Commercial Law (Mgmt 348) Professor Charles H. Smith Capacity and Legality (Chapter 13) Spring 2009

Introduction to Voidable or Void Contracts Most contracts that have offer, acceptance and consideration are enforced without further inquiry. However, further inquiry may show that the contract is voidable or void due to lack of capacity, illegality, mistake, fraud, duress, undue influence or unconscionability.

Introduction to Voidable or Void Contracts cont. Voidable contract –Can be disaffirmed by party who lacks capacity or is victim of situations such as mistake or fraud. –Other party must perform unless disaffirmance takes place. –If disaffirmed, voidable contract will be rescinded (see Civil Code § 1689(b)(1)). Void contract (Civil Code §§ 1598 and 1599) –Will not be enforced by the court due to illegal purpose. –Instead, court will dismiss case involving illegal contract.

Introduction to Capacity to Enter Into a Contract “All persons are capable of contracting, except minors, persons of unsound mind, and persons deprived of civil rights” (Civil Code § 1556). We will cover capacity issues relating to “minors” and “persons of unsound mind.” Underlying notion here is minors and persons of unsound mind are not capable of agreeing to contracts; therefore, no contract can be formed due to no mutual assent.

Capacity – Minors Capacity to contract accrues on 18 th birthday (Civil Code §1557(a); Family Code § 6500); while general rule is minors may contract in same manner as adults (Family Code § 6700), most contracts by minors are voidable (Family Code § 6710). A few contracts by minors are void (Family Code § 6710) such as contracts which purport to transfer personal property not in minor’s “immediate possession or control” – common example is minor’s wages before they are paid. Some contracts are binding on minors such as contracts for “necessaries” for support of minor or minor’s family; minor cannot be under care of parent or guardian able to provide (Family Code § 6712); case study – Yale Diagnostic Radiology v. Estate of Harun Fountain (pages ).

Capacity – Unsound Mind Civil Code §1557(b) refers to §§ –“Person entirely without understanding” incapable of contracting but still liable for reasonable value of things furnished that are necessary for support of person or family (§ 38). –Contract by “person of unsound mind, but not entirely without understanding” before judicial determination of incapacity is subject to rescission. –Contract is void if made after judicial determination of incapacity. –Student examples of “unsound mind” and “without understanding.”

Introduction to Legality of a Contract “The consideration of a contract must be lawful within the meaning of [Civil Code] Section 1667” (Civil Code § 1607); this includes consideration contrary to the express provision or policy of law, or otherwise contrary to good morals. “If any part of a single consideration for one or more objects, or of several considerations for a single object, is unlawful, the entire contract is void” (Civil Code § 1608).

Illegal Contracts – Usury California Constitution Art. XV, § 1 sets maximum interest rates –Household items – 10% –Other – higher of (a) 10% or (b) 5% plus Fed rate on 25 th of preceding month. –However, many exemptions; e.g., college student loans (Finance Code § 22050(c)). If usurious interest rate, interest is still owed but only at legal limit; a few statutes render the entire contract void.

Illegal Contracts – Unlicensed Persons Main purpose of licensing statutes is to regulate profession. Unlicensed person who causes personal injury or damage for providing goods or services when license required liable for treble damages, costs and attorney’s fees (C.C.P. § ). Unlicensed person barred from suing or recovering in law or equity based on performance for which license required (B & P Code § 143(a)).

Illegal Contracts – Covenants Not to Compete in Employment Agreements Covenant not to compete – contract provision barring employee from working in same type of job/profession and/or in same area for certain time period. General rule – covenant must be “reasonable” in scope as to geography and time. California rule – covenant is illegal and therefore cannot be enforced in court (B & P Code § 16600); exceptions – sale or dissolution of business (B & P Code § ). Case studies – Stultz v. Safety and Compliance Management, Inc. (pages ); Case Problems and 13-7 (pages ).

Unconscionability Common challenge to enforceability of arbitration agreements so that will be our emphasis in this area of contract law. Both aspects of unconscionability must be present though not necessarily to same degree –Substantive unconscionability – harsh, one-sided nature of contract; e.g., prohibition of or limits on remedies otherwise available in court. –Procedural unconscionability – manner on which contract negotiated when there is unequal bargaining power; contract presented on “take-it-or-leave-it” basis or arbitration clause “buried in the fine print” (commonly called “adhesion” contracts).

Unconscionability – Case Studies Simpson v. MSA of Myrtle Beach, Inc. (pages ); please note this case is in Chapter 14. Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9 th Cir. 2002) (federal court of appeal case applying California law). Gentry v. Superior Court, 64 Cal.Rptr.3d 773 (Cal. 2007) (California Supreme Court case applying California law).