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Chapter 16: Capacity and Legality

– the third element of a legally binding contract
– a person who has legal capacity has the mental ability to understand his/her rights and obligations under a contract and therefore presumably to comply with the terms
Incapacity/ incompetence
– the possession of a mental or physical defect that prevents a natural person from being able to enter into a legally binding contract
– a person may have no capacity= complete inability to enter
– or limited capacity= the ability to form only voidable contracts
– as a general rule, minors (under the legal age of 18)
– any contract entered into by a minor is voidable by the minor until he or she reaches the age of majority or a reasonable time thereafter
– a person is given full legal capacity to enter into a contract when he/she becomes emancipated before reaching the age of majority
– emancipation occurs when a minor’s parents or legal guardians give up their right to exercise legal control over the minor
Disaffirmance of the contract
– because their contracts are voidable, minors have the right, until a reasonable time after reaching the age of majority, to disaffirm or void their contracts
– only the minor has the right to disaffirm
– must void the entire contract
– traditionally, states required the minor to notify the competent party and return any consideration received, regardless of condition
– now, states require the minor to place the competent party back in the position that the party was in at the time the deal was made
Exceptions to the minor’s right to disaffirm
– the right is to protect minors from competent parties who might otherwise take advantage of them
– but in most states, minors do NOT have the right to disaffirm contracts for life insurance, health insurance, psychological counseling, the performance of duties related to stock and bond transfers and bank accounts, education loan contracts, child support contracts, marriage contracts, and enlistment in the armed services
– plus the issue of what to do when a minor misrepresents his/her age- states have differing viewpoints
A necessary
– a basic necessity of life (food, clothing, shelter, basic medical services)
– minors can disaffirm contracts for necessaries, but they will still be held liable for the reasonable value of the necessary
–limitation so that sellers will not be reluctant to provide minors the basic necessities of life when their parents will not provide them
– issue of how to determine if its a “necessary”
-> to “maintain his/her standard of living/financial and social status”
-once a person reaches the age of majority, he or she may ratify, or legally affirm contracts made as a minor
– once ratified, the contract is no longer voidable
– ratification may be either express or implied
Express ratification
– occurs when the person makes an oral or written statement of intention to be bound by the contract
ex: email to reassure continued payments
Implied ratification
-occurs when the person takes some action consistent with the intent to ratify the contract
ex: former minor takes action after reaching the age
Parents’ liability for their children’s contracts
– as a general rule, parents are not liable for contracts entered into by their minor children
– merchants are often reluctant to enter into contracts with minors unless some competent person is willing to cosign and become legally bound to perform if the minor no longer wishes to live up to the terms of the contract
Parents’ liability for their children’s necessaries
– parents to have the legal duty to provide their kids with the basic necessaries of life
– may be held accountable for the reasonable value of necessaries for which their children enter into contracts for
Parents’ liability for their children’s torts
– minors are liable for personal torts
– parents may be liable when a child causes harm if it can be proved that the parent failed to properly supervise the child -> therefore subjecting others to an unreasonable risk of harm
Mentally incapacitated persons
– persons may have full, limited, or no legal capacity
– if a person suffers from mental problems yet still understands the nature of the contract and the obligation it imposes, that person may enter to a binding, legal agreement (delusional rock star example)
– a person only has limited capacity to enter into a contract if she suffers from a mental illness/deficiency that prevents her from understanding the nature and obligations of the transaction (example: if rockstar thought she was giving an autograph)
– a contract for necessaries by a person suffering from a mental deficiency can be enforced for the reasonable value of the necessary
– if a person has been adjudicated insane and has a guardian appointed, the person has no capacity to enter into contracts
Intoxicated persons
– restatement of contracts, section 16 provides that contracts of an intoxicated person are voidable if the other party had reason to know that intoxication rendered the person unable to understand the nature and consequences of the transaction or unable to act in a reasonable manner in relation to the transaction
Lucy v. Zehmer case
Selling the ranch UPDATE with class notes
Exceptions to voidable nature of contracts entered into with intoxicated persons
1) if the intoxication just causes the person to exercise poor judgement, the contract is not voidable unless the other party capitalized on the impaired judgement
