Business Law Chapter 6 Capacity and Legality Introduction

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 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 doneebeneficiary 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.