1. CHAPTERCHAPTER McGraw-Hill/Irwin©2008 The McGraw-Hill Companies, All Rights Reserved Capacity and Illegality SEVENSEVEN

2. 7-2 Objectives Chapter Objectives: Use vocabulary regarding the capacity and illegality properly Discuss the three categories of incapacity Evaluate the ramifications of each kind of incapacity on the enforceability of a contract

3. 7-3 Objectives Chapter Objectives: Determine if ratification or disavowal of the contract has occurred given a certain set of facts Determine whether the subject matter of the contract is illegal and if so whether it is malum in se or malum prohibitum Evaluate whether a court would sever an illegal clause from a contract or hold the entire contract void

4. 7-4 This chapter will explore: WHO may create a binding legal contract and WHO may not WHAT the agreement may pertain to and WHAT it may not Objectives

5. 7-5 Defects in the formation of a contract are affirmative defenses to enforcement. The contract was never formed and therefore cannot be properly or legally performed upon Affirmative Defenses

6. 7-6 A party may avoid enforcement of an agreement if unable to understand the transaction due to: –diminished capacity, either lack of majority or mental infirmity, or –if the subject matter of the contract is improper, either requiring a criminal or statutorily prohibited act Affirmative Defenses

7. 7-7 There are certain circumstances under which a person cannot enter into a contract as it is deemed legally impossible Affirmative Defenses

8. 7-8 The law of contracts protects persons who are: –under 18 (minors) –once a person has reached 18, they have reached the age of majority Affirmative Defenses

9. 7-9 The law of contracts protects persons who are: –mentally infirm –persons not having the capacity to understand a transaction due to a defect in their ability to reason therefore, do not have the requisite mental intent to enter into a contract Affirmative Defenses

10. 7-10 The law of contracts protects persons who are: –under the influence of drugs or alcohol –persons who do not have the capacity to understand a transaction due to overconsumption of alcohol or drugs do not have the requisite mental intent to enter into a contract Affirmative Defenses

11. 7-11 A person must have the present intent to contract. The people in these three categories are unable to make an informed decision regarding their potential contractual obligations The law protects those least able to protect themselves Affirmative Defenses

12. 7-12 Diminished Capacity: Minority Contracts entered into by minors are voidable, not per se void –A contract that is void is invalid and never enforceable

13. 7-13 Diminished Capacity: Minority A minor has the option upon attaining the age of 18 to ratify the contract. By ratifying the contract, the minor validates it –Ratification: The minor, upon reaching majority, can simply continue to abide by the contract. This continued performance indicates that the former minor intends to honor the contract

14. 7-14 The first exception to rule of avoidability is a contract for necessities –Necessities: Goods and services that are required; basic elements of living and employment Exception to Rule of Avoidability

15. 7-15 Public policy prefers that all citizens obtain the necessities of living; the law protects the suppliers of these necessities by disallowing avoidance –The supplier (the adult in the contract) is protected without fear that the minor will be able to escape his/her obligations –It must be noted that the item contracted for be truly necessary to the minor Exception to Rule of Avoidability

16. 7-16 The second exception to rule of avoidability is legislation –Legislation: Regulations codified into laws by Congress Contracts include educational loan documents, military enlistments, marriage or child- support agreements, banking, and insurance contracts are disallowed avoidance to facilitate legally enforceable contracts between a minor and the other parties Exception to Rule of Avoidability

17. 7-17 Diminished Capacity: Mentally Infirm Mental Disability: –It is not enough to show that the contracting party was under a mental disability, but also that the mental disability rendered the party incapable of understanding the transaction –The mental disability must relate to the capacity to contract

18. 7-18 The standard for mental infirmity is hard to meet The party wishing to avoid the contract, or his/her representative, must show that the condition rendered that person incapable of understanding the transaction at issue This means that a person may be mentally incapable of performing certain acts but still retain the capacity to contract Diminished Capacity: Mentally Infirm

19. 7-19 Diminished Capacity: Under the Influence Intoxication –Under the influence of alcohol or drugs which may, depending on the degree of inebriation, render a party incapable of entering into a contractual relationship Medicinal side effects –Under the influence of over-the-counter or prescription drugs having an impact on mental capacity which may render a party incapable of entering into a contractual relationship

20. 7-20 The most elusive of the capacity standards –Courts have little sympathy for self- induced reduction of capacity and overindulgent persons and will hold them to their contractual undertakings –The court also will look to the other party in the transaction –It is a matter of reasonableness Diminished Capacity: Under the Influence

21. 7-21 There must be a present intent to contract There is no present intent because the very nature of the transaction cannot be understood by the impaired party Diminished Capacity: Under the Influence

22. 7-22 Illegality Malum in se –An act that is prohibited because it is “evil in itself ” –It is an act that is universally recognized as immoral and repugnant, such as murder, arson, or rape These “contracts” are absolutely unenforceable as their purpose is inherently bad and the courts will never find any justification in them. There can never be any “innocent” party to award damages in equity

23. 7-23 Malum prohibitum is “prohibited evil,” – Malum prohibitum is not morally reprehensible; it is a violation of the law –Certain acts are not allowed in order to maintain a harmonious and fair society Sometimes, the court deems them void and unenforceable; other times, the court will try to protect an “innocent” party to the transaction or one who has relied on the contract to his/her detriment Illegality

24. 7-24 Illegal scheme –A plan that uses legal steps to achieve an illegal result On more unclear ground are the contracts that appear to have a legal purpose but for which the performance is part of an illegal scheme Illegality

25. 7-25 Covenant not to compete –Generally speaking, public policy and fairness dictate that agreements that restrict trade, market competition, and a person’s livelihood are invalid. A covenant not to compete is usually found in the employment contract. A company will attempt to control what an employee does after he/she leaves that particular company—to limit the scope of his/her subsequent employment It prohibits the former employee from working for a competitor for a certain period of time in a certain geographical area Illegality

26. 7-26 Severability of contract –The ability of a court to choose to separate and discard those clauses in a contract that are unenforceable and retain those that are enforceable Illegality

27. 7-27 Summary 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 In the most general sense, freedom of contract allows anyone to contract for anything; however, there are some reasonable restrictions on this laissez-faire attitude

28. 7-28 Summary Courts also restrict the subject matter of the contract, what the parties can bargain for. The transaction must not involve illegal activities or illegal purposes These prohibited 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