BUSINESS LAW MODULE I

CHAPTER 5

CAPACITY TO CONTRACT

1. The contracts that a business enters into with its customers and other individuals
are important to its long-term growth and profitability.
2. However, certain individuals lack the capacity or legal ability to enter into contracts.
3. The law defines who these people are and prevents other individuals and businesses
from having valid contracts with those who are said to lack capacity.

MINORS

1. As a general rule, anyone under the age of 18 is said to lack capacity to enter into
contracts.
2. From a business standpoint, however, there are a number of important exceptions to
the law prohibiting minors from having capacity.
3. A minor is allowed to enter into contracts -- that is, to purchase -- for necessities
such as food, clothing and accommodation.
4. Additionally, some states allow minors to obtain credit and bank accounts. They
are responsible for these accounts as if they were legally binding contracts.

MENTAL INCAPACITATION

1. Mental incapacitation is a legal term that refers to individuals who cannot enter
into contracts because of psychological disabilities.
2. In the majority of jurisdictions, mental capacity is defined as the ability to understand
the full meaning and effects of the contract.
3. If the person is not able to cognitively delineate all of her rights and responsibilities
under the contract, then she is not of legal capacity to enter the contract.
4. Some states have also adopted a "motivational test" to measure capacity.
5. If there is a motivation to enter the contract, then the person may be considered
to have legal capacity.
6. Ultimately the courts will rely on expert witnesses to determine legal capacity,
7. because the situations can vary dramatically between people with differing levels of
psychological disability.
 UNDER THE INFLUENCE

1. Individuals who are under the influence of alcohol or drugs are normally not
considered to have the capacity to enter contracts.
2. In some cases, however, the courts force those who have voluntarily intoxicated
themselves to uphold the obligations they've made while under the influence.
3. This is a sticky situation, though, because most courts have also agreed that the sober
party should not take advantage of someone intoxicated by drugs or alcohol.
4. In business settings, therefore, it is best to avoid selling products and services to
anyone who appears to be under the influence.

VOIDABLE CONTRACTS

1. If an agreement is made with someone who does not have the legal capacity to
enter a contract, that agreement or contract is said to be voidable.
2. This means that the person who lacks legal capacity is said to have misrepresented
herself, even if unintentionally.
3. The other party to whom the misrepresentation was made may void the contract and
all of its terms and conditions. This is called rescinding the contract.
4. The courts may also rescind or void a contract if legal capacity is not met.
5. Once the contract is voided, it is no longer binding, and the court will attempt to
restore the parties to the position they were in before the agreement was made.
6. This means returning money and property where at all possible.

WHO LACKS THE CAPACITY TO CONTRACT?

1. When it comes to legally binding agreements, certain people are always considered to
lack the legal ability (or "capacity") to contract.
2. As a legal matter, basically they are presumed not to know what they're doing.
3. These people--legal minors and the mentally ill, for example--are placed into a
special category.
4. If they enter into a contract, the agreement is considered "voidable" by them (as the
person who lacked capacity to enter the agreement in the first place).
5. Voidable means that the person who lacked capacity to enter the contact can
either end the contract or permit it to go ahead as agreed on.
6. This protects the party who lacks capacity from being forced to go through with a deal
that takes advantage of his or her lack of savvy.
 SOME SITUATIONS IN WHICH A PERSON MIGHT LACK THE LEGAL
CAPACITY TO ENTER INTO A LEGALLY BINDING CONTRACT.

a. MINORS HAVE NO CAPACITY TO CONTRACT

1. Minors (those under the age of 18, in most states) lack the capacity to make a
contract. So a minor who signs a contract can either honor the deal or void the
contract.
2. There are a few exceptions, however.
3. For example, in most states, a minor cannot void a contract for necessities like food,
clothing, and lodging.
4. Also, a minor can void a contract for lack of capacity only while still under the age of
majority.
5. In most states, if a minor turns 18 and hasn't done anything to void the contract, then
the contract can no longer be voided.

EXAMPLE

Sean, 17, a snowboarder, signs a long-term endorsement agreement for sportswear. He

endorses the products and deposits his compensation for the endorsements for several
years. At age 19, he decides he wants to void the agreement to take a better endorsement
deal. He claims he lacked capacity when he signed the deal at 17. A court probably will
not permit Sean to now void the agreement. For another example of minors entering into
contracts, see Nolo's Q&A Is a 15-year-old's contract with a cell phone service valid?

b. MENTAL INCAPACITY
1. A person who lacks mental capacity can void, or have a guardian void, most contracts
(except contracts for necessities).
2. In most states, the standard for mental capacity is whether the party understood
the meaning and effect of the words comprising the contract or transaction.
3. This is called the "cognitive" test.
4. Some states use what's called the "affective" test: a contract can be voided if one
party is unable to act in a reasonable manner and the other party has reason to
know of the condition.
5. And some states use a third measure, called the "motivational" test.
6. Courts in these states measure capacity by the person's ability to judge whether or not
to enter into the agreement.
 7. These tests may produce varying results when applied to mental conditions such as
bipolar disorder.

EXAMPLE

Mr. Smalley contracted to sell an invention, and then later claimed that the contract
was void because he lacked capacity. Smalley had been diagnosed as manic-depressive
and had been in and out of mental hospitals. His doctor stated that Mr. Smalley was not
capable of evaluating business deals when he was in a "manic" state. A California Court
of Appeals refused to terminate the contract and stated that Smalley, in his manic state, was
capable of contracting. "The manic phase of the illness under discussion is not, however, a
weakness of mind rendering a person incompetent to contract ." In other words, the Court's
view of manic-depression was cognitive--that the condition may have impaired Smalley's
judgment but not his understanding.

c. ALCOHOL AND DRUGS

1. People who are intoxicated by drugs or alcohol are usually not considered to lack
capacity to contract.
2. Courts generally rule that those who are voluntarily intoxicated shouldn't be
allowed to avoid their contractual obligations,
3. but should instead have to take responsibility for the results of their self-induced
altered state of mind.
4. However, if a party is so far gone as to be unable to understand even the nature and
consequences of the agreement,
5. and the other (sober) party takes advantage of the person's condition, then the contract
may be voidable by the inebriated party.

EXAMPLE

In the late 19th century, Mr. Thackrah, a Utah resident and owner of $80,000 worth of
mining stock, went on a three-month bender. Mr. T's fondness for alcohol was well
known, and a local bank hired Mr. Haas to contract with the inebriated Thackrah.
Haas did the deal, getting Thackrah to agree to accept $1,200 for his mining stock.
When he sobered up (a month later), Thackrah learned that Haas had turned over the
mining shares to a local bank (apparently the real culprits in the scheme). Thackrah
sued Haas. The case went all the way to the U.S. Supreme Court, which ruled that the
agreement was void because the bank and Hass knew that Thackrah had no idea what
he was doing when he entered the contract. The bank had to return the shares to
Thackrah, less the $1,200 he had already been paid