Despite the best efforts of their drafters, contracts cannot always account for all variables that may arise during the performance of a contract, particularly when the contracts seek to govern the business relationship between parties over an extended period of time. Consequently, parties may wish to modify their existing contract to better account for changed circumstances and the evolution of their relationship. However, because the agreement to modify a contract is itself a contract, it must satisfy all the prerequisites for a contract to be enforceable.
These contractual prerequisites include the requirement that the agreement to modify be supported by “consideration” – meaning a bargained-for exchange in which either the promising party receives a benefit or the promised party accepts a detriment. The benefit or detriment need not be substantial; the law generally does not question the sufficiency of consideration supporting a contract. Indeed, a promise by itself can qualify as consideration, and the mutual exchange of promises by the parties can support contract modification. However, the consideration supporting the contract modification, whatever its form, must be new and distinct to the agreement to modify – preexisting obligations do not qualify. In other words, if a party wishes to modify its contract, it cannot “double dip” by merely promising to do what it was already contractually obligated to do.
The Indiana Supreme Court’s opinion in AM General LLC v. Armour, 46 N.E.3d 436 (Ind. 2015), illustrates how preexisting obligations cannot support contract modification. The litigation in Armour arose out of a dispute over James Armour’s entitlement to a long-term incentive plan (LTIP) payment from his former employer, AM General LLC. See Armour, 46 N.E. 3d at 437-39. Pursuant to his employment contract with AM, Mr. Armour was entitled to a lump-sum LTIP payment upon retirement. See id. Instead, AM began paying Mr. Armour in quarterly installments following his retirement. See id. AM then attempted to pay the remaining LTIP balance owed with a promissory note, the terms of which stated that acceptance by Mr. Armour would release AM from all further obligations under the LTIP provision of the employment contract. See id. Mr. Armour rejected the note, and litigation ensued. See id. The trial court granted summary judgment in Mr. Armour’s favor, finding that AM breached the employment contract by attempting to pay the LTIP benefits with the promissory note. See id. A divided Indiana Court of Appeals reversed on the grounds that a genuine issue of material fact existed regarding what qualified as “payment” under the LTIP provision of the employment contract. See id. The Indiana Supreme Court granted transfer. See id.
Before the Indiana Supreme Court, AM argued in part that Mr. Armour orally agreed to the deviation from the employment contract’s requirement of a lump-sum LTIP payment upon retirement. See id. at 442. However, the Indiana Supreme Court found that, “even if the oral agreement occurred as AM General contends, Armour received nothing in exchange for AM General making the LTIP payments in four installments, rather than as a lump sum payment.” Id. at 443. Rather, “AM General only agreed to do what it already had an obligation to do under the existing Employment Agreement; pay the full amount owed under the LTIP provision.” Id. Accordingly, the Indiana Supreme Court held that, “even if the oral agreement had occurred, it fails as a valid contract modification for lack of consideration,” and it affirmed summary judgment in Mr. Armour’s favor. Id. See also Hinkel v. Sataria Distribution & Packaging, Inc., 920 N.E.2d 776, 770-71 (Ind. Ct. App. 2010) (holding that the employer’s alleged oral agreement to pay an employee a severance package “was not supported by an independent, bargained-for exchange” where the employee provided no additional consideration beyond duties and obligations assumed as consideration for the original employment agreement); Seastrom, Inc. v. Amick Const. Co., Inc., 315 N.E.2d 431, 433 (Ind. Ct. App. 1974) (finding no “new and distinct consideration” to support a contract modification where the promisor was “doing no more than he was obligated to do under” the existing contract).
In light of the formal requirements for enforcement, parties wishing to modify their contracts should approach any agreement to modify with the same care taken in negotiating, drafting, and executing the original contract. In particular, the parties would do well to confirm – and make clear in the terms of the agreement – that the agreement to modify requires them to do more than what they were already obligated to do under the original contract.
If you have questions about contract modification, please contact your DSV attorney or Jeffrey M. Kraft at jkraft@dsvlaw.com.
***The information contained on this website is for informational purposes and is not intended as formal legal advice and cannot be relied upon as such. No attorney client relationship is established or intended as a result of the information contained on this website.**