Contracts II: Incapacity

Vocabulary flashcards covering key concepts related to incapacity in contracts.

What are defenses?

Defenses are asserted to avoid enforcement of the K

Defenses

Reasons asserted to avoid enforcement of a contract.

Excuses

Asserted to escape liability for not performing contractual duties.

What are remedies for defenses and excuses

1. Rescission

2. Restitution

3. Reformation

What is the defense of capacity to contract

The law generally assumes all persons have legal capacity to K except in a few contexts:

1. Minors

2. Mental Incapacity

3. Intoxication.

Mental Capacity

The ability to understand the nature and consequences of a transaction.

Intoxication

Condition where a person cannot understand the nature of the transaction due to substance use.

What is the rationale for not allowing minors, mentally incapacitated and intoxicated people to have capacity to contract?

There is an inability to assent.

What happens when someone is found to not have capacity to contract?

A finding of incapacity renders the K voidable by the incapacitated party, not void.

Capacity to Contract Issue Spotting

Facts that indicate AT THE TIME THE CONTRACT IS FORMED a party lacked capacity to contract because they were:

• A minor

• Mentally incapacitated

• Intoxicated

Analytical Framework for Capacity

1. Did the party seeking to void teh K lack capacity to contract at the time of contract formation?

2. Does an exception apply?

3. If the contract is voidable due to incapacity, must the party claiming incapacity restore the consideration to the other party? (make restitution)

Minors Incapacity Rule

A minor’s contracts are voidable by the minor at any time before reaching the age of majority or within a reasonable time after becoming an adult.

Rule for Ratifying Minor Ks

Can also ratify or affirm Ks made as minors rather than disaffirm.

• Ratify expressly or by conduct

• How to ratify conduct:

  • Taking and retaining a benefit after turning 18 or

  • Failing to disaffirm w/in a reasonable time after turning 18.

Exceptions to the Rule of Minor Incapacity

1. Contracts that provide for necessities of life

2. Where a minor misrepresents his age

3. Where the minor willfully harms the property that is the subject of the contract

4. Statutory exceptions such as student loans, insurance and certain employment contracts.

Rule for a minor restoring consideration.

A minor who disaffirms or discharges the K is entitled to recover the consideration he has paid, but must also restore as much of the consideration as remains in the minor’s possession.

What is Mental Incapacity Cognitive Test (Majority Rule)

Whether the person involved had sufficient ability to understand in a reasonable manner the nature and consequences of the transaction.

What is the Volitional Test (Minority Rule)

• Lacks capacity to contract if they are unable to act in a reasonable manner in the transaction and the other party knows/ has reason to know of this condition.

• Under this test, a party might understand the consequences of the action but cannot help himself from acting in an irrational manner.

What are the exceptions to mental incapacity?

1. Necessities

2. The contract has been performed in whole or in party, the other party did not know of the mental illness or defect and the contract is on fair terms.

What is the intoxication rule?

• A person who is so intoxicated as to be unable to understand in a reasonable manner the nature and consequences of the transaction may be held to have made a voidable promise if the to her party had reason to know of the intoxication.

• The intoxicated person may reaffirm the contract upon becoming lucid.

• Exception: Contract for necessities are not voidable.

Sally Student, who just turned seventeen, wants to buy a new Mac laptop to use when she goes off to college. She goes to the Apple store and picks out a new computer that she likes for $900. She puts $300 down that she had saved up from babysitting, and will pay the remaining balance at $100 per month with no interest. Two months go by in which Sally has made two monthly payments when she realizes that she will not be able to make the remaining payments and wants to void the contract.

Assuming she can disaffirm the contract, in a jurisdiction that follows the Restatement 2d, what will be her recovery? (For purposes of this question, assume a judge would conclude that a computer is not a “necessity”).

$500, the amount of money she has paid thus far, not subject to any offset due to depreciation in value of the computer.

