Key Takeaways

  • Contractual capacity is the legal ability to understand and enter into binding agreements.
  • Minors, individuals with mental impairments, and intoxicated persons are commonly considered lacking capacity.
  • Courts apply different legal tests—cognitive, affective, and motivational—to assess mental capacity.
  • Contracts entered into by those lacking capacity may be void, voidable, or valid, depending on circumstances.
  • Disaffirmance rules differ by category (e.g., minors must act before reaching the age of majority).
  • Even voluntary intoxication may not automatically invalidate a contract unless exploitation is proven.

Contractual capacity is required for both parties entering into a contract. Specifically, both parties must be mentally capable in order for the contract to be legally binding. If either party doesn’t have the capacity, then the contract will not be enforceable.

Mental Capacity Defined

Mental capacity is the degree of understanding and ability to enter into a contract; whether or not the party can actually understand the purpose of the agreement, what is expected of him, and the consequences for failing to act under the contract. The degree of understanding is determined by law. Courts will usually look to the level of education, age, and other mental impairments of the individual.

Contractual capacity is required for both parties entering into a contract. Specifically, both parties must be mentally capable in order for the contract to be legally binding. If either party doesn’t have the capacity, then the contract will not be enforceable.

Legal Tests for Mental Capacity

Courts may apply different legal tests to determine if someone had the mental capacity to enter a contract. These include:

  • Cognitive Test: Most commonly used, this test examines whether the individual understood the nature and consequences of the contract at the time of agreement.
  • Affective Test: Applied in some jurisdictions, this evaluates whether a person could act reasonably and whether the other party knew of their impairment.
  • Motivational Test: This less common approach looks at whether the person was capable of making a reasoned judgment about entering the agreement.

For instance, someone experiencing a manic episode might be considered legally capable under the cognitive test if they understood the transaction, even if their judgment was impaired.

Mental Capacity Defined

Mental capacity is the degree of understanding and ability to enter into a contract; whether or not the party can actually understand the purpose of the agreement, what is expected of him, and the consequences for failing to act under the contract. The degree of understanding is determined by law. Courts will usually look to the level of education, age, and other mental impairments of the individual.

People without Contractual Capacity

There are several classes of people who don’t lack contractual capacity, including:

  1. Those under the age of eighteen
  2. Mentally challenged people, i.e., impairment in intelligence and social functioning
  3. Those under the influence of drugs or alcohol
  4. Those who are currently incarcerated

While the above-mentioned are the most common types of people who can’t enter into contracts, there are additional arguments that can be made to hold someone mentally incompetent.

Contractual Capacity of Minors

Minors (typically those under 18 years old) are considered to lack full contractual capacity. However, contracts entered into by minors are not automatically void—they are voidable at the minor’s discretion. Exceptions apply for essential items like food, clothing, or shelter.

Minors must disaffirm a contract while still underage. Once they reach the age of majority, failure to act can result in the contract becoming binding. A minor can disaffirm through verbal or written statements or by actions clearly indicating intent not to honor the agreement.

Drugs & Alcohol: Mental Capacity

Anyone who is under the influence of drugs or alcohol, whether it is a prescription or non-prescription drug, might be incapable of giving consent when entering into a contract. Therefore, if a person is being sued for breach of contract, and that person believes that he was under the influence of drugs or alcohol when signing the agreement, then he will want to bring the defense of contractual capacity by arguing that he wasn’t capable of entering into the contract due to such incapacity.

Keep in mind that even if the other party doesn’t know that the other person is intoxicated, the court could still deem that the contract is unenforceable due to the drugs or alcohol. However, if one party can clearly see that the other party is intoxicated, then the party trying to enter into the contract with the intoxicated person might actually be held liable for essentially using such intoxication as a means to have the other party sign the contract.

While some courts might find a contract unenforceable under these circumstances, other courts could provide that those who are voluntarily intoxicated shouldn’t be allowed to avoid their contractual responsibilities, but should instead be required to act under the contract since they did in fact consent to it at the time of signing, even if they were intoxicated.

What Happens If a Person Is Found to Be Mentally Incompetent?

There are three different outcomes if a court determines that one of the parties was in fact incapacitated, including the following:

  1. Void contract
  2. Voidable contract
  3. Valid contract

If the court deems the contract void, then the parties will walk away freely as if the contract didn’t exist in the first place. With a voidable contract, the court is stating that only the incapacitated party can disaffirm his contractual duties under the contract; however, if he doesn’t, the parties will be bound to the terms of the contract. If the court deems the contract valid, it is stating that both parties are bound by the terms and provisions in the contract and must satisfy the contract.

An example of when a court might determine a contract to be void is if one of the parties has some sort of mental impairment. Furthermore, an example of a voidable contract might be if one of the parties is under the age of 18, i.e., a 17-year-old entering into a contract with an adult wherein the 17-year-old wants to purchase the other person’s car. If the minor wants to perform under the contract by purchasing the car, then the other party is bound by the contract. If, however, the minor decides not to purchase the car, then the other party need not satisfy the terms in the contract.

An example of when a court might deem a contract valid is if a plaintiff brings a breach of contract against the defendant, and the defendant makes a defense of incapacity claiming that he was intoxicated when having signed the agreement. The court might determine that even though the defendant was intoxicated at that time, he voluntarily chose to become intoxicated and enter into the agreement. Therefore, he should be bound by the terms of the agreement.

Consequences of Lacking Contractual Capacity

If a contract is found to involve a party lacking capacity, it may be:

  • Void: Has no legal effect from the beginning (e.g., severe incompetence).
  • Voidable: Can be canceled by the incapacitated party (e.g., minor’s contracts).
  • Valid: Enforceable if the court deems the individual capable at the time of signing.

In voidable cases, the incapacitated party must take action to rescind the contract. Otherwise, they may be bound if they continue to accept benefits or fail to disaffirm the agreement after regaining capacity or reaching the age of majority.

Real-World Examples of Capacity Issues

Real-life court decisions illustrate how contractual capacity issues play out. In one historic case, a man sold valuable mining stock while severely intoxicated, and the court voided the contract because the buyer knowingly took advantage of his condition.

In contrast, individuals who voluntarily become intoxicated without exploitation by the other party are often held to their contractual obligations. Courts typically assess whether the person understood the general nature of the agreement and whether any unfair advantage was taken.

Organizational Capacity to Contract

While contractual capacity often refers to individuals, organizations must also meet legal requirements to enter contracts. A business entity’s capacity is tied to its legal status—corporations, LLCs, and other entities must be duly formed and in good standing under applicable law.

In practice:

  • Authorized Agents must sign on behalf of the company.
  • Ultra Vires Acts, or actions beyond the scope of corporate authority, can render contracts unenforceable.
  • Certain entities (like unregistered associations) may face limitations on contractual power.

This ensures that only valid, recognized entities with proper representation can bind themselves to agreements.

Frequently Asked Questions

  1. What is contractual capacity in contract law?
    Contractual capacity refers to the legal ability of a person or entity to enter into a binding contract, based on mental competence and legal status.
  2. Can minors enter into contracts?
    Yes, but such contracts are typically voidable by the minor, except in cases involving essential goods or services.
  3. What happens if someone lacks capacity when signing a contract?
    The contract may be voidable or void, depending on the circumstances, such as mental state or whether the person was taken advantage of.
  4. Does voluntary intoxication affect contractual capacity?
    Generally, voluntary intoxication does not void a contract unless the other party knowingly exploited the intoxicated person's condition.
  5. Can companies lack contractual capacity?
    Yes. A company may lack capacity if it has not been legally formed, lacks authority, or the signatory exceeds their legal authority.

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