chapter 6

Business Law

Chapter 6:

Capacity and Legality

Introduction

• Contracts must have a legal subject in order to be enforceable.

Why is capacity important?

• If a plaintiff seeks to enforce a contract, he must prove that the defendant had legal capacity to enter into a contract.

Defining Capacity

• Capacity: Ability to do something, such as the mental ability to make a rational decision.

• Capacity is an essential element of a contract because it shows that a party understood the contractual obligation.

• Capacity refers to a party’s ability to understand what is happening, the effect of what agreeing to a contract means and the ability to exercise free will in making this choice.

• Capacity is not the same thing as wise choice.

• A person can exercise poor judgment, enter into a contract that is disadvantageous, or even make a bad bargain, and still have full, legal capacity to contract.

A Short History of Capacity

• Prior to a more enlightened approach to law in general and contractual obligations in particular, certain classes of people were absolutely barred from entering into contracts.

Who May Contract?

• Contracts need at least two parties, both of whom have legal capacity.

Natural Persons

• Any person who is not disqualified for some reason can enter into a contract, provided that he or she has legal capacity.

Artificial Persons

• Corporations, and some other forms of business entities, are considered to be artificial persons.

• They can bargain, negotiate and enter into contracts.

• Artificial persons have capacity.

Legal Competency

• To say that a person is legally competent is to say that he has the ability to know, understand and voluntarily engage in actions that can affect his interests.

Age or Infirmity

• The rules of capacity center on a person’s age, physical or mental infirmity.

Infancy

• When a person falls below a certain age level, the law presumes that he or she lacks capacity to contract.

Advanced Age

• No state, for instance, has a rule stating that a person above a specific age is presumed to be legally incompetent to enter into a contract.

• A person’s age is one of the factors that a court may take into account when it assesses a person’s capacity.

Physical Infirmity

• A disabled person who has the mental capacity to contract may do so, regardless of the disability.

• A person may be in such severe pain, or under the influence of drugs, that his capacity will be affected.

Guardianship

• When a person has been declared mentally incompetent, it is common for a court to appoint a guardian to represent that person.

Partial versus Total Incapacity

• When a person suffers from partial incapacity, he or she may still undertake a contractual obligation

Mental Incompetence or Mental Illness

• When a person is of lower than average intelligence, or suffers from some form of mental illness less than legal insanity, this person is still entitled to enter into a contract.

The Other Party’s Good Faith

• A party’s good faith does not circumvent the rules surrounding capacity.

Intoxication

• Intoxication resembles a form of insanity.

Authority

• When we say the person has authority to enter into a contract it simply means that he or she has legal capacity and has no legal impediment to becoming a party to a contract.

Apparent authority

• If it appears that a person has the authority to make certain commitments in a contract, or to act for another, and the principal does not negate this perception, then the person has authority, even though it was never officially conferred upon him.

Actual authority

• When a person has actual authority it is usually vested in him through some overt action by another.

Third party contracts

• Third party contracts stem not from their involvement in the contract but from the fact that they derive some benefit from the contract between the other parties.

Creditor

• Creditor beneficiaries are created when a contract’s provisions include a promise to satisfy an outstanding debt.

Beneficiary

• Anyone who benefits from something or who is treated as the real owner of something for tax or other purposes.

Donee

• In most jurisdictions, a donee- beneficiary is created by contract provisions that show a clear intention by the parties to make a gift to a third party.

Assignee

• An assignee-beneficiary is a person or entity who will eventually be granted a specific right under the contract, such as a person who will eventually become a party to the contract.

Legal subject of contract

• A contract is void when the subject of the contract is illegal, such as a contract to engage in illegal activity or for an illegal purpose.

Contracts that are illegal because of subject

• Contracts that involve illegal actions are void for a very simple reason.

• If this were not so, then a party seeking to enforce the contract could bring an action through the court system and request that a judge rule on the contract.

Contracts that are unenforceable because of

public policy• The general rule followed in all

jurisdictions is that any contract that violates public policy is void and unenforceable.