8 Capacity of the parties
Learning objectives
By the end of this chapter, you should be able to:
- Explain the common law rules regarding contracts entered into by minors (infants).
- Outline the common law rules regarding capacity to contract corporations, the mentally ill and those under the influence of alcohol.
Key Terms
You will notice these key terms, which are mentioned throughout the chapter, to help you to better understand and remember the material:
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- Beneficial contracts of service: contracts that are for the minor’s benefit and are not oppressive, including employment, education, apprenticeship and training contracts.
- Corporation: a legal entity (also known as a legal person) created by the Corporations Act 2001 (Cth); also known as a ‘company’.
- Infant: a person under the age of 18 years; also known as a ‘minor’.
- Necessaries: goods or services that are reasonably necessary to the ‘station in life’ of an infant and their actual requirements (defined in the Goods Act 1951, s 4).
- Void: of no legal effect.
- Voidable: an agreement that may be affirmed or rejected at the option of one of the parties.
Introduction
In this, and the next two chapters on consent and legality, we look whether the contract that you created is valid, voidable, void or unenforceable. In other words, is the contract you created (or working with, valid?) This chapter will also introduce you to the rules regarding the capacity of the parties to a contract and whether they fully understand the terms and conditions of the contract. Under both common law and statute law there are certain types of people who are considered to be incapable, either partly or completely, of understanding the rules and obligations associated with them entering into a contract. However, this is not the end of the story. You still need to know whether there is real consent to the contract by one or both of the parties (Chapter 9) and whether the purpose of the contract is legal (Chapter 10) before you can say with any confidence that the contract is valid. And even though we might have a valid contract, don’t assume that is the end of contract law because problems can still arise as to exactly what have the parties agreed to (Chapter 11) and what happens if one of the parties doesn’t comply the terms of the contract, in other words, they breach the contract (Chapter 12).
Step 4: Capacity to contract
Do the parties to the contract have full contractual capacity?
Only a normal, sane, sober adult person (s 17 of the Companies Act 1997 gives a company the same legal capacity as an ‘individual’ until it is deregistered) has full capacity to make a contract. Only adult persons, as in, those persons over the age of 18 have the capacity or ability to understand what it is they are entering into.
Having capacity is more than just having the ability to sign the contract. You need to consider a number of factors concerning the party you are dealing with including:
- Do they understand all the facts?
- Do they understand what their rights and obligations are?
- Are they able to weigh up those rights and obligations in coming to a decision?
- Do they understand the consequences of the choices they make?
So who are infants (or minors) in PNG?
The Constitution and Organic Law provides for full contractual capacity from the age of 18 years. This does not mean that an infant, as in, someone under the age of 18 cannot enter into contracts. They can and the law will offer protection to them from exploitation.
For example, in the case of an infant getting a job, there is an employment contract between the infant and the employer (see, for example, the Employment Act 1978 which prohibits the employment of children under 11) which provides that children between 11 and 16 can be employed as long as the employment doesn’t interfere with school attendance, they have parental permission and the infant gets paid for their services.
Online reference
If you are interested in the employment of young persons and what the Employment Act 1978 says about terms of employment (s 103), working under injurious conditions (s 104) or hours of employment (s 105) see sections 103 – 105 of the Employment Act 1978.
Classification of contracts for infants
Insofar as an infant is concerned, whether the contract is valid, voidable or void will depend on what the contract is about.
What is a valid contract for an infant?
The general rule at common law is that a contract made by an infant is voidable except in two instances (where it is valid and binding on both parties):
- contracts for necessaries
- beneficial contracts of service.
What are contracts for necessaries?
The definition of necessaries includes articles and services essential for the reasonable comfort of the infant, as well as basic food, medicine, education, clothing and shelter. Goods supplied to the married infant’s family, and goods supplied in contemplation of marriage, are also regarded as necessaries at common law. This means that lifestyle and the infant’s situation must be considered when trying to determine whether the goods or services are capable of being necessaries or not and the transaction may be caught under s 4 of the Fairness of Transactions Act 1993 if the contract is unfair.
Section 4 of the Good Act 1951 defines necessaries as goods suitable to the condition in life of a person (including an infant) and to their actual requirements at the time of sale and delivery. In other words, the lifestyle and situation of the person or infant will determine what are necessaries.
To successfully sue an infant, a business (the plaintiff) must be able to establish two factors.
