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Business LawChapter 6:

Capacity and Legality

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Introduction

Contracts must have a legal subject in

order to be enforceable.

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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.

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Defining Capacity

Capacity:Ability to do something, such

as the mental ability to make a rational

decision.

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Capacity is an essential element of a

contract because it shows that a party

understood the contractual obligation.

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Capacity refers to a partys ability to

understand what is happening, the

effect of what agreeing to a contractmeans and the ability to exercise free

will in making this choice.

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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, legalcapacity to contract.

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A Short History of Capacity

Prior to a more enlightened approach to

law in general and contractual

obligations in particular, certain classesof people were absolutely barred from

entering into contracts.

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Who May Contract?

Contracts need at least two parties,

both of whom have legal capacity.

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Natural Persons

Any person who is not disqualified for

some reason can enter into a contract,

provided that he or she has legalcapacity.

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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.

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Legal Competency

To say that a person is legally

competent is to say that he has the

ability to know, understand andvoluntarily engage in actions that can

affect his interests.

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Age or Infirmity

The rules of capacity center on a

persons age, physical or mental

infirmity.

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Infancy

When a person falls below a certain age

level, the law presumes that he or she

lacks capacity to contract.

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Advanced Age

No state, for instance, has a rule stating

that a person above a specific age is

presumed to be legally incompetent toenter into a contract.

A persons age is one of the factors that

a court may take into account when itassesses a persons capacity.

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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.

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Guardianship

When a person has been declared

mentally incompetent, it is common for

a court to appoint a guardian torepresent that person.

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Partial versus Total Incapacity

When a person suffers from partial

incapacity, he or she may still undertake

a contractual obligation

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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.

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The Other Partys Good Faith

A partys good faith does not circumvent

the rules surrounding capacity.

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Intoxication

Intoxication resembles a form of

insanity.

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Authority

When we say the person has authority

to enter into a contract it simply means

that he or she has legal capacity andhas no legal impediment to becoming a

party to a contract.

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Apparent authority

If it appears that a person has the

authority to make certain commitments

in a contract, or to act for another, andthe principal does not negate this

perception, then the person has

authority, even though it was neverofficially conferred upon him.

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Actual authority

When a person has actual authority it is

usually vested in him through some

overt action by another.

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Third party contracts

Third party contracts stem not from their

involvement in the contract but from the

fact that they derive some benefit fromthe contract between the other parties.

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Creditor

Creditor beneficiariesare created

when a contracts provisions include a

promise to satisfy an outstanding debt.

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Beneficiary

Anyone who benefits from something or

who is treated as the real owner of

something for tax or other purposes.

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Donee

In most jurisdictions, a donee-

beneficiary is created by contract

provisions that show a clear intention bythe parties to make a gift to a third

party.

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Assignee

An assignee-beneficiary is a person or

entity who will eventually be granted a

specific right under the contract, suchas a person who will eventually become

a party to the contract.

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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 anillegal purpose.

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Contracts that are illegal

because of subject Contracts that involve illegal actions are

void for a very simple reason.

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If this were not so, then a party seeking

to enforce the contract could bring an

action through the court system andrequest that a judge rule on the

contract.

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Contracts that are

unenforceable because of

public policy The general rule followed in all

jurisdictions is that any contract thatviolates public policy is void and

unenforceable.