Correct. The majority and Restatement 2d rule regarding treatment of the economic benefit received by the minor while in possession of the goods is that there is no restitutionary recovery for any loss in value for the non-minor in credit sales. Restatement 2d § 14, Cmt. c. This rule is subject to several exceptions, some of which are adopted in various states (i.e., the exact rules in any one state can vary):

• cash sales, e.g., where a minor buys a candy bar from a grocery store for $1 and eats it, the minor can disaffirm the contract, but is liable in restitution for the value of the harm to the good or $1;

• contracts for “necessities,” where the minor buys, whether for cash or on credit, something like food, bedding, etc. that the court determines is a “necessity;” and

• where the benefit procured by the minor was via misrepresentation of age, e.g., where a minor takes affirmative steps to convince the seller that he or she is an adult at the time of contracting, such as a fake ID or even just a statement of adulthood.

None of these exceptions are present in this question. Therefore, Sally is entitled to recover what she has put into the contract, and that amount is not subject to any restitution to the other party or offset due to any loss in value.

Ben is an adult male that was diagnosed with a mental illness. His mother has been appointed as his guardian by the court. Ben recently entered into a contract to purchase a new television set with a retail store. He said nothing to the sales representative that would indicate any mental illness and the representative otherwise had no knowledge of Ben’s illness.

Ben’s mother found out about the sale and wishes to avoid the contract as a guardian on Ben’s behalf.

In a jurisdiction that follows the Restatement 2d, can Ben’s mother, in her role as guardian, disaffirm the contract?

Yes, but Ben’s estate will have to pay restitution if the salesperson did not have any reason to know of Ben’s mental defect.

Correct. If a guardian has been appointed for an individual due to a mental illness, Restatement 2d § 13 provides that the individual has no capacity to contract and any contract entered into by the individual under guardianship is voidable by the guardian. However, the general rule regarding the requirement of the person subject to a guardianship to pay restitution is that restitution is required for the use of the good or service by such an individual if either: (a) the contract was for “necessities,” or (b) the non-incapacitated person neither knew or should have known of the individual’s incapacity at the time of contracting. Applied here, the facts indicate that the salesperson was unaware of Ben’s incapacity, and thus restitution would be due for Ben’s usage of the television (including depreciation), but the contract itself would be voidable.

Note that the contract is voidable by the guardian, not void. So if Ben’s mother wanted to go ahead with the purchase, she could do so and ratify the transaction.

Note also that if Ben were somehow to get a court to dissolve the guardianship, then he too could ratify the contract, either expressly or by implication. Restatement 2d § 85.

Terry was a public school teacher who participated in the school’s retirement system for twenty years prior to her going on medical leave for mental illness. No guardian was appointed for Terry, but the school district was aware of the reasons why she went on leave.

After going on leave, Terry was required to make a decision regarding her retirement benefits. One option provided a greater payment per month, but payments would continue under this choice only as long as she lived; while a second option called for a smaller monthly payment, but allowed the payments to continue to her husband if she died first.

Prior to her mental illness, Terry showed great affection for her husband throughout their marriage and often spoke about her desire to protect her husband financially during her retirement. However, during the period in which she was affected by her mental illness, she chose the first option described above. Terry died two months after making the change and her husband sues to void her decision due to mental incapacity.

In a jurisdiction which adopts the “cognition” test for mental illness, would he be able to do so?

Yes, if Terry did not understand in a reasonable manner the nature and legal consequences of her decision and the transaction.

Correct. The rules regarding the capacity of a mentally ill person, who does not have a guardian appointed, to enter into enforceable agreements are set forth in Restatement 2d § 15. That section describes two separate tests (assuming the incapacity is not due to temporary intoxication and/or drug use): the “cognition” test under Restatement 2d § 15(1); and the “acts” test under Restatement 2d § 15(2). Some jurisdictions adopt one or the other test; some adopt either, meaning the plaintiff gets to choose which theory he or she wants to use to avoid the contract.

This question asks about the cognition rule, which provides that an individual incurs voidable contractual duties if he or she entered into a contract “unable to understand in a reasonable manner the nature and consequences of the transaction.” Restatement 2d § 15(1). Applied here, the key fact is that Terry was not completely aware of the decision’s ramifications, and the words of the test were incorporated into this answer choice. As such, the contract would be voidable.