Defining an Illusory Contract
The definition of an illusory contract refers to one that holds no contractual obligation for either party. No actual obligation is present because there is no binding obligation from one party to perform what they have signed up for, and there is no way for the other party to enforce this. Such a contract occurs when one party lacks consideration or there is no mutuality between the contractual parties. To be enforceable, a contract needs to have a binding promise from both parties. However, if a consideration is absent in a sale agreement, the contract is void .
An illusory contract describes a type of arrangement where the offer and acceptance are contained in writing but one of the parties to the contract is not bound to the contract. For instance, a publisher may tell a writer that he/she will pay for a book manuscript once it has been read by a critic and reviewed favorably. In such a case, a contract has been formed, but as long as the reviewer is not contractually obligated to provide such review, the publishing house is not obliged to pay the writer.
The term "illusory" means that something is deceptive and/or misleading. As such, an illusory contract is typically not a valid or legally enforceable contract.
Elements of a Valid Contract
The law is fairly consistent in the definition of a contract as requiring elements such as offer, acceptance, consideration and mutual obligation. Strictly speaking, all these elements must be present for the contract to be considered enforceable by law.
An offer is a statement of the terms on which one party is willing to contract with another. Offer must not be ambiguous and must be clear so that parties can accept on those terms and bind themselves in law.
Acceptance is an unequivocal indication of assent to those terms, whether express or implied. Acceptance must exactly match the offer.
Consideration is a legal benefit to the party to whom the promise is made or a legal detriment to the promisor.
Mutuality means that both parties have obligations to the other under the contract.
Where any of the above elements are missing, the law of contract will not enforce the promise. Where one party is bound but not the other, the contract is illusory. No action can be brought at law to enforce the promise unless the contract has been performed.
The importance of these elements to the law of contract is shown in Moore v Moore (1985) 7 ALL ER 1067 where Lord Denning MR stated: "Now the law of contract does not enforce all promises. It only does so where it is just and reasonable to do so. And in deciding that question, the court looks at the whole circumstances of the case. The court would take into account all the circumstances known to it. It would take the view of the reasonable person acting judiciously with all the circumstances known to the parties."
The law requires complete performance of the contract by which promises are made. As where one party undertook an obligation to send cattle to a butcher’s but sent them to a different butcher. The act of sending was an attempt to make the contract valid, but no valid contract existed in the first place since the parties had intended to send the cattle to Barny’s butcher.
It is important to note that mere inadequacy of consideration will not satisfy the law. If for instance a horse is exchanged for £500 when its value is only £400, the court will not intervene. If a contract is proven to be fair, the court will uphold the contract even when there is doubt over the intentions of the parties. The court will always interpret contracts in favour of justice and fairness to ensure that obligations are met in law.
Common Examples of Illusory Contracts
The most prevalent situations in which agreements may be found to be illusory involve employment or other continuing engagements. For example, in Mulligan v. Impath (N.Y.App.1 Dept., 2003), 754 N.Y.S.2d 187, a director of the national banks was advised that he could take an early retirement or a buy-out. Thereafter, the bank sent him a letter stating that he was eligible to participate in the voluntary separation program, but that the program was voluntary and that the letter was not a request for his retirement. The letter also stated that "[e]mployment with the [bank] ceases when you cease working for the [bank] for any reason, including but not limited to your voluntary separation from the [bank]." He signed the letter so that he could participate in the program, but was thereafter terminated involuntarily. The court ruled the letter did not constitute a binding agreement to retire because the bank did not promise it would accept plaintiff’s request for early retirement or buy-out, or otherwise promise not to terminate him involuntarily. In re Telecredit Service Corporation Litigation, 281 A.D.2d 700 (N.Y.App. 1Dept. 2001), illustrates the employment situation. There, an agreement between the owner of an agency and a staffing company provided that employee claims would be shared by the parties according to formula at the end of each year. Because of the voluminous nature of the claims, agency began to investigate earlier than contemplated in the agreement. When that occurred, staffing company took the position that the agreement had not been formed since the agency had failed to provide its cost report. The court found that while the claimed formula for allocating employee claims may have been clear and definite, it was not supported by any commitment on the part of the staffing company to investigate or respond to claims. Thus, "[t]he mere possibility that defendant might have a claim against the plaintiffs, if defendant chooses to pursue it like any other creditor, is insufficient to constitute the performance element of any legally enforceable agreement." What about language like "will", as in "the buyer will purchase"? The court in Right-Than-There, Inc. v. Windward Agency, Inc., 327 S.C. 273, 290, 489 S.E. 2d 648,653 (1997), held that the term "will" in a contract was clearly subject to varying interpretations, some of which would render it a promise and others an illusory expression of intention. Some courts may find the difference in meaning to be material and others may not. A final example, more formally analyzed, is provided by Leibel v. Robinson Aviation, Inc., 250 F.Supp.2d 603 (E.D.Va. 2003). Buyer and seller executed an agreement under which buyer agreed to buy and seller agreed to sell certain assets of seller’s aviation department. The agreement stated that buyer would pay $1.6 million dollars for the assets, and that if buyer caused the companies he controlled to purchase any of seller’s other businesses, seller would hold the purchase price the same as its own if he bought out the other companies. Seller also promised that he would deliver the assets to the buyer on a certain date. The agreement did not set up a distinct business relationship acting as a disinterested and objective third party. Thus, despite the language which seemed to indicate that both sides had obligations, the court concluded that buyer had been promised the buyer’s choice of accepting seller’s cash offer, or receiving, at seller’s option, the market value of the assets in cash.
