5.1 General Perspectives on Capacity

Contractual capacity refers to the legal ability of an individual or entity to enter into a binding contract and be held legally responsible for their actions and obligations under that contract. It is an important principle in contract law as it ensures that contracts are entered into voluntarily and that all parties involved are capable of understanding and fulfilling their contractual obligations. Capacity is necessary for a legally binding contract.

Most people who enter contracts have capacity. Because of that, and to avoid having to prove one’s capacity every single time they wish to enter a contract, capacity is presumed unless there is something about the person or the transaction that calls capacity into question. In instances where capacity is questioned, it is possible to have either limited capacity (also called limited competency), or be incapable of contracting at all due to a lack of capacity, or incompetency.

The rule of contractual capacity is important because it helps to protect individuals who may be vulnerable or not fully capable of making informed decisions. Minors, people with mental disabilities, and individuals who are under the influence of drugs or alcohol may not have the capacity to fully understand the terms of a contract or the consequences of entering into it. By requiring that parties have the legal capacity to enter into a contract, the law seeks to prevent unfair contracts where one party may take advantage of the other party’s lack of understanding of the legal consequences of an agreement. Further, requiring capacity to enter a contract helps to ensure that the terms of the contract are understood and agreed upon by both parties. Since a contract is a meeting of the minds, if someone lacks mental capacity to understand what they are agreeing to, it is unreasonable to hold that person to the consequences of the contract. At common law there are various classes of people who are presumed to lack the requisite capacity to fully understand the consequences of a contract. These include infants (minors), the mentally ill, and the intoxicated. This Chapter will review each of these in turn.

5.2 Minors (or “Infants”)

The General Rule

Minors – persons younger than eighteen years of age in most states – may only enter into voidable contracts. This is because minors do not have full legal capacity to enter into contracts. Minors can enter into most contracts, but they can avoid their contracts, up to and within a reasonable time after reaching majority, while the other contracting party with full contractual capacity cannot. The idea is that minors do not stand on an equal footing with adults, and it is unfair to require them to abide by contracts made when they have immature judgment.

For example, suppose a 16-year-old enters into a contract to purchase a new phone from a mobile phone company. Since the 16-year-old is a minor and not yet legally capable of entering into a contract, the contract is voidable. This means that the 16-year-old has the option to either affirm the contract or void it. If the 16-year-old decides to go ahead with the purchase, the contract will be binding on the mobile phone company. However, if the 16-year-old chooses to avoid the contract, they will be released from any obligations or liabilities that may have arisen from the contract, and they will be entitled to a refund if they have already made any payments. This is called disaffirming a contract. To disaffirm a contract means to repudiate or reject a contract that has been previously entered into.

Most people will recognize the 16-year-old in the above example as a minor. But legal term infant is also used to describe the 16-year-old contracting party above. The words minor and infant are mostly synonymous, but there are some differences between the terms. Historically speaking, in a state where the legal age to drink alcohol is twenty-one, a twenty-year-old would be a minor, but not an infant, because infancy is under eighteen. A seventeen-year-old may avoid contracts (usually), but an eighteen-year-old, while legally bound to his contracts, cannot legally drink alcohol. This is why some states use the term infant for one who may avoid his contracts even though, of course, in everyday terms we think of an infant as a baby.

In nearly all U.S. states, an 18-year-old may assent to a binding contract, but there may still be some exceptions associated with age. For those under twenty-one, there may also be legal impediments to holding certain kinds of jobs, and agreeing to certain kinds of contracts, marrying, leaving home, and drinking alcohol. There is no uniform set of rules since each state can make their own laws in these areas. Because of these ambiguities, contracting adults like landlords or creditors may still require parents to co-sign contracts for a young adult over the age of 18. This is lawful, but is often unnecessary.

