Chapter 14 – Capacity to Contract
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Powerpoint from textbook Business Law - the ethical, global, and e-commerce environment to accompany BA 330 course at the University of Alaska Fairbanks.
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Chapter 14 – Capacity to Contract
- 1. Introduction to Contracts The Agreement: Offer The Agreement: Acceptance Consideration Reality of Consent © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Capacity to Contract Illegality Writing Rights of Third Parties Performance and Remedies © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 3. Capacity to Contract No brilliance is needed in the law. Nothing but common sense, and relatively clean fingernails. John Mortimer © 2010 The McGraw-Hill Companies, Inc. All rights reserved.
- 4. Learning Objectives The meaning of capacity The classes of persons without capacity The rights to disaffirm or ratify The duties of disaffirmance 14 - 4
- 5. Definition A person must have the ability to give consent before he can be legally bound to an agreement, thus capacity is the ability to incur legal obligations and acquire legal rights 14 - 5
- 6. The Lack of Capacity Groups lacking capacity: Minors Those suffering a mental disability Those who are intoxicated Effect -- a person who contracts without the requisite capacity may avoid the contract at his/her option 14 - 6
- 7. Minor’s Right to Disaffirm Right to avoid a contract is disaffirmance Only the minor may avoid the contract Example of disaffirmance: Stroupes v. The Finish Line, Inc. Court ruled that a minor’s employment contracts, including arbitration agreements, were voidable by the minor If minor wants to affirm the contract, adult party must perform 14 - 7
- 8. Details About Disaffirmance Minors may not avoid contracts if statutory exception exists Marriage, educational loans, insurance Emancipation of minor from parents does not give minor capacity to contract Minor’s power to avoid contracts does not end on day he/she reaches age of majority, but continues for reasonable time thereafter 14 - 8
- 9. Ratification Ratification occurs when a person who reaches majority indicates that he/she intends to be bound by a contract made while still a minor May be express or implied by conduct 14 - 9
- 10. Duties Upon Disaffirmance Each party has duty to return to the other any consideration (money, goods) that the other has given If the consideration given by the adult has been lost, damaged, destroyed, or depreciated in value, courts are split on whether the minor party must make restitution to the adult party 14 - 10
- 11. Dodson v. Shrader Facts & Procedural History: Dodson, age 16, bought a truck from the Shraders Dodson drove truck until engine ruined Dodson contacted Shraders to obtain full refund, which they refused to make Dodson filed suit Shraders argued for difference between present value of truck ($500) and purchase price ($4900) Trial court found for Dodson and full refund 14 - 11
- 12. Dodson v. Shrader Issue & Ruling: Must Dodson make restitution? Purpose of “infancy doctrine” is protect minors from their own lack of judgment Should not work hardship on innocent merchant “Benefit Rule” holds that, upon rescission, recovery of the full purchase price is subject to a deduction for the minor’s use of the merchandise Reversed and remanded in favor of the Shraders 14 - 12
- 13. Duties Upon Disaffirmance Disaffirming minors are required to pay reasonable value for necessaries (required for survival) furnished to them Quasi-contractual theory Example: Young v. Weaver Was the apartment really a necessity for Young? 14 - 13
- 14. Capacity & Mental Impairment Like minors, people who suffer from a mental illness or defect are disadvantaged in their ability to protect their interests in the bargaining process, thus contract law makes their contracts void or voidable Test: Did the person have sufficient mental capacity to understand the nature and effect of the contract? 14 - 14
- 15. Right to Disaffirm or Ratify If a contract is voidable due to mental impairment, the person may: Disaffirm the contract Once he/she regains capacity, ratify the contract Upon disaffirmance, consideration must be returned and the person is liable for reasonable value of any necessaries 14 - 15
- 16. Kenai Chrysler Center, Inc. v. De Facts & Opinion: Developmentally disabled man (David) under legal guardianship of parents entered into contract to purchase car from auto dealership Dealership (Kenai) refused repeatedly to take back the car after multiple notifications of David’s incapacity and legally void nature of contract Parents (Denisons) sued Kenai and trial court held in favor of Denisons; appellate court affirmed that the contract was void as a matter of law 14 - 16
- 17. Contracts of Intoxicated Persons Intoxication is a ground for lack of capacity only when it is so extreme that the person is unable to understand the nature of the bargaining process Note: courts are not sympathetic! 14 - 17
- 18. Test Your Knowledge True=A, False = B Capacity is the ability to know the details of the legal rights in a contract Ratification is the actual signature on the written contract Disaffirmance is the right to avoid a contract due to incapacity 14 - 18
- 19. Test Your Knowledge True=A, False = B A minor’s right to disaffirm a contract ends on the day the minor achieves the age of majority Intoxicated persons are always allowed to disaffirm a contract Persons with a mental incapacity may disaffirm a contract, but cannot ratify the contract 14 - 19
- 20. Test Your Knowledge Multiple Choice The “benefit rule” states that when a minor disaffirms a contract: (a) They have no further duties (b) Recovery of the full purchase price is subject to a deduction for the minor’s use of the merchandise (c) They have the duty to return the subject goods 14 - 20
- 21. Test Your Knowledge Multiple Choice Ted just turned 17 years old. Emancipated from his parents, Ted bought a car from CarCo. Two weeks after he bought the car, Ted damaged it. Ted returned the vehicle to CarCo asking for a full refund. CarCo must: (a) Give Ted back the full amount (b) Pay Ted only the present value of the car (c) Pay Ted the purchase price less the current value of the car 14 - 21
- 22. Thought Questions The requirement of capacity is rooted in ancient law. Should the law continue to protect minors and intoxicated persons? Why or why not? 14 - 22
Editor's Notes
- At common law, the age of majority was 21. However, the Twenty-sixth Amendment to the Constitution gave 18-year-olds the right to vote. In response, the age of majority has been lowered by 49 states. In almost all of these states, the age of majority for contracting purposes is now 18.