Effect of an Illusory Contract
Parties that enter into contracts with free or illusory promises risk voiding the obligation to perform under the contract. Courts have the power to dissolve parties from their obligations under contracts that are illusory.
In Golden Gate Restaurant Group, Inc. v. Red Bull of N.Y., Inc. a prisoner challenged his franchise agreement with Red Bull. The agreement alleged misrepresentations about sales, store performance, and royalties that made it economically infeasible for the prisoner to continue the franchise. Red Bull argued that the prisoner was not liable for any damages because the contract allowed Red Bull to terminate the agreement for "any reason," and so the prisoner could not sue Red Bull. The court held that the prisoner could possibly establish a cause of action for breach of contract because the contract was illusory. The prisoner did not have to pay royalties because the contract allowed Red Bull to terminate the contract for "any reason." Therefore, no money was exchanged and the contract itself did not require the prisoner to provide anything because he was not required to pay .
First, the court explained that "[a]n illusory promise is a statement which, on its face, promises nothing, but which may actually commit the speaker to do something in the future." The court reasoned that Red Bull could terminate the franchise agreement for "any reason." The court distinguished that illusory promises are "mere puffery, and cannot bind the promisor." "A promise cannot be binding upon the promisor unless it is supported by consideration." "A promise is supported by consideration in those cases in which the promisor asks something in return for his promise, that he would not have been compelled to give ‘but for the promise.’"
The court concluded that the prisoner was not bound to pay any consideration because Red Bull could terminate the agreement. Without consideration, the contract was an illusory promise. Just because Red Bull may be entitled to terminate the contract at will does not mean that Red Bull is entitled to damages.
Ways to Avoid an Illusory Contract
To minimize or eliminate the potential for use of the illusory promises defense, you should adhere to the following best practices when drafting and negotiating contracts: Clearly identify the specific nature of the responsibilities being agreed to by each party as part of the contract. Where this contract is part of a larger master agreement, or the negotiation is part of an extended relationship, the drafters should establish a clear process for addressing the overdue obligation of the ongoing relationship such that this agreement can be subject to enforcement in and of itself. The inclusion of a specific time frame (and not simply "reasonable time") by which obligations should be met under the agreement will help to prevent the illusory promises defense from being used successfully. However, it’s important to ensure that a clearly established schedule for performance does not render an aspect of the contract unjustly harsh on the receiving party. Rather, an appropriately balanced timeline should be mutually agreed to by both parties. Be clear regarding the consequences for failing to perform as required under the terms of the contract, and make specific mention of the circumstances under which such a consequence may be delayed, changed, or avoided altogether due to outside circumstances (e.g. natural disasters, strikes, workplace misconduct, etc.) The primary goal is to ensure that the obligations are not open-ended and that both parties are responsibly held equally accountable for their failures to uphold the contract. Ensure that a third party that has nothing to do with the contract is responsible for acknowledging said contract and enforcing its provisions. This third party may be a legal entity created to operate under certain guidelines that make it ideal for upholding the integrity of such agreements, or a person whose obligations under the agreement are much less significant than those of one of the signing parties (e.g. a witness or notary republic). Define appropriate guidelines for how modifications to the contract should be made, as well as when such changes may be made that will not impact the validity of the agreement.
Conclusion: Essential Facts About Illusory Contracts
In summary of all we’ve discussed, companies must pay attention to the existence of illusory contracts to ensure that the agreements they enter into are enforceable. An agreement needs to be an actual offer and an actual acceptance of an offer in order to be a true and binding contract. A valid contract should also contain an exchange of consideration that is serious and that is supported by the parties’ mutual agreement. An absence of any of the above three factors could spell disaster for the agreement and result in the entire agreement becoming illusory. Remember , the entire agreement must be enforceable and legally binding. In addition, it is crucial that the company and the employee each have definite roles and responsibilities within the agreement such that they are equally bound to the terms stated within. Only then can a company prevent the agreement from becoming illusory.