LEGALITY & CAPACITY Chapter 4

OBJECTIVES Compare and contrast the legality and capacity elements of the contract formula. Describe adhesion and unconscionable contracts. Define the term ratification in the context of contract law. Evaluate the ramifications of each kind of incapacity on the enforceability of a contract.

Legality A contract to perform an illegal act is called an illegal contract and is void. An illegal contract cannot be enforced by either party to the contract. An illegal contract is characterized as either: Malum in se Malum prohibitum

Malum in se “Evil in itself.” Acts universally recognized as immoral or repugnant (i.e., murder, rape, or arson). Such contracts are absolutely unenforceable as their purpose is inherently bad.

Malum in se Example Tony Soprano contracts with Big Fat Paulie, a reliable hitman, to kill Tony’s ambitious cousin. In exchange for $10,000, Big Fat Paulie has agreed to “take out” Tony’s cousin and thereby prevent him from taking over the “family.” Instead, Big Fat Paulie is unsuccessful in his attempt. When Tony hears of the failed assassination, he files suit against Big Fat Paulie for breach of contract. Will Tony’s suit be successful? No. Tony cannot sue to enforce the contract for a “hit ” on his cousin. Murder-for-hire contracts are per se invalid and illegal.

Malum prohibitum “Prohibited evil” Prohibited as a violation of the law. Example: usury, gambling, liquor sales

Malum prohibitum (continued) Malum prohibitum agreements may be enforced if the innocent party has reasonably and detrimentally relied on the agreement, not knowing it violated the law (unjust enrichment). For example, if Tony contracted with Larry, a liquor supplier, to deliver various alcohol to his speak-easy. If the illegality of the speak-easy was unknown to Larry, he could sue Tony for the cost of the liquor under the contract should Tony refuse to pay.

Malum in se vs. Malum prohibitum Prohibited because it is “evil in itself.” Never enforceable! There is no innocent party, so equitable damages are also unavailable. Prohibited by a rule of law. May be enforced, if the innocent party can demonstrate unjust enrichment.

Unconscionable Contracts An unconscionable contract is one that is so oppressive and manifestly unfair, it would be unjust to enforce it. Also known as contracts of adhesion. One-sided contracts (i.e.,  “take it or leave it”)

Noncompete Agreements Also called a covenant not to compete. Usually found in employment contracts; an employer seeks to limit the scope of an employee’s subsequent employment. Prohibits a former employee from working for a competitor for a certain period of time in a certain geographical area. Must be the same type of employment and must be necessary to protect a valid business interest. Not favored; may be an illegal restraint on trade.

Weigh In! Suzie Scientist landed a new job at Medicine Company after being let go from Famous Pharmaceuticals. She has been hired to conduct research for a new cancer drug similar to a project she participated in at Famous. Famous commences a lawsuit against Suzie asserting that she is in breach of a covenant not to compete that reads: Employee hereby covenants and agrees that she will not seek employment with any competitor for a period of two years after she leaves the employ of Famous Pharmaceuticals. She agrees not to act as a consultant to any such competitor whether for research or marketing purposes. Additionally, she agrees not to have any interest in any competing company as director, shareholder, creditor, or otherwise. As the judge in this matter, how would you rule and why?

Capacity Legally impossible for the following to form contracts: Persons who are under 18 (minors) Those who are mentally infirm (competence) Those under the influence of drugs or alcohol (intoxication) The law views the people in these categories as being unable to make an informed decision regarding their potential contractual obligations.

Minors Contracts entered into by minors are voidable, not void. Only minor has right of disavowal (avoiding the contract). Recall that a void contract is invalid and therefore is NEVER enforceable. A voidable contract MAY be invalid, but we need to wait and see. Once minor turns 18, can ratify the contract. Can be informal; minor can simply continue to abide by the contract.