- Stroupes was 16 and worked at The Finish Line, Inc. until she quit alleging sexual harassment. The company tried to compel arbitration under an arbitration clause in the written employment contract. The court stated: “…under Tennessee law, a minor’s employment contracts, including arbitration agreements, are voidable by the minor. The court finds that Lindsey’s employment contract with Finish Line was voidable by Lindsey, and was voided by filing this action.”
- Joseph Dodson, age 16, bought a 1984 Chevrolet truck from Burns and Mary Shrader, owners of Shrader’s Auto Sales, for $4,900 cash. At the time, Burns Shrader, believing Dodson to be 18 or 19, did not ask Dodson’s age and Dodson did not volunteer it. Dodson drove the truck for about eight months, when he learned from an auto mechanic that there was a burned valve in the engine. Dodson did not have the money for the repairs, so he continued to drive the truck without repair for another month until the engine “blew up” and stopped operating. He parked the car in the front yard of his parents’ house. He then contacted the Shraders, rescinding the purchase of the truck and requesting a full refund. The Shraders refused to accept the truck or to give Dodson a refund. Dodson then filed an action seeking to rescind the contract and recover the amount paid for the truck. Before the court could hear the case, a hit-and-run driver struck Dodson’s parked truck, damaging its left front fender. At the time of the circuit court trial, the truck was worth only $500. The Shraders argued that Dodson should be responsible for paying the difference between the present value of the truck and the $4,900 purchase price. The trial court found in Dodson’s favor, ordering the Shraders to refund the $4,900 purchase price upon delivery of the truck. The Tennessee Court of Appeals affirmed this judgment, and the Shraders appealed.
- Court: “The first of these minority rules is called the “Benefit Rule.” This rule holds that, upon rescission, recovery of the full purchase price is subject to a deduction for the minor’s use of the merchandise. This rule recognizes that the traditional rule in regard to necessaries has been extended so far as to hold an infant bound by his contracts, where he failed to restore what he has received under them to the extent of the benefit actually derived by him from what he has received from the other party to the transaction. The other minority rule holds that the minor’s recovery of the full purchase price is subject to a deduction for the minor’s “use” of the consideration he or she received under the contract, or for the “depreciation” or “deterioration” of the consideration in his or her possession.”
- Kim Young contracted as a minor with a friend to lease an apartment from Weaver. The two stayed in the apartment and paid rent for three months. Young moved out near the end of November and returned to live with her parents. Young had a dog that caused damage to the apartment in the amount of $270. Y oung did not pay for this damage before vacating the apartment. Weaver managed to rent the apartment to someone else several months later. Weaver filed a claim against Young in Small Claims, seeking damages for the unpaid rent and the damage done by Young’s dog. The court ruled in favor of Weaver and awarded $1,370 in damages. Young appealed the decision to the Tuscaloosa Circuit Court, which tried the case and also entered a judgment in favor Weaver and awarded him $1,095. Young appealed. Court: “Alabama law, like the law of most other states, provides that persons providing “necessaries” of life to minors may recover the reasonable value of such necessaries irrespective of the existence, or nonexistence, of a voidable contract respecting those necessaries. …Determining whether the subject of a contract is a necessity to a minor entails a two-step analysis…[generally considered a necessity and a necessity to that minor]. …Young’s parents were willing and able to provide lodging for their daughter at the time she rented the apartment from Weaver. Given the authorities cited above and the particular facts of this case, we conclude that the trial court erred in its determination that the apartment in question was a necessity for Young. Therefore, as a minor, Young is not legally bound under the lease agreement. Reversed and remanded in favor of Young. ”
- The test for mental capacity is a cognitive test. The traditional test has been criticized as unscientific because it does not take into account the fact that a person suffering from a mental illness or defect might be unable to control his conduct. Section 15 of the Restatement (Second) of Contracts provides that a person’s contracts are voidable if he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition. Where the other party has reason to know of the condition of the mentally impaired person, the Restatement (Second) standard would provide protection to people who understood the transaction but, because of some mental defect or illness, were unable to exercise appropriate judgment or to control their conduct effectively.
