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Business LawChapter 6:
Capacity and Legality
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Introduction
Contracts must have a legal subject in
order to be enforceable.
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Why is capacity important?
If a plaintiff seeks to enforce a contract,
he must prove that the defendant had
legal capacity to enter into a contract.
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Defining Capacity
Capacity:Ability to do something, such
as the mental ability to make a rational
decision.
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Capacity is an essential element of a
contract because it shows that a party
understood the contractual obligation.
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Capacity refers to a partys ability to
understand what is happening, the
effect of what agreeing to a contractmeans and the ability to exercise free
will in making this choice.
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Capacity is not the same thing as wise
choice.
A person can exercise poor judgment,enter into a contract that is
disadvantageous, or even make a bad
bargain, and still have full, legalcapacity to contract.
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A Short History of Capacity
Prior to a more enlightened approach to
law in general and contractual
obligations in particular, certain classesof people were absolutely barred from
entering into contracts.
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Who May Contract?
Contracts need at least two parties,
both of whom have legal capacity.
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Natural Persons
Any person who is not disqualified for
some reason can enter into a contract,
provided that he or she has legalcapacity.
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Artificial Persons
Corporations, and some other forms of
business entities, are considered to be
artificial persons. They can bargain, negotiate and enter
into contracts.
Artificial persons have capacity.
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Legal Competency
To say that a person is legally
competent is to say that he has the
ability to know, understand andvoluntarily engage in actions that can
affect his interests.
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Age or Infirmity
The rules of capacity center on a
persons age, physical or mental
infirmity.
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Infancy
When a person falls below a certain age
level, the law presumes that he or she
lacks capacity to contract.
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Advanced Age
No state, for instance, has a rule stating
that a person above a specific age is
presumed to be legally incompetent toenter into a contract.
A persons age is one of the factors that
a court may take into account when itassesses a persons capacity.
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Physical Infirmity
A disabled person who has the mental
capacity to contract may do so,
regardless of the disability. A person may be in such severe pain,
or under the influence of drugs, that his
capacity will be affected.
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Guardianship
When a person has been declared
mentally incompetent, it is common for
a court to appoint a guardian torepresent that person.
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Partial versus Total Incapacity
When a person suffers from partial
incapacity, he or she may still undertake
a contractual obligation
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Mental Incompetence or
Mental Illness When a person is of lower than average
intelligence, or suffers from some form
of mental illness less than legal insanity,this person is still entitled to enter into a
contract.
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The Other Partys Good Faith
A partys good faith does not circumvent
the rules surrounding capacity.
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Intoxication
Intoxication resembles a form of
insanity.
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Authority
When we say the person has authority
to enter into a contract it simply means
that he or she has legal capacity andhas no legal impediment to becoming a
party to a contract.
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Apparent authority
If it appears that a person has the
authority to make certain commitments
in a contract, or to act for another, andthe principal does not negate this
perception, then the person has
authority, even though it was neverofficially conferred upon him.
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Actual authority
When a person has actual authority it is
usually vested in him through some
overt action by another.
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Third party contracts
Third party contracts stem not from their
involvement in the contract but from the
fact that they derive some benefit fromthe contract between the other parties.
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Creditor
Creditor beneficiariesare created
when a contracts provisions include a
promise to satisfy an outstanding debt.
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Beneficiary
Anyone who benefits from something or
who is treated as the real owner of
something for tax or other purposes.
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Donee
In most jurisdictions, a donee-
beneficiary is created by contract
provisions that show a clear intention bythe parties to make a gift to a third
party.
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Assignee
An assignee-beneficiary is a person or
entity who will eventually be granted a
specific right under the contract, suchas a person who will eventually become
a party to the contract.
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Legal subject of contract
A contract is void when the subject of
the contract is illegal, such as a contract
to engage in illegal activity or for anillegal purpose.
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Contracts that are illegal
because of subject Contracts that involve illegal actions are
void for a very simple reason.
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If this were not so, then a party seeking
to enforce the contract could bring an
action through the court system andrequest that a judge rule on the
contract.
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Contracts that are
unenforceable because of
public policy The general rule followed in all
jurisdictions is that any contract thatviolates public policy is void and
unenforceable.