Meaning
The legal rule that an act performed or a benefit conferred in the past cannot support a new promise to pay or transfer assets defines a common contractual defect. This principle, known as past consideration invalidity, prevents the enforceability of contracts where the bargained-for exchange is not contemporaneous with the agreement. It governs the validity of equity grants, service contracts, and promissory notes.
The boundary of this rule stops applying where a recognized exception, such as a moral obligation combined with a material benefit, is established by statute or equity.
Contractual Defect
Issuing equity to an early contributor for work they finished before the company was incorporated often runs into legal issues. This transaction can be voided under the doctrine of past consideration invalidity if the corporate record does not show a new exchange of value. The written resolution must prove that the equity was granted for current or future obligations rather than past services alone.
When founders ignore this rule, they risk having the equity grant challenged by future investors during due diligence.
Legal Execution
Companies must structure agreements to ensure that each commitment is matched by a current or future obligation from the counterparty. This can be achieved by executing a new consulting agreement or specifying a future performance metric in the contract. The written and signed agreement is the primary evidence that the exchange of value is valid.
This process protects the company from claims that the equity or payment was a non-binding gift.
Strategic Restructuring
Ensuring that all service agreements are drafted with current or future performance obligations prevents later disputes. The legal fee to restructure a defective grant is a fraction of the cost of defending a lawsuit. These practices secure the equity structure.