2) when the intoxicated person becomes sober, the contract can be ratified or disaffirmed; however, the courts will fairly liberally interpret behavior that seems like ratifying the contract once the intoxicated person becomes sober
— if the contract is disaffirmed on the basis of intoxication, each party must return the other to the condition he/she was in at the time they entered into the contract
– the courts will enforce an intoxicated person’s contract for necessaries for their reasonable value
-to be enforceable, contracts must have legal subject matter and also must be able to be performed legally
– cannot violate either state or federal law
– a contract overturned is generally declared void
– agreements against generally acceptable public policy are also illegal and unenforceable
– contracts that are made for an illegal purpose or cannot be carried out by legal means are void for 2 reasons
1) Making them void clearly indicated that such social agreements are not socially acceptable
2) doing so prevents the legal system’s being used to promote agreements that are harmful to societies
Contracts that violate state or federal statutes
– agreements to commit a crime or tort are illegal in all states
– agreements made for the purpose of protecting the public’s health, safety, or welfare by a party unlicensed to do so are typically illegal in all states
– agreements regarding usurious loans may be illegal in some states
– agreements that violate the Sabbath or Sunday laws are illegal in some states
– agreements regarding gambling are illegal in most states
Agreements to commit a crime or tort
– any agreement to commit a crime or tort is illegal and unenforceable
– however, should a legal contract be formed and its subject later become illegal under a new statue, the contract is considered to be discharged under law -> both parties are discharged from their obligations
Licensing Statutes
– all 50 states have statutes requiring that people in certain professions obtain a license before practicing
– licensing statutes have 3 main purposes indicating the value society places on proper performance
1) to give the government some control over which people and how many people can perform certain jobs
2) By charging for licenses, the government can obtain revenue
3) By imposing legal standards on a profession, the government can try to prevent harm to the public’s health, safety, and welfare due to substandard work
Outcomes of contracts w/ unlawfully licensed people
– depends on the purpose of the licensing statute
–the state in which the unlicensed person is practicing is relevant because many licensing statutes occur at state level and therefore vary from state to state
-if the licensing statute is intended simply to generate revenue, then the contract of an unlicensed person is valid
-if the purpose of the licensing statute is to protect the public’s health, safety, and welfare however, the agreement of an unlicensed person is typically deemed illegal and unenforceable
– occurs when a party gives a loan at an interest rate exceeding the legal maximum
(statutes prohibiting usury are found on the books of nearly every state)
Exceptions to usury
1) to facilitate business transactions and keep the economy healthy, most states with usury statues allow corporations willing to pay more to lend and borrow at rates exceeding the maximum
(the rationale: if a biz need money to expand and is willing to pay the higher interest rate, the corporation should be afforded the opportunity to borrow)
2) allows cash advance to institutions to operate
-allow parties to make small loans at rates above the maximum to parties that cannot obtain a loan at the statutory maximum
(the rationale: if people need $ and the statutory maximum isn’t inducing others to lend, certain parties will make loans at a higher rate as long as the loan is “small”
State laws on usury
– if no exception allows a usurious loan, the legal outcome varies by state
– some states declare all usurious loans void
– some states allow lenders to recover the principal but no interest
– some states most favorable toward lenders allow recovery of the principal as well as interest up to, but not exceeding, the statutory maximum
– refers to agreements which parties pay consideration (money placed during bets) for the chance, or opportunity, to obtain an amount of $ or property
– all states regulate gambling
– illegal in most states but allow some legal loopholes
Sabbath Laws
– limit the types of biz activities in which parties can legally engage on Sundays
– laws vary by state, some prohibit the sale of alcohol or to enter into a contract- however, an executed (fully performed) contract created on a Sunday cannot be rescinded
Exceptions to Sabbath Laws
– charity work
– obtaining necessaries
– a lot of states don’t enforce Sabbath Laws
– some sabbath laws have been held to violate the 1st amendment
Agreements in Contradiction to public policy
-public policy involves both the government’s concern for its citizens and the beliefs people hold regarding the proper subject of business transactions
1) contracts in restraint of trade
Contracts in restraint of trade
– agreements that restrain trade called anti competitive agreements, are viewed as being harmful to consumers and against public policy
– when courts determine a restraint on trade is reasonable, however, and the restraint is part of a subordinate, or ancillary clause in the contract, the restraint is typically allowed
