What is an Illusory Contract?
An illusory agreement is defined as a unilateral contract or a statement in which a contract would be made but the deal is without substance. It is an offer that does not bind either party to perform their end of the bargain. There is no consideration promised by the promisor to bind them. For an agreement to be binding for both parties, they must perform a legal act or promise something in exchange for something else. If party A offers to paint party B’s house in exchange for $300, and party C overhears and says, "yea, I’ll paint your house for $200," then party C is not a legally binding offer and is considered illusory. Lack of consideration is a promise without exchange for anything of value so that it is only the illusion of a contract, i.e., an illusory agreement. While not legally binding, an illusory agreement will be enforced in court if there was some form of payment for a service rendered. The courts are not concerned with the amount but rather if anything was paid for a service rendered for another.
Basic Examples:
1 . ) A landlord offers a tenant either a 3-year contract or a 2-year contract. The landlord chooses the 3-year contract and informs the tenant to start selecting paint colors for inside the home. In this example, the offer is a unilateral contract that obligates only one party, the landlord, to be bound to fulfill their bargain.
2.) A landlord offers a tenant either a 3-year contract or a 2-year contract. The tenant chooses the 2-year contract because the rent is decreased. The tenant starts selecting paint colors for inside the home to which the landlord says construction on the house will not begin until the contract ends, and the tenant can choose new colors legally binding the landlord to fulfill their end of the bargain.
3.) A student makes a "good student" promise to a school in exchange for $3000 at the start of each semester. The student does not show up to class. The school sues the student to receive the $3000. The court will force the student to give the money and award the school it’s legal fees because there was an agreement between two parties.
Characteristics of Illusory Promises
The lack of mutuality in an illusory promise makes it an inadequate consideration for a promise by the other. However, the true nature of the matter is that the illusory promise takes away the real binding force of the contract and essential elements of a contract are lacking. An illusory promise by one party leaves the whole of the promise to be performed at the mere subjective discretion of the party beyond all legal control.
Characteristics of an illusory promise include:
• The lack of mutuality – e.g. service rendered by one of the contracting parties on one side for the other side although without consideration.
• Vague terms – a statement is too vague to form an illusory promise if no performance by the promisor is possible.
• Uncertainty as to the strictness of the terms of the promise.
• The promise of one party to future performances, the terms of which depends upon the will or judgment of the party and upon no different conditions; or the performance to be made, not by one party or by the other, but by neither.
• The language used may allow the promissor to act or fail to act.
• A promise with the "unfettered" right not to perform.
How Illusory Contracts Differ from Enforceable Contracts
In order to establish a valid contract, "an offer, acceptance, consideration, performance and/or a promise" are essential. (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal. App. 4th 502, 511, fn. 4.) An agreement that does not incorporate these elements is an illusory agreement and lacks the mutual obligations and/or exchange necessary for enforceability. Penney v. Wells Fargo Bank, N.A. (N.D. Cal. Sept. 15, 2009) 2009 WL 2990354, *11. Illusory agreements are so optional with reference to performance or nonperformance of its provisions that the "promisor can avoid its performance by merely not choosing to perform." Zanakis-Pico v. Kleargear.com (D. Utah Mar. 26, 2010) 2009 WL 734062. The amount or focus on the consideration itself is not necessarily dispositive of whether the agreement is illusory. Hot Rods, Inc. v. Warner Bros. Entertainment Inc. (C.D. Cal. Jan. 29, 2010) 2010 WL 389362, *5. A renewed effort to enforce an illusory contract or one with an indefinite duration may not salvage an otherwise unenforceable agreement. Zanakis-Pico v. Kleargear.com, supra, 2009 WL 734062, *5. On the other hand, the conditional promise of Gardner’s to pay Greenih, upon Gardner’s receipt of money from sales of certain copyrights, was performance for purposes of a contract. Triumph Construction, Inc. v. Pacific-Union Assurance Co. (N.D. Cal. Mar. 30, 2006) 431 F. Supp. 2d 1137, 1143; see also California State Auto. Assn. Inter-Ins. Bureau v. CitiCorp (1986) 183 Cal.App.3d 1198, 1208.
Legal Implications and Interpretation by the Courts
The principal legal consequence of a party engaging in an illusory promise is that the resulting agreement is unenforceable and will not carry the same weight as a common law contract. However, the effect of that unenforceability can vary across jurisdictions. For instance, in the United States, the existence of an illusory agreement can have further legal consequences; for example, the Uniform Commercial Code (UCC) and the Restatement (Second) of Contracts allow for the resumption of an offer that has been withdrawn or revoked in some contexts to prevent manipulation of the law related to illusory contracts ("the Circuit City-Rampart Decision"). Accordingly, under U.S. law, if the offer has been withdrawn, but the public generally would not be prejudiced by its resumption, the offer may be revived, in which case, there will be an enforceable contract. If the offer was withdrawn after the irrevocability period without prejudice to others, it will be permitted to be revived. After giving notice of revocation to the offeree, if the offeree renders performance, acceptance will be considered complete and will relate back to when the act was conducted.
In addition to being unenforceable, courts may also construe an illusory promise to mean that the parties never intended to become legally bound, particularly if the contract lacks additional consideration. In Lilly v. Herbert J. Thomas Mem’l Hosp. Ass’n. , the Court described an illusory promise as "a statement lacking any true meaning because it confers no obligations." The Court asserted that an illusory promise can be satisfied if merely a token amount is given if the promise is to pay "whatever or almost nothing" or an undefined quantity or amount; however, the Court stated that a promise to pay an unspecified sum is fine if the value is sufficiently measurable. Though the Court did not explicitly say whether the agreement was enforceable, even if the promise purported to satisfy consideration requirements, it presumed that the agreement did not. This aligns with U.S. states’ majority rule that an illusory promise is not valid consideration for a contract. Applying this approach, if the agreement is illusory, the parties cannot be legally bound, as in the case of overbroad clauses with no actual obligations to follow.
