What is contractual capacity?

Explainer
October 17, 2022
4
min

Contracts can affect everyone - but not everyone can bind themselves, or their company, to a contract. So what is contractual capacity, who has it, who doesn’t, and what are its implications?

Let’s find out in this Juro explainer.

What is contractual capacity? (Definition)

Contractual capacity is the ability of an individual to enter into a binding legal contract, and in so doing expose themselves (or their company, if they have signatory authority) to the obligations and consequences that flow from the contract.

Contractual capacity is key element of a contract, along with core concepts like offer, acceptance, consideration and so on. Specifically, in the US, the requirements without which a contract is not legally binding are:

  • Offer
  • Acceptance
  • Consideration
  • Contractual capacity
  • Legality

If one of these is missing, you may have a simple agreement rather than a contract (read about the difference between an agreement and a contract).

Contractual capacity is important because not everyone should have the ability to bind themselves to a series of legal obligations. A breach of contract that fails to honor those obligations can result in legal action and a range of remedies.

So when might a person intending to enter into a contract actually lack capacity to do so?

A person lacks contractual capacity if …

There are two main ways that someone might lack contractual capacity.

1. Lacking mental ability

The first is to do with their mental ability to understand the contract and its consequences. This means someone can lack capacity by:

👶 Being a minor

Although a minor can enter into some contracts legally, they are also afforded some special legal protection that entitles them to either void a contract or choose to enforce it.

In the US, those under the age of 18 (in most states) are minors, which means they can void most contracts they sign up to.

There are some exceptions to this (this is not legal advice!), such as contracts for entering into education, or contracts for necessities that are deemed as having fair terms.

One of the most common tests is whether or not the contract is deemed to be benefitting the minor. If it is, it's likely that the contract will be regarded as fair and therefore can't be voided. However, if a contract's terms aren't particularly beneficial to the minor (or fair), the contract is more likely to be voidable.

It's also worth noting that when minors reach the age of majority and become adults, they may lose the ability to void the contract altogether. This is because they are no longer perceived to be a minor by the law and thus they are bound by contracts in the same way that fully consenting adults are.

🧠 Lacking mental capacity

Another instance where an individual may lack contractual capacity is if they are lacking mental capacity.

This means that individuals suffering from certain mental illnesses or psychological conditions can often void a contract (or have their guardian do so) if they are regarded as mentally incompetent.

Different states have different tests for this. However, many states rely on the "appreciate effects" test to calculate mental and therefore contractual capacity. This means that they try to evaluate whether or not the individual was capable of understanding what they were involved in and whether they could recognize the effects of that relationship.

Regardless of how each state decides to measure mental incompetence, the final decision is typically taken by the court.

🍺 Being intoxicated

Being intoxicated can also enable a party to void the contract, but under exceptional circumstances, rather than being the rule. 

When assessing whether the intoxication can negate contractual capacity, the court will look at the severity of the intoxication and the counterparty's knowledge of this intoxication.

Generally speaking, the intoxication must be quite severe for a contract to be voidable, and the intoxicated party must try to rescind the contract within a reasonable period of regaining their full consciousness and recognising their mistake in entering the contract. Failing this, the contract will likely remain enforceable.

2. Lacking signatory authority

The second way, and the most common in a business context, is that the individual signing a contract was not an authorised signatory (i.e. they lacked signatory authority).

Not every employee of a company is empowered to sign business contracts on behalf of their employer. This power is usually reserved for directors of the company, and delegated from the board of directors by passing a resolution during a board meeting.

If someone without signatory authority signs a significant contract on their business’ behalf, and they lacked contractual capacity, it’s likely this contract would be difficult to enforce. In this scenario, it’s a good idea to re-send the contract and ensure that the right signatory is asked to sign.

contractual capacity
Before you attempt to bind your company to a contract, check you have contractual capacity to do so.

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