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The law requires that a party to a contract has capacity to enter a contract. This means that the person is recognised in law as being able to commit to a contract. Most people and companies have capacity and so in the vast majority of contracts this is not a problem. In the following circumstances, capacity to contract may be an issue:

  • people who have a mental impairment;
  • young people;
  • bankrupts;
  • corporations (people acting on behalf of a company); and
  • prisoners.

People who have a mental impairment

Generally speaking, people are free to enter into contracts even though they may have a mental impairment, or be temporarily disabled by drugs or alcohol. They are, however, sometimes vulnerable to being bound by contracts they do not fully understand. The question of capacity to make the contract often arises only after the contract is in place.

People with disabilities

People with disabilities and their advocates will find some protection in the rule that a contract is not valid and enforceable unless there was genuine consent to its making. This is discussed further at Undue influence and unconscionability.

Capacity to give consent involves a general understanding of the nature of the contract (not necessarily its fine details). A person with a mental impairment, for example, may have the capacity to understand some contracts (for example, buying a loaf of bread), but not to understand other, more complicated contracts (for example, buying a car on credit). The law recognises that people with impaired capacity nevertheless must be able to purchase the necessities of life, for example, food, clothing, accommodation, medical services and so forth. The Sale of Goods Act 1896 (Tas)section 7(1) provides that a reasonable price must be paid for necessary goods sold to someone with a disability. What are ‘necessaries’ and the rules applicable here are dealt with under Young people (because the definition is the same for both groups).

Where a person with a disability did not understand the general nature of the contract, a court can intervene to set aside the contract only if:

  • the other party knew, or ought to have known, of the disability or lack of capacity; and
  • the person with the disability can give back most of the benefit he or she received under the contract, and
  • the benefit received by the disabled person has not been sold to a third party who did not know the previous transaction might not be valid.

Generally, to escape the consequences of a contract, the other party should be notified of the intention not to be bound by the contract within a reasonable time.

If the contract was made during a period when the person was able to understand it (legally termed a lucid interval), the contract will be binding even though the other party knew of the disability.

Some people with disabilities (temporary or long term) are assisted by a manager appointed under the Guardianship and Administration Act 1995 (Tas). People with disabilities who have a manager appointed to act on their behalf are generally not free to enter into contracts, unless this is approved in writing by their manager or by an order of the Guardianship and Administration Board.

Young people

The term young person is used here to refer to anyone under the age of 18 years (s3Age of Majority Act 1973 (Tas)). Sometimes, legal writing refers to ‘minors’ or ‘infants’, although the latter is now unusual.

The exact capacity of young people to bind themselves and be bound by contract is limited but it is also not clear, because no legislation completely covers this area of law. The law is overly complicated. Only in New South Wales has the law been rationalised in a sensible way.

Bankrupts

Bankrupt people are not deprived of their general capacity to contract. However, there are provisions of the Bankruptcy Act 1966 (Cth) that relate to dealings and contracts by bankrupts. For example, obtaining credit of $4,145 (indexed under s304A) or more without disclosing your bankruptcy is an offence and liable to penalty under section 269 of the Bankruptcy Act.

Corporations

A corporation is an artificial body created by law. The corporation has a legal existence separate from the individual people who comprise it. However, a corporation or company has the legal capacity of a natural person and therefore has the capacity to enter contractual relations (see s124 of the Corporations Act 2001 (Cth) ('the Corporations Act')). This is so even if there is an express provision contained in the company’s constitution which limits the company’s powers. Transactions are not deemed void and beyond the company’s powers simply because the exercise of such powers is in breach of the restrictions placed in the company’s constitution (s125(1)).

A company has capacity to enter into contracts but such contracts are only binding on the company if those acting on behalf of the company do so with the company’s express or implied authority (s126(1)). The courts have been quite liberal in their interpretation of implied authority. A company has to deal with the outside world through its people. The Corporations Act sections 128-9 provide that anyone dealing with a company is entitled to assume that the person they are dealing with has authority to act for the company unless the outsider knows, or has reason to know, that the company representative lacked authority. It is therefore difficult for a company to deny that a person, apparently acting for the company, lacked authority and could not bind the company.

Prisoners

During their imprisonment, prisoners may enter contracts, including contracts to buy and sell property. The usual restrictions about supervision and censorship of anything coming into the prison still apply, so that the permission of prison authorities is required before a prisoner may sign for, deliver or receive any document.

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