Covenants not to compete
restraints that are typically allowed:
– covenants not to compete, aka restrictive covenants; 2 types
– generally enforceable if they are for a reasonable length of time and a reasonable location
Covenants not to compete in conjunction with the sale of an ongoing biz
– public policy requires fairness in biz transactions, which does not occur when people profit from the sale of a biz and then start a new biz that destroys the one the sold (jewelry store example)
– if the covenant not to compete is an integral part of the main agreement, not subordinate, the agreement is typically considered unenforceable and void because it goes against public policy by creating unreasonable restraints on trade
– when the covenant is subordinate, however, the specific noncompetitive clause can be removed and the agreement can go forward as planned
Covenants not to compete in employment contracts
– the employee is agreeing, in the event of her leaving, not to compete with her boss (by starting her own company or working for competitors) for a designated period of time within a designated geographic area
-they must protect a legitimate business interest
-they must apply to a period of time and a geographic area that are reasonable for that purpose and not unlawfully impinge on the employee’s rights
– vary among states
Unconscionable agreements
– agreements that are so one-sided that courts will not make the innocent party be harmed by fulfilling his/her contractual duties
– refers to the fact that the agreement is so unfair that it is void of conscience
– rules against unconscionable contracts in both the restatement of contracts and the UCC
– common law would not enforce contracts deemed unconscionable
– every state except CA and Louisiana has incorporated the unconscionable section into its UCC
2 main types of unconscionable agreements
1. Procedural unconscionablity
2. Substantive unconscionablity
Procedural unconscionablity
– describes conditions that impair one party’s understanding of a contract, as well as the integration of terms into a contract
–conditions: anything from tiny, hard to read print on the back of an agreement to excessive use of legalese (unnecessarily technical legal language) or even a person’s inability to fully read a contract and ask questions before being required to sign
– procedural unconscionability arises in an ADHESION CONTRACT- an agreement presented on a take-it-or-leave-it basis or as the only chance the presented party (the adhering party) will have to enter it (legal but heavily scrutinized)
Substantive unconcionability
– occurs when an agreement is overly harsh or lopsided
ex: large differences between cost and price in a sales agreement in which one party gains vastly more than the other
ex: when one party is prevented from having equal benefit or has little to no legal recourse and portions of an agreement unrelated to either party’s biz risk
An exculpatory clause
– release one of the contracting parties from all liability, regardless of who is at fault or what injury is suffered
– b/c tort law attempts to return the wronged party to a state he/she was in before the wrong occurred, anything preventing this corrective mechanism is against public policy
– it doesn’t benefit society to allow some parties to get away with not having to pay for wrongs they commit simply because they state they will not be liable in various contracts (similar to the idea of unconscionable contracts)
– exculpatory clauses frequently show up in rental agreements for commercial or residential property
– it doesn’t serve the public interest to allow landlords to disavow in advance all liabilities for injuries due to carelessness, negligence etc
For an exculpatory clause to be legal
– the party seeking enforcement must be a private individual or business NOT important to the public interest
-must provide nonessential services and therefore don’t have as much bargaining power
– examples: private gyms, resorts, sky-diving
(still not automatically enforceable)
Illegal agreements
– when an agreement is deemed illegal, courts will usually label it void
– legal principle of IN PARI DELICTO= means that both parties are equally responsible for the agreement
Exceptions to the rule of illegal agreements
(if one party is significantly more culpable)
1. when a member of a protected class is party to an agreement that contradicts a statute intended to protect the specific class (truck driver example)
2. when justifiable ignorance of facts leaves one party unaware of a provision of the agreement that would make it illegal (while ignorance of the law doesn’t excuse illegal behavior, not knowing the other party intended to fulfill the agreement through illegal means does function as an excuse)
3. when one of the parties withdraws from an illegal agreement
– the party must have withdrawn before any illegality occurred
Severable contracts
(aka divisible contracts)
– contain multiple parts that can each be performed separately and for which separate consideration is offered (like numerous contracts in one)
LP: if the court can sever the illegal part of a contract from the legal part, it will generally do so and enforce only the legal part
Indivisible contracts
– requires complete performance by both parties, even if it appears to contain multiple contracts
LP: if the contract is indivisible, then it generally will be unenforceable

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