The exact day of “majority” – the day on which the limitations on contracting as a minor or infant vanish – can also vary. The old common-law rule put it on the day before the twenty-first birthday. Many states have changed this rule so that majority commences on the day of the eighteenth birthday. For the most part, the remainder of this Chapter will use the word minor to describe a contracting party under the age of 18. This is consistent with the law in New Jersey, where by statute an individual under the age of 18 is defined as an infant, and therefore lacks the legal capacity to contract.

Even though a minor lacks the legal capacity to contract, the minor’s contract is not automatically invalid. Instead, the minor has the right to choose to either affirm the contract or void it which makes the minor’s contract voidable. This means that despite having limited competence minors can enter contracts, but most of those contracts can be avoided, or disaffirmed, without any reason for doing so other than the party is a minor. If a lawsuit about the contract was filed, the minor would claim the defense of infancy, and this defense would be sufficient unless there are other reasons why the contract could not be disaffirmed. Should the adult wish to get out of the contract, they cannot make the same claim. The adult cannot seek to disaffirm the contract; only the minor can.

When a minor disaffirms a contract, the minor has the legal right of a minor to walk away from a contract and be released from any obligations or liabilities arising from it. In addition, the minor is restored to their original position, meaning that they would be entitled to the return of any consideration, without the responsibility of being liable for damages under the contract. A minor need only return whatever part of the consideration in the contract that they still have. So, if the 16-year-old in our example above opts to disaffirm their purchase of the new phone one month after entering the contract, the minor may disaffirm. The minor would be entitled to the return of any down payment or other fees paid for the phone. The minor will return the phone but would not be liable for any damage done to the phone while it was in the minor’s possession, even if the phone was broken. This is called the general rule of law pertaining to contracts entered into by minors. This means that the majority of states, but not all, follow this rule.

Exceptions to the Minor’s Right to Disaffirm

There are several exceptions and limitations to the minor’s right to disaffirm. These are discussed below.

Duty to Return Consideration Received

As we explored under the general rule, when a minor disaffirms a contract their own obligation would be to return an item of consideration if that item is still in the minor’s possession. For instance, the minor would have to return the untouched groceries in a contract with a grocery store. Under the general rule, if some of the groceries were already eaten, there would be nothing to return and thus the minor would not be liable for the value of the groceries that were consumed. Some courts, however, have required more from the minor when necessary to avoid injustice to the adult. Suppose that our 16-year-old minor that purchased the cell phone decided to disaffirm their purchase after dropping and breaking the phone. There are some courts that would limit what the minor could receive in disaffirming the contract. For example, a court could determine that the minor should not receive full value back for the phone, but instead receive only that value associated with the (wrecked) phone at the time of the disaffirmance. Since this is contrary to the general rule, it is called the “minority rule” of law, where minority here means that less than half of the states follow this rule. On this area of law, New Jersey is in the minority, typically requiring that a minor return all of the consideration (or the value of that consideration) that was received in order to disaffirm.

Necessaries

A necessary is a basic need of life such as food, clothing, shelter and basic medical services. This has historically been the definition at common law. In recent years, however, the courts have expanded the concept so that in many states today, necessities include property and services that will enable a person to earn a living and to provide for those dependent on them.

When a contract with a minor is for an item that is a necessary, an exception to the general rule that minors can disaffirm their contracts is that minors are generally liable for the reasonable cost of necessities. The reason behind this change from the general rule that minors may disaffirm without further obligation is that denying minors a full right of contract for necessaries would actually harm minors, not protect them. The minor will not be obligated to perform the contract so technically the minor can still disaffirm. However, the minor will be responsible to the other party for the reasonable value of the contracted necessary. For example, suppose a minor enters into a contract with a grocery store to purchase food items where the food qualifies as a necessary. If the minor later disaffirms the contract, they will not be liable for the contract price of the food items if they have not been consumed or used by the minor. Those items can be returned, which is required under the general rule. However, if the minor has already consumed or used the food items, and those food items are necessaries, the minor is responsible for the reasonable cost of the food items. The requirement that the minor be liable for the reasonable value of the necessary is rooted in the theory of quasi contract, which was explored in an earlier Chapter.

