When determining the parties to a contract, it is important to consider if the parties have contractual capacity to enter into legal relations. If a party falls within a category of persons that lack the legal qualification or capacity to enter into a contract, it is likely that the contract will not be enforceable against them.
On a preliminary basis, it is important to remember the presumption of capacity, which states that where a party enters into a contract, it is presumed that the party has legal capacity to do so. Such a presumption may however be rebutted by evidence showing that the party lacks capacity. In this regard, different rules apply for different categories of people, for instance – minors, people with mental disabilities or those who are intoxicated, corporations (including partnerships and unincorporated associations), the Crown and bankrupts. This article will focus on a couple of these classes of people.
Typically, a contract will be voidable if a party can put forward evidence that:
- Due to them having a certified mental disorder, they were unable to understand the nature and consequences of entering into the contract; and
- The other party had knowledge, or ought to have had knowledge, about this mental disability (Knowledge Criterion).
This means that even if the contract entered was ‘unfair’ to the party alleged to have been lacking capacity, the presumption of capacity will not be rebutted until the Knowledge Criterion has been satisfied (see Hart v O’Connor  1 AC 1000).
In Gibbons v Wright (1954) 91 CLR 423, the High Court of Australia was required to determine if the plaintiff would become the sole registered proprietor of a property after she argued that her two sisters (who were co-owners) lacked capacity when they executed documents to change the ownership of that property from joint tenancy to tenants in common. The Court stated the threshold regarding the soundness of the parties’ minds, being that, the parties ought to have had the capability to understand the general nature of their participation in the contract and the capacity to understand the nature of the transaction when explained. Here, the plaintiff’s sisters had already died and the criteria for capacity was not met, which means that unless the plaintiff’s sisters sought to avoid the contract during their lifetime, the contract would remain valid.
It is also noteworthy that the degree of a party’s incapacity may also become relevant to determine if the other party acted unconscionably during the negotiation of the contract’s terms (see Blomley v Ryan (1954) 99 CLR 362). Here, even if capacity has been satisfied, the contract may nevertheless become unenforceable if unconscionable conduct is present.
Whilst bankrupts are not prohibited from entering into contracts, some sections of the Bankruptcy Act 1966 (Cth) (Act) may classify it as an offence if the bankrupt entered into certain transactions. For example, a bankrupt will commit an offence and be liable to penalty pursuant to section 269 of the Act if they obtain credit greater than $5,881.00 without disclosing that they are a bankrupt.
The key takeaway is that it is extremely important to check that the party you may be entering into a contract with has the requisite capacity to enter into legal relations. If the other party is successful in arguing that you ought to have known about them lacking capacity, this may render the contract unenforceable.
*** Assisted by: Neil Bookseller ***
If you have any questions or claims regarding contract law, please contact Mr Stipe Vuleta or Ms Sayward McKeown of our Litigation & Restructuring Team on (02) 6188 3600.