Some other notable court cases in relation to illusory contracts are Cincinnati Indians, Ltd. v. Cincinnati Reds, L.P., and Infor Global Solutions (USA), Inc. v. Departure Financial LLC. In the first case, the greater context of the contract was reviewed in order to determine whether the employee had an enforceable non-compete agreement in place. In the second case, it was held that an agreement for a quarterly bonus was illusory because of the lack of obligation on the part of the employer.
Examples of real illusory contracts
In the case of Lee v. Red Lion Hotels, No. 60 MM 2018 (May 23, 2018), the Pennsylvania Supreme Court reminded us that non-competition agreements are disfavored in Pennsylvania and will not be enforced unless they serve a legitimate purpose and do not impose an undue hardship on the employee. In Lee, the Supreme Court concluded that a non-competition agreement was unenforceable because the employer was not even in the same industry.
There are various legal theories under which an agreement can be found to be illusory. For example, in Pennsylvania, mere statements of present intention, mere statements of future promises and promises supported by a so-called "recital" such as "in consideration of the promise" or similar phrases are not binding. See Spellman v. Am. Honda Motor Co., 241 F.3d 632 (3d Cir. 2001). The Pennsylvania Supreme Court has also held that a "unilateral right" where "only one party to the contract has the right to terminate the agreement" is insufficient consideration and thus illusory. See Overall v. Univ. of Delaware, 544 A.2d 459 (Pa. 1988) (where plaintiff employee received new employment manual with implied right of unilateral termination, but defendant employer did not promise any reciprocal obligation to implement disciplinary procedures, including termination, in good faith, employment for just cause was illusory). Id.
A recent application of the illusory promise doctrine can be found in Martinez-Vazquez v. Dynamic Power Sport & Manufacturing, Inc., No. PICS 1969, 2018 WL 6826043 (Pa. Commw. Ct. Dec. 28, 2018). In Martinez-Vazquez, the Commonwealth Court in Pennsylvania concluded that a forum selection clause in an employment agreement which allowed either party "to unilaterally modify the Memorandum of Understanding at any time" was not binding. The Court held that the agreement was illusory due to the lack of mutuality of obligation because the forum selection clause only required a reciprocal obligation between Martinez-Vazquez and Dynamic Power in the event of change in law whereas other obligations set forth in the agreement were solely imposed on Martinez-Vazquez. Id. ("Dynamic Power maintains the right to control Martinez’s compensation, responsibilities, and role and Martinez is bound by restrictive covenants.").
While agreements can be illusory for many reasons, the Court in Martinez-Vazquez was primarily concerned that because Dynamic Power could unilaterally terminate the agreement, neither party was actually obligated to arbitrate its claims. Given the demurrer stage at which the issue arose, the Court could not find that the alleged facts were sufficient to prove that Dynamic Power actually intended to modify the forum selection clause when necessary to avoid arbitration as Martinez-Vazquez alleged. In reaching its conclusion, the Court advanced a balance between the competing interests that arise out of the intent to arbitrate and the right to redress in the courts by ensuring a basic level of mutuality of obligation that did not hinder either party from bringing claims before the appropriate forum. Id.
The Court in Martinez-Vazquez extended its analysis to include an examination of the arbitration provision that was embedded in the parties’ employment agreement. While the fact that the provision did not clearly explain the rules and procedures in which the parties would be bound was arguably vague, the Court noted that it contained a detailed arbitration clause. If the clause contained sufficiently clear terms, the agreement requirement of mutuality of obligation was satisfied. The Court indicated that even though there may have been an imbalance in rights because one party had the power to arbitrarily modify the forum selection provision, such modification did not render the non-competitive clauses of the agreement unenforceable since the practical implications rendered a balance on the parties’ respective rights. Id. ("if the forum selection clause did not alter the obligations of the parties, the arbitration clause remained enforceable.").
How to avoid illusory contracts when drafting agreements
The other example in contract interpretation is of a void or voidable agreement (in the case of illusory agreements, void – as being without any content). In general, parties who enter into an illusory agreement are not bound to any enforceable obligations, and neither party can claim a breach of contract for failure to fulfill any obligations. Therefore, a useful contract drafting tip is drafting in order to avoid the creation of illusory agreements.
A tip for this is simple: ensure that the contract sets out the obligations of the parties, and that there are obligations on both sides; I.e. that the contract is supported by consideration on both sides.
In addition, ensure that the terms of the contract are not too vague or broad. If the language or terms are so vague or broad that either party can use such as a reason for such party to avoid its obligations, then that agreement can be an illusory agreement. Do not make provisions in contracts that are so vague or broad that they can be used by one party to escape its obligations when necessary .
A further tip on that note is to include specific performance clauses in the contract. This forces parties to fulfil their obligations – and if a party claims later that it will not be possible, it would have to show how and in what situation it is impossible, taking consideration of all circumstances – such as worse conditions in climate, bad management moves, etc. Climate in particular should not be a reason for it not being a "benefit or privilege" to the other party, as does not have to fulfil its obligations to provide the same to the other party.
Another tip is to ensure that the contracts are clear and concise, not vague or ambiguous, specifically in the provisions regarding the termination of the contract. The clauses relating to the termination of a contract must be very clear and unambiguous, and not vague with many exceptions that let the parties escape their obligations, as this is a common cause of illusory agreements.