Introduction
Capacity to contract law pertains to the legal competence of parties to enter into a valid and binding agreement. This area of law focuses on determining which individuals or entities possess the necessary legal attributes to make contractual promises enforceable. The core concept is grounded in the principle that not all individuals can be held equally responsible for their contractual obligations. Technical principles require that parties possess both the cognitive ability to understand the nature and implications of their actions and the legal status to do so. Key requirements include a clear understanding of the agreement's terms and the legal capacity to engage in contractual relationships, ensuring a balance between individual autonomy and protection against exploitation. This article explores the complexities of this area of law using field-specific terminology and authoritative citations.
Legal Capacity and its Significance
The ability to contract is not a universal right; rather, it is a privilege afforded to those deemed legally competent. A person who lacks capacity, whether due to age, mental incapacity or intoxication, cannot form a legally binding contract. The principles governing contractual capacity are fundamental, seeking to protect vulnerable individuals from entering into agreements they may not fully comprehend or that are against their best interests. Furthermore, it is a necessity for the functioning of trade and commerce that parties who enter into a legal agreement can be held to the terms they have agreed upon. Therefore, the technical principles are designed to balance the desire for a commercially viable system of contract and to give confidence to parties when contracting and at the same time, protect those who are vulnerable or who do not fully appreciate the nature and implications of what they are undertaking. These include minors, persons with mental health conditions or those under the influence of alcohol or drugs. This principle was recognised in Hart v O'Connor [1985] AC 1000, where it was established that a party’s mental incapacity needs to be apparent to the other contracting party for a contract to be voided.
Minors and Contractual Capacity
Minors, or individuals below the age of 18, are subject to special rules concerning their contractual capacity. The law generally protects minors from the consequences of their actions due to their perceived immaturity and lack of experience. In most cases, contracts entered into by minors are voidable at the minor's option, meaning they can choose to cancel the contract at any time before reaching the age of majority or within a reasonable time afterward. This principle is designed to protect minors from exploitation. There are however, exceptions to this rule.
Contracts for necessaries, which include goods and services essential for the minor's survival and well-being, are generally binding. This is codified under the Sale of Goods Act 1979, s. 3, and means that a minor can be held liable to pay a reasonable price for necessaries. For example, if a minor contracts to buy food or shelter, then they can be held liable for a reasonable price. The question of what constitutes a necessary is determined by the individual circumstances of the minor, including their social status and wealth.
Similarly, contracts of employment which are deemed for the minor’s benefit, are also binding. This is to provide opportunities for minors to work and learn skills that would further their own opportunities. It is worthy to note that a contract may not be binding, even if it is considered beneficial, if it contains harsh and onerous terms. An example of this can be found in Fawcett v Smethurst (1914) 84 LJKB 473.
Mental Incapacity and Contractual Capacity
Individuals with mental incapacity, such as those suffering from severe mental disorders, dementia or cognitive impairments, have restricted capacity to contract. The extent to which a person lacks capacity varies and there are certain points that must be addressed to successfully use this as a ground to avoid a contract. The key test of capacity relates to whether an individual has the capacity to understand the nature and effect of the transaction they are undertaking. This test is well established within the case law, where in Imperial Loan Co. v. Stone [1892] 1 QB 599, the Court determined that if a contract is to be avoided, a party must demonstrate that the mental incapacity affected their understanding of what they were contracting for and also that the other contracting party was aware of the incapacity.
Under the Mental Capacity Act 2005, a person lacks capacity if they are unable to make a decision for themselves due to an impairment of their mind or brain. The impairment must be of a nature which prevents the person from understanding the information pertinent to making the decision, retaining the information long enough to make a decision, using that information to decide, or communicating their decision.
However, the courts are keen to uphold contracts wherever possible and will not simply accept that a party has demonstrated a mental incapacity. A party has to show that they lacked the understanding of the contract at the point the contract was agreed, not after the fact.
Intoxication and Contractual Capacity
Intoxication, whether due to alcohol or drugs, can affect contractual capacity. The general rule is that a contract made while intoxicated is voidable if the intoxicated party was unaware of the nature of the transaction and their condition was known to the other party. This principle is illustrated in Gore v. Gibson (1845) 13 M & W 623. In this scenario, the law seeks to strike a balance, recognising that a party is not wholly devoid of responsibility for their actions because they have voluntarily put themselves in that position. It has been established that contracts made in this capacity are not void, but voidable. This means that if, upon regaining sobriety, an intoxicated individual ratifies a previously agreed contract, then they are bound by it: Matthews v Baxter (1873) LR 8 Ex 132.
The Sale of Goods Act 1979, s. 3 also makes similar provisions for those lacking capacity due to intoxication to that of a minor and persons with mental incapacity. The courts will need to determine the level of intoxication needed to invalidate a contract.
Corporations and Contractual Capacity
Historically, the contractual capacity of corporations, particularly those formed under the Companies Acts, was limited by their objects clauses. Any actions outside of the stated objectives in the memorandum of association were deemed ultra vires (beyond powers) and void. This common law principle was affirmed in the case of Ashbury Railway Carriage and Iron Co. Ltd v Riche (1875) LR 7 HL 653.
Significant changes, however, were introduced by the Companies Act 1989 which inserted a new section 35 into the Companies Act 1985. This statute effectively limited the ultra vires principle by stating that the validity of any actions made by a company could not be called into question on the basis of a lack of capacity in the company's memorandum.
Section 35A(1) of the Companies Act 1985 went further by stating that any act made by a board of directors is deemed free from the limitations of the company’s constitution, provided the third party acted in good faith. This section enables third parties to have the ability to enter contracts with companies without fear of being left out of pocket due to the company’s internal governance or a breach of the company's constitution. Therefore the contractual capacity of corporations has been extended with limited circumstances where this capacity can be challenged.
Conclusion
Capacity to contract is a foundational principle in contract law, designed to ensure that parties entering into agreements have the requisite understanding and legal status to do so. The law balances the protection of vulnerable parties and the necessity for commercial certainty. Minors are protected via special rules to ensure they are not exploited, those with mental incapacity are protected where their condition is known, and those under the influence of alcohol or drugs can also have contracts avoided under specific conditions. The capacity of corporations has also evolved to align with commercial realities. These rules and regulations are put in place to protect vulnerable parties, and to ensure that there is confidence in contractual relationships. This body of law provides a legal framework governing who can validly form a contract, which is essential to all commercial activity. This topic is ever changing as a result of both case law and statute.
