Consideration is something that is done or promised in return for a contractual promise. It’s a central concept in the common law of contracts, and is required for a contract to be enforceable. Essentially, consideration is what must be given up by each party when making an agreement. It may be means of doing or not doing an act or simply promising to do or not do an act. It’s a benefit to one party and a detriment to the other party. In general, for a contract to satisfy the requirement of consideration, the contract must fulfill three elements: (1) there must be a bargain regarding terms of an exchange; (2) there must be a mutual exchange; and (3) the exchange must be something of value. The issue of contractual consideration was at the heart of the dispute in this case.
Here, a bank and a family-owned business entered into an agreement for non-judicial foreclosure, and the mortgaged property was sold. The plaintiff, the mother of the family that ran the business, loaned money to the family and took a mortgage on the business’s land and buildings as security for the loan. However, unknown to the mother, the family members had obtained financing by granting two other mortgages on the business to two banks. The first bank had priority on the loans in the event of a foreclosure, the plaintiff had second priority and the second bank had third priority. When another bank refused to provide additional financing to the business unless the plaintiff would sign a subordination agreement assigning her priority position to the bank, the plaintiff signed the agreement. As a result, the third bank loaned additional funds to the business. Two months later the business folded and foreclosure proceedings began. Due to the subordination agreement, the proceeds from the sale were applied to the bank loans first. The plaintiff sued, but the trial court ruled against the plaintiff on the basis that the subordination agreement was valid. The plaintiff appealed claiming that the subordination agreement was not valid because it was not supported by consideration.
The appellate court reversed. The court found that although the trial court properly analyzed the transaction to find a potential benefit or detriment to serve as consideration, the trial court erred by not identifying whether the consideration was bargained-for and contemplated by the parties at the time of the transaction. The court noted that there was no consideration stated in the subordination agreement that identified what exchange the parties contemplated. The record did not show that the plaintiff subordinated her priority to induce the bank to make additional loans to the family business. Also, the court believed that the evidence showed that the plaintiff did not understand what was occurring as a result of the transaction, and did not contemplate a bargained exchange. The court determined that the testimony showed that the plaintiff was not aware of her priority position before she signed the subordination agreement. She simply believed that she needed to sign the document to obtain the funds owed to her from the sale of the business property. As such, the subordination agreement was invalid due to a lack of consideration. Meincke v. Northwest Bank & Trust Co. and Scramm Enterprises, L.C., No. 7-829/06-1541, 2007 Iowa App. LEXIS 1330 (Iowa Ct. App. Dec. 28, 2007).