- Are the unpaid goods or services capable of being necessaries? The court has to first be satisfied that, in the circumstances, the goods or services are capable of being a necessary, and this is a question of law. The onus is on the plaintiff to prove that they are, and, if they fail, the case is dismissed. If the goods or services are capable of being considered to be a necessary for the infant, then the plaintiff needs to go on and establish the second point.
- Are the goods or services necessaries at the time of sale and delivery? This is a question of fact. Look at the actual requirements of the infant and decide whether the infant was adequately supplied with these goods or services at the time of sale or delivery. It may be necessary here to consider the social standing of the infant, their occupation, social conditions, whether they were already adequately supplied and other similar factors.
There seems to be no reason why services cannot also amount to necessaries if it can be established that the contract is beneficial to, or a necessary service for, the infant – for example, paying for tuition that the infant could subsequently use to obtain employment.
Even if a trader establishes that a contract with an infant is for the supply of goods or services that amount to necessaries, the contract can still be void if it contains harsh or onerous terms under s 4 of the Fairness of Transactions Act 1993. The contract must, on balance, be fair. Note the words ‘on balance’ because they suggest that the law recognises that a contract can contain unreasonable terms without being invalid. There has to be a balance. If it is, the infant will be bound to pay but only a reasonable price for the goods under s 4(3) of the Goods Act 1951.
Business tip
Should I sell goods or provide services to an infant on credit?
There is considerable risk for a trader to sell goods or services to an infant on credit. If the infant is already well supplied with those articles or services, then the supplier would not only be unable to enforce payment, but in the case of goods they may not be able to recover them (unless the goods were obtained by fraud). If the supplier hopes to be able to enforce the contract, they must ensure that:
- the goods or services are capable of being, and are, necessaries
- the contract does not contain any harsh or onerous terms; and
- the price is reasonable.
What is a beneficial contracts of service?
Beneficial contracts of service are the second exception to the non-enforceability rule of a contract entered into by an infant at common law and there is limited protection under legislation (for example, ss. 79-80 of the Child Welfare Act 1961, the Lukautim Pikinini (Child) Act 2015, and ss 103-105 of the Employment Act 1978).
Beneficial contracts of employment are contracts of employment, apprenticeship, training or education and can contain unfavourable terms but this does not necessarily mean the contract will automatically be declared void. In these types of cases, the court will:
- examine the contract as a whole
- weigh the onerous (harsh) terms against the beneficial terms, and
- decide, looking at the contract as a whole, whether the balance is in favour of the infant.
Reflection question
Let’s test your understanding of what is a fair contract of employment for an infant.
FACTS: The defendant, while still an infant, had entered into an article clerkship with the plaintiff to become a solicitor. One of the terms in the agreement was that the defendant would not practise as a solicitor within 200 kilometres of Port Morseby, where the plaintiff had his practice. A year after the defendant had finished his articles, he commenced practice in Lae and the plaintiff sought an injunction to stop him.
ISSUE: Do you think the clause was so onerous that it outweighed the beneficial terms and that therefore the contract was not valid?
DECISION: So, what do you think?
COMMENT: Look at the question from both points of view, as in, the infant and the employer. Also think about whether something like s 4 of the Fairness of Transaction Act 1993 could apply here.
Where the contract is for employment, instruction or education of the infant, it will generally be treated as binding by the courts as long as it is possible to identify that it provides, on balance, benefits to the infant.
While benefit is the basis for the validity of this type of contract, this does not mean that any contract that the infant enters into and obtains benefits from will be automatically enforced against the infant. Thus, a trading contract such as a loan agreement with a finance company may result in financial benefit to the infant but it may not be binding.
What types of contract are valid unless voided by an infant?
The class of contracts involved is limited to those through which the infant acquires an interest in some subject matter of a permanent and continuous nature. For example, purchase of shares in a company and partnerships. The contractual obligation then remains until the infant decides to put an end to it.
When an infant repudiates (rejects or ends) a voidable contract during infancy or within a reasonable time after becoming an adult (and what constitutes a ‘reasonable time’ depends on the circumstances in each case), under the common law the rights and liabilities that accrue after repudiation cease. The infant will remain liable for any obligations accrued up to the time of repudiation of the contract unless there has been a total failure of consideration.
Money already paid by an infant under a voidable contract is irrecoverable unless the infant has received no benefit from the contract whatsoever – that is, there has been a total failure of consideration. However, no matter what the subject may be, the courts are reluctant to find that the infant has received no benefit.