Ratification v. Disaffirmation/Disavowal An expression in words or actions which indicates an intention to remain bound by a contractual agreement. Minors can ratify a contract once they have reached 18. Time for disaffirming after reaching age of majority may vary according to the jurisdiction. A step taken by a formerly incapacitated person that denies and cancels the voidable contract and thereby makes it unenforceable.

Minors Example 17 year-old Bethany signs a lease for a car that states that the lease cannot be canceled for the first two years. Bethany can avoid the contract before turning 18. The adult cannot claim Bethany’s minority as a defense to enforcement. Instead, the adult is bound to the contract until it is disavowed by Bethany. After turning 18, Bethany can ratify the contract by continuing to make payments. The lease agreement is now an enforceable contract.

Exceptions to Minority Necessities Minors cannot disaffirm contracts for the acquisition of food, shelter, clothing, medical care, and the like. Legislation Certain contracts cannot be disaffirmed because of minority: educational loan documents, military enlistments, marriage or child-support agreements, banking, and insurance contracts.

Exceptions Example Marvin, a 16 year-old, is a computer genius and has set up quite a lucrative “help desk” at school; other students pay him for help with their computer problems. Marvin goes on a shopping spree with his hard-earned cash, purchasing a new motorcycle and new computer hardware, and also enters into a lease agreement for a little studio apartment near his school. Marvin then sets up a line of credit at the local supermarket to deliver a steady stream of soda, chips, cookies, and frozen pizzas to his new place. Which contracts are avoidable due to Marvin’s minority status?

Competence Mental disability must relate to the capacity to contract. Burden is on party seeking avoidance to show that the mental infirmity rendered the person incapable of understanding the transaction at issue. Disability does not have to be permanent; if the party is incapable due to a temporary mental infirmity, the contract may be avoided or ratified upon regaining mental capacity.

Competence (cont.) Adjudged Insane (judicial finding of insanity) Any contract who is entered into by a person who has been adjudged insane is void. The court-appointed guardian is the only one who has the legal authority to enter into contracts on behalf of the person. Insane But Not Adjudged Insane Any contracts entered into by a person with a mental impairment are voidable. Any contracts made during a lucid interval are enforceable. Contracts made while the person was not legally sane can be disaffirmed.

Intoxication Intoxication by alcohol or illicit drugs may render a person incapable of entering into a contract. The incapacity as a result of the intoxication must be extensive enough to deprive the person of reason and understanding. A temporary impairment; must take action to disaffirm and avoid the contract once sobriety is regained. If other party had reason to know of the diminished capacity of the drunkard, then the courts are not likely to uphold the contract.

Intoxication (cont.) Whether the courts will enforce the contract is a matter of reasonableness: A person swaggers up to the bar, down a few shots, and then offers to sell her brand new Porsche for $100 to the bartender. vs. Businessman Donald Drunk, who is in the habit of taking “liquid lunches” and holds his liquor well, is at a lunch meeting. Donald Drunk decides to sell part of his company for less than what it is worth because he is feeling parrticularly generous after several single-malt scotches (consumed prior to the meeting).

Severability The court can sever a contract if it contains some lawful and some unlawful portions. This permits the legal portions of the contract to be enforced. Severability clauses are used by the parties to state that, if any of the portions of the agreement are found to be illegal, then that portion only will be omitted from the contract and the remainder will be enforceable.

Closure Contract law gives an affirmative defense to those parties who find themselves in a contract that they were not capable of making in the first place or for which the subject matter is illegal. Restrictions on contracting are placed on minors, the mentally infirm, and those under the influence. A minor may affirm or disavow a contract upon reaching majority.; a mentally incompetent person may do the same upon reestablishing soundness of mind; and the party under the influence may take either action upon sobriety.

Closure (continued) If a minor contracts for necessities or for a certain type of statutorily controlled transaction, the minor is unable to avoid the contract for lack of capacity. A contractual transaction cannot involve illegal activities or illegal purposes. These activities and purposes can either be characterized as malum in se (an act that is morally reprehensible) or malum prohibitum (an act prohibited by law for the well-being of society)