So, how does this rule protect minors? Since the rule provides protection to the seller of the necessary, in this case the food, that seller will want to sell to minors that need food for nourishment, because the seller does not risk the harsh consequences of the general rule.

Nonvoidable Contracts

There are some contracts that are considered nonvoidable. The contracts that are nonvoidable can vary by state, and can include contracts such as insurance, education or medical care, bonding agreements, stocks, or bank accounts, and child support agreements. The rationale behind making these contract nonvoidable is this: if a contract is voidable it is a disincentive to an adult party to contract with a minor (or other party that lacks capacity) since there is a risk that the minor will disaffirm the contract in the future. Many sellers simply will not take that risk and instead refuse to contract with minors completely. There are certain types of contracts, though, that we want to be available to minors and so making those contracts nonvoidable encourages these types of contracts with minors. For example, it is beneficial both to a minor and to society that the minor receive an education. Education can be expensive, and so to help assure that education loans are available to minors, the right of the minor to disaffirm that loan in the future is limited or eliminated.

Misrepresentation of Age

A minor that misrepresents their age in order to enter a contract may be limited in their ability to later disaffirm that contract. Typically, an adult that simply thought that the minor was over the age of 18 could not raise that as a defense to the minor’s attempt to disaffirm the contract. This is true even if the adult’s belief that the minor was older was reasonable. Importantly, the minor must affirmatively misrepresent their age. Even so, this limitation on disaffirmance will depend on the state. A Michigan statute, for instance, prohibits an infant from disaffirming if he has signed a “separate instrument containing only the statement of age, date of signing and the signature.” And some states estop him from claiming to be an infant even if he less expressly falsely represented himself as an adult. Estoppel is a refusal by the courts on equitable grounds to allow a person to escape liability on an otherwise valid defense; unless the infant can return the consideration, the contract will be enforced. It is a question of fact how far a non-express (an implied) misrepresentation will be allowed to go before it is considered so clearly misleading as to stray into the prohibited area. Some states hold the infant liable for damages for the tort of misrepresentation, but others do not. As William Prosser, the noted torts scholar, said of cases paying no attention to an infant’s lying about his age, “The effect of the decisions refusing to recognize tort liability for misrepresentation is to create a privileged class of liars who are a great trouble to the business world.”

Tort Connected with a Contract

Although the lack of contractual capacity can protect a minor from a contract by permitting the minor to disaffirm, this same rule does not extend to other areas of the law. Recall that minors can be liable for their torts (e.g., assault, trespass, nuisance, negligence). So, if there is also a tort claim connected with a contract involving a minor, the minor can be liable for the tort unless the tort suit is only an indirect method of enforcing the contract. For example, Tandy, who is 16, agrees to mow the neighbor’s lawn for $50. The neighbor pays Tandy up front. Tandy can disaffirm this contract because Tandy is a minor. If Tandy doesn’t mow the lawn, the neighbor could not sue for fraud because that would be an indirect attempt to enforce the contract. However, let’s say that while mowing the lawn, Tandy accidentally damages the neighbor’s flower bed with the lawnmower. The neighbor could then sue Tandy for the tort of negligence, which is a civil wrong resulting from a failure to exercise reasonable care.

Ratification

When a minor becomes an adult (i.e., reaches the age of majority when the “disability” that rendered the party of limited contractual capacity has been lifted) there are two options for an existing contract. The party to the contract can disaffirm that contract up to a reasonable period of time after reaching the age of majority, where what is reasonable will depend on the circumstances. Or, the contract can be ratified. Ratification takes place upon accepting or confirming a contract that was originally voidable because a party lacked contractual capacity.

