3 Contracts Capacity to Contract Illegality Writing Rights of Third Parties Performance and Remedies

14 Capacity to Contract C H A P T E R No brilliance is needed in the law. Nothing but common sense, and relatively clean fingernails. John Mortimer

Learning Objectives Explain concept of capacity List the classes of persons without capacity and the effect on a contract Describe the effect of lack of capacity on a contract Describe the rights to disaffirm or ratify and duties of disaffirmance

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

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 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.

Minor’s Right to Disaffirm Right to avoid a contract is disaffirmance Only the minor may avoid the contract Example of disaffirmance: Woodman v. Kera LLC: Parent or guardian cannot contractually bind a minor ward. If minor wants to affirm the contract, adult party must perform Five-year-old Trent Woodman’s parents had his birthday party at Bounce Party (operated by Kera LLC). Bounce Party is an indoor play area with inflatable play equipment. Before the party, Trent’s father, Jeffrey Woodman, signed a liability waiver on Trent’s behalf. Trent jumped off a slide and broke his leg. Trent’s mother, Sheila Woodman, filed suit on his behalf against Kera on several bases, including negligence and gross negligence. Kera filed a motion for summary judgment, arguing that Trent’s claims were barred by the liability waiver. Woodmans argued the waiver was invalid as a matter of law. Trial court ruled that waiver barred Trent’s negligence claim but not his gross negligence claim. Both parties appealed. Court of appeals reversed and held the waiver invalid to bar the negligence claim. Kera appealed. Issue: can a parent bind his child by contract if the child could not otherwise be bound? Michigan common law rule is clear: a guardian, including a parent, cannot contractually bind his minor ward. Affirmed in favor of Trent.

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

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 Joining ROTC during high school indicates intent to serve in the military as an adult

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 Dodson v. Schrader: 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.”

Duties Upon Disaffirmance Disaffirming minors are required to pay reasonable value for necessaries (required for survival) furnished to them Quasi-contractual theory Example: Zelnick v. Adams Was legal services really a necessity for Adams? In this appeal the court considered whether a contract for legal services enter into on behalf of a minor is voidable upon a plea on infancy or subject to enforcement as an implied contract for necessaries and if enforceable the basis for determining value of service rendered

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? 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.

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 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.

Rogers v. Household Life Insurance Company Facts & Opinion: Alan Rogers diagnosed with Alzheimer’s and dementia; his son, Jason, was appointed guardian (no limitations on guardianship power) May 2007, Jason assisted Alan with online application for life insurance offered by HLIC Application did not inquire about health status HLIC approved application and premium paid June 2007, Alan died and HLIC argued it was not obligated to perform since Alan’s incapacity rendered contract void under Idaho law The hyperlink is to the case opinion in pdf. Alan Rogers was diagnosed with Alzheimer’s and dementia in 2003. Soon after, Alan’s son, Jason, sought an adjudication that Alan was incapacitated. An order to that effect was entered in 2004. The letters appointing Jason as guardian and conservator for his father did not place any limitations on Jason’s powers. On May 15, 2007, Jason helped his father complete and submit an online application for life insurance offered by Household Life Insurance Company (HLIC). HLIC approved the application, the initial $447.20 premium was paid, and Alan Rogers’ term life insurance policy with a face value of $250,000 took effect. Jason was the sole beneficiary of the policy. Alan passed away on June 7, 2007. His death certificate lists the sole cause of his death as “dementia of the Alzheimer’s type.” Jason submitted a notice of claim to HLIC and HLIC refused to perform.

Rogers v. Household Life Insurance Company Idaho Supreme Court Ruling: Idaho statute declares a person adjudicated as incapacitated to lack contractual capacity as a matter of law, but Jason claims contract is merely voidable Legislative purpose and statute’s plain meaning leads to conclusion that appointment of guardian with full powers represents judicial finding that the ward lacks capacity to contract as a matter of law District court properly granted HLIC's motion for summary judgment

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!

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 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.

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 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.

Test Your Knowledge Multiple Choice The “benefit rule” states that when a minor disaffirms a contract: They have no further duties Recovery of the full purchase price is subject to deduction for the minor’s use of the merchandise They have the duty to return the subject goods The correct answer is (b)

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: Give Ted back the full amount Pay Ted only the present value of the car Pay Ted the purchase price less the current value of the car The correct answer is (b).

Thought Question The requirement of capacity is rooted in ancient law. Should the law continue to protect minors and intoxicated persons? Why or why not?