Does a corporation have the capacity to contract?
Contracts can be made by both ‘natural persons’ and ‘legal persons’. The latter are a creation of the law but are treated by the law as having the complete legal capacity of a natural person – for example, corporations.
In corporation under the Companies Act 1997 s 16 gives a company a separate legal existence from that of its members. It should be viewed as an ‘independent person’ with its own rights and liabilities. As such, its contractual capacity is limited only by natural impossibility when it comes to entering into personal contracts because it is an artificial creation.
The fact that an act is not in the best interests of a company does not affect the capacity of the company to do the act (s 18(3)). Under s 155, a company may be bound by contracts (including deeds) entered into by its agents acting on behalf of the company with express or implied authority.
Do bankrupts have the capacity to contract?
Bankruptcy is a legal process that can occur when an individual cannot pay their debts as and when they fall due. The process is governed by the Insolvency Act 1951.
A person can become bankrupt voluntarily while owing any amount – a debtor’s petition. However, creditors cannot make a person bankrupt unless the debt they are owed is K100 to one creditor, K140 to two creditors or three or more creditors K200 or more (s 25(2))(a creditor’s petition).
As a general rule, bankrupts can still contract, but their contractual capacity is limited during the period of bankruptcy (which will normally last for three years: ss 131(c), 134(1)). A director cannot hold their position on a company Board while bankrupt (Companies Act 1997, Sch 5.3(a1))
Do mentally unsound and intoxicated persons have the capacity to contract?
Contracts with the mentally unsound or the intoxicated are usually regarded as being voidable at the option of that person unless they are for necessaries. The Goods Act 1951, s 4(3) requires that mentally unsound and intoxicated persons who purchase goods that are necessaries must pay a reasonable price for them.
The Goods Act 1951 is silent where the goods are not necessaries. Under the common law the person suffering the disability may be able to repudiate the contract when they are again of sound mind or sober, if at the time of contracting:
- they were suffering from such a degree of mental instability or were so inebriated that they were incapable of understanding the nature of the contract; and
- this was known, or ought to have been known, by the other party.
The onus of proof lies on the person wishing to repudiate the contract and must occur within a reasonable time of regaining sobriety or soundness of mind. But it should also be noted that it is not easy to have a contract set aside unless the lack of capacity was known or was readily observable at the time of contracting.
Reflection questions
Well done. You have reached the end of another chapter. Here are some more reflection questions to test your understanding of what you have read. Don’t forget to make notes of your answers as it will help you with your revision at the end of the Unit.
- Discuss how a court decides whether goods or services purchased by an infant will result in a valid contract.
- Samantha, an infant, obtained a loan of money from Lucy by telling her that she was 19 when in fact she was only 16. Samantha subsequently defaulted on the loan repayments and Lucy wants to know whether she can recover her money. Advise Lucy.
- Ryan, a 78 year old alcoholic who, during a drinking session with Bromley, was induced to sell his farm to him for much less than its market value. A written contract was drawn up at the Bar and signed by both parties. Ryan later refused to go through with the sale. Is the contract that Ryan signed enforceable by Bromley? Explain.
- Steinberg, a minor, applied for and was allotted shares in a company when she was 16. She received no dividends and attended no company meetings. Before she turned 18 she repudiated the contract and tried to recover the money she had paid for the shares. Can she recover the money? Explain why?
Key points
An understanding of the following points will help you to better revise material on capacity.
- What are the common law rules regarding contracts entered into by infants, and when are such contracts valid, voidable or void? Contracts entered into by infants at common law are regarded as either:
- valid (if it can be established that they are for necessaries or beneficial contracts of service and that the price is reasonable)
- voidable (binding unless repudiated by the infant and involving the acquisition of an interest in property of a permanent nature or a continuing obligation), or
- void (they do bind the other party and cover purchases of non-necessaries and trading contracts, but are not binding unless ratified by the minor after attaining majority).
- What are the common law rules with regard to capacity to contract with respect to the following?
- Corporations. A company is an artificially created legal person, but has the capacity of a natural person. The contractual capacity of a corporation is exercised through individuals who have the company’s express or implied authority and are acting on behalf of the company.
- The mentally ill and those under the influence of alcohol. If a person who was mentally ill or intoxicated at the time of contracting can establish that they did not understand what they were doing and that the other person was aware of their disability, the contract (which is voidable) can be set aside at the option of the mentally ill or intoxicated person when they become mentally sound or sober.