For example, suppose a minor signs a contract to buy a car, but the contract is voidable due to the minor’s age. Once the minor reaches the age of majority, they may ratify the contract, thereby making it legally binding. They may ratify the contract by sending a letter to the seller of the car letting them know they intend to ratify the contract. This is express ratification. Or, they may ratify the contract by doing nothing to disaffirm it while continuing to drive the car. This is implied ratification. Express ratification occurs when a party explicitly confirms or approves the previously voidable contract. Implied ratification, on the other hand, occurs when a party behaves in a manner consistent with accepting a contract, or in a manner inconsistent with disaffirming the contract. Both express and implied ratification have the effect of making the previously voidable contract legally binding.

5.3 Persons Who Are Mentally Incapacitated

Mental incapacity can result from mental illness, physical illness, or deficiency, and may have the effect of causing full incompetence, limited competence, or have no impact on contractual capacity at all. As an initial determination, the impact of the illness or deficiency on the ability of the party to understand the legal consequences of entering into a contract should be reviewed. A person who has an illness or deficiency that does not impact the ability to understand the legal consequences of a contract would not qualify for mental incapacity, and therefore could enter a valid contract.

When a person is suffering from an illness or deficiency that prevents them from understanding the legal consequences of entering a contract, a contract entered during this time period is voidable due to limited competence. The time period to avoid the contract would be during the contract or when capacity is restored. For this limitation on competency, it is more likely that avoiding a contract will occur once the deficiency is lifted, restoring mental understanding. A disaffirmance may also take place by a guardian, if a court appoints a guardian and a voidable contract exists at that time of appointment.

When a person that is suffering from an illness or deficiency is adjudicated to be fully incompetent in a court proceeding, any further efforts of that person to enter a contract will result in a void contract. In this situation, a guardian will be appointed to proceed with contracting for the incompetent party in the future.

For example, suppose a seller diagnosed with a mental illness agrees to sell their property to a buyer. Even though the seller has a diagnosis, this contract will be valid unless the mental illness has impacted the seller’s ability to understand the legal consequences of the contract. If the seller, due to their mental illness, cannot understand the legal consequences of the contract, the contract may be considered voidable. The seller would be able to disaffirm the contract. Similarly, the buyer may not be able to enforce the contract and may have to return any money or property received from the seller. If the seller has been adjudicated incompetent in a Court proceeding, the contract would be void. This means that the guardian responsible for making decisions on the seller’s behalf could avoid the contract.

As in the situation with a minor, if the contract was for a necessity, the other party may have a valid claim against the estate of the one who is mentally incapacitated in order to prevent unjust enrichment. In any case, when a contract is disaffirmed, the mentally incapacitated person must return any property in their possession to the other contracting party. If the contract was fair and the other party had no knowledge of the mental illness, the court has the power to order other relief.

5.4 Persons who are Intoxicated

People who are intoxicated at the time of entering a contract may have limited competency if the nature of their intoxication rendered the person unable to understand the nature and consequences of a contract. Intoxication could be the effect of alcohol, drugs, or other intoxicating substances, and could be voluntary or involuntary.

If a person is so drunk that he has little awareness of his acts, and if the other person knows this, any contract that results is voidable. Should the intoxicated person disaffirm the contract when regaining competency, he is obligated to refund the consideration to the other party unless he dissipated it during his drunkenness. If the other person is reasonably unaware of his intoxicated state, however, an offer or acceptance of fair terms would be upheld by most courts.

If a person is only partially inebriated and has some (but not a full) understanding of his actions, courts will review factors in determining whether the transaction would be voidable or valid, for example, whether the other party induced the drunkenness, the adequacy of the consideration exchanged, and whether the transaction is one which a reasonably competent person might have made.

A person who was intoxicated at the time he made the contract may nevertheless subsequently ratify it. Thus, where a party, several times involuntarily committed for alcoholism, executed a promissory note in an alcoholic stupor but later, while sober, paid the interest on the past-due note, he was denied the defense of intoxication; the court said he had ratified his contract. In any event, intoxication is a disfavored defense on public policy grounds.