- Contract law makes a distinction between a contract involving a person who has been adjudicated (judged by a court) incompetent at the time the contract was made and a contract involving a person who was suffering from some mental impairment at the time the contract was entered but whose incompetency was not established until after the contract was formed. If a person is under guardianship at the time the contract is formed—that is, if a court has found a person mentally incompetent after holding a hearing on his mental competency and has appointed a guardian for him—the contract is considered void and not merely voidable. See Kenai Chrysler v. Denison.
- The hyperlink is to the case opinion on a State of Alaska website. Besides the law being clear on this issue, Kenai’s behavior in this case is shocking: One or two days after David signed the contract, his mother (Dorothy) went to Kenai Chrysler with David and informed the salesman who had sold the car to David and a Kenai Chrysler manager that David was under the legal guardianship of his parents and had no legal authority to enter into a contract to buy the Neon. Dorothy showed the manager David’s guardianship papers and asked him to take back the car. The manager refused; according to Dorothy, he told her that Kenai Chrysler would not take back the car, and that the company sold cars to “a lot of people who aren’t very smart.” Dorothy insisted that the contract was void, but the Kenai Chrysler manager ignored her and handed the keys to David over Dorothy’s objection. David drove off in the new car. Dorothy contacted the general manager of Kenai Chrysler, the next day, who told her that he had seen the guardianship papers, but he still thought that the contract was valid and that David was boundby it. A couple of days after Kenai Chrysler gave David the keys, David damaged the Neon in a one-car accident. The Denisons then managed to get the car away from David and return it to Kenai Chrysler, but six days later, when David called Kenai Chrysler to ask for his Pontiac back, someone at the dealership told him that he could not have it but could pick up his new car any time. David got a ride to Kenai Chrysler and picked up the Neon. The next day the Denisons were able to convince David to return the car to Kenai Chrysler yet again, and this time he left the car there. While they were trying to handle the return of the Neon to Kenai Chrysler and preventing anyone there from giving it back to David, the Denisons sought legal advice about the validity of the contract, consulting the Alaska State Association for Guardianship and Advocacy and the Disability Law Center. Advocates at both offices confirmed that the contract was void. Michael Denison (the father) also contacted the court-appointed investigator for David’s guardianship case. The investigator contacted Kenai Chrysler’s general manager, Bannock, and advised Bannock that the guardianship did indeed make the contract legally void, but Bannock refused to listen to the advice. An advocate from the Disability Law Center contacted Robert Favretto, the owner of Kenai Chrysler, on the Denisons’ behalf. Favretto would not listen to the advocate’s advice. Despite these contacts, Kenai Chrysler sought no legal advice concerning the validity of the sales contract until a full month after the sale. During this time, Kenai Chrysler continued in its active efforts to enforce the contract, including assigning David’s loan to the General Motors Acceptance Corporation (GMAC). Kenai never informed GMAC of David’s incapacity. Kenai also demanded storage fees from David for keeping the Neon on its lot and sold David’s Pontiac trade-in on the same day the Denisons brought the Neon back for the second time, even though the Denisons were still contesting the sale. GMAC eventually repossessed the Neon and sold it, resulting in a deficiency on the loan. After the Denisons’ attorney informed GMAC of David’s guardianship, GMAC agreed to treat the loan as uncollectible. Kenai Chrysler paid GMAC the deficiency without asking whether GMAC intended to collect the loan. The Denisons sued the company, seeking a judgment declaring that the sales contract was void because of the guardianship and seeking additional relief. Kenai Chrysler counterclaimed for restitution, including reimbursement for paying the deficiency to GMAC. The Denisons moved for summary judgment on their claim for declaratory relief and the trial court granted it. Kenai Chrysler appealed and argued that David’s parents had abandoned guardianship. The appellate court affirmed.
- False. Capacity is the ability to incur legal obligations and acquire legal rights . False. Ratification occurs when a person who reaches majority indicates that he/she intends to be bound by a contract made while still a minor True.
- False. The right ends within a “reasonable” time after the minor achieves the age of majority. False. Intoxicated persons may disaffirm a contract only when it is so extreme that the person is unable to understand the nature of the bargaining process. False. Once the person regains capacity, she/he may ratify the contract.
- The correct answer is (b)
- The correct answer is (b).