to do this, for whatever reason, in all likelihood, the new contract will not be invalid because of a lack of consideration.  In some circumstances, it might be invalid if the Owner could prove that he agreed to cancel the old contract and enter into the new one because of duress (a topic for another day).

Lastly, for Tennessee lawyers who handle breach of contract cases involving the sale of goods covered by the Uniform Commercial Code (“UCC”), the UCC expressly does away with the preexisting duty rule.  It provides that an agreement modifying a contract needs no consideration to be binding.  T.C.A. §47-2-209