I. FORMATION DEFENSES
A. Lack of Capacity
· Restatement (Second) § 7. Voidable Contracts
o A voidable contract is one where one or more parties have the power, by a manifestation of election to do so, to avoid the legal relations created by the contract, or by ratification of the contract to extinguish the power of avoidance.
· Restatement (Second) § 8. Unenforceable Contracts
o An unenforceable contract is one for the breach of which neither the remedy of damages nor the remedy of specific performance is available, but which is recognized in some other way as creating a duty of performance, though there has been no ratification.
· Restatement (Second) § 12. Capacity to Contract
o (1) No one can be bound by contract who has not legal capacity to incur at least voidable contractual duties. Capacity to contract may be partial and its existence in respect of a particular transaction may depend upon the nature of the transaction or upon other circumstances.
o (2) A natural person who manifests assent to a transaction has full legal capacity to incur contractual duties thereby unless he is
§ (a) under guardianship, or
§ (b) an infant, or
§ (c) mentally ill or defective, or
§ (d) intoxicated.
· Restatement (Second) § 13. Persons Affected by Guardianship
o A person has no capacity to incur contractual duties if his property is under guardianship by reason of adjudication of mental illness or defect.
· Restatement (Second) § 14. Infants
o Unless a statute provides otherwise, a natural person has the capacity to incur only voidable contractual duties until the beginning of the day before the person’s eighteenth birthday.
· Restatement (Second) § 15. Mental Illness or Defect
o (1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect
§ (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or
§ (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition.
o (2) Where the contract is made on fair terms and the other party is without knowledge of the mental illness or defect, the power of avoidance under Subsection (1) terminates to the extent that the contract has been so performed in whole or in part or the circumstances have so changed that avoidance would be unjust. In such a case a court may grant relief as justice requires.
· Restatement (Second) § 16. Intoxicated Persons
o A person incurs only voidable contractual duties by entering into a transaction if the other party has reason to know that by reason of intoxication
§ (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or
§ (b) he is unable to act in a reasonable manner in relation to the transaction.
· Restatement (Second) § 48. Death or Incapacity of Offeror or Offeree
o An offeree’s power of acceptance is terminated when the offeree or offeror dies or is deprived of legal capacity to enter into the proposed contract.
§ Comment: a. Death of offeror. The offeror’s death terminates the power of the offeree without notice to him. This rule seems to be a relic of the obsolete view that a contract requires a “meeting of minds,” and it is out of harmony with the modern doctrine that a manifestation of assent is effective without regard to actual mental assent….
· UCC § 1-103 (b). Construction of [Uniform Commercial Code] to Promote Its Purposes and Policies; Applicability of Supplemental Principles of Law
o (b) Unless displaced by the particular provisions of [the Uniform Commercial Code], the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, and other validating or invalidating cause supplement its provision.
· Legal capacity of both the offeror and offeree is essential to formation of a contract. Parties lacking legal capacity cannot give legally binding mutual assent. Legal capacity should be distinguished from physical capacity. While a person may be physically able to perform the acts necessary to otherwise create a binding contract, if that person possesses a legal disability, the purported contract will either be void or voidable. Typically, contracts entered into by the following persons will be void or voidable: minors, insane persons, convicts deprived of their civil rights, and intoxicated persons.
o Contracts of Minors: The contracts of a minor are voidable at the option of the minor, although the minor may nevertheless enforce the contract against the adult. Note that in some states there are contracts that are not merely voidable but void (e.g., contracts for the sale of real estate).
o Quasi-contract liability for “necessaries.” Minors are always liable for the reasonable value of necessaries of life (e.g., food, clothing, shelter). This is based on quasi-contract rather than contract liability.
o Bowling v. Sperry, 184 N.E.2d 901 (Ind. Ct. App. 1962) – Determination of “necessary”
§ Facts: Bowling (P), who was 16, and his aunt went to Sperry (D), a car dealer, and P bought a used car for $140. After a week, he discovered that the main bearing was burned out and returned it for repairs. D told him repairs would cost up to $95, and P disaffirmed the purchase contract and demanded that D return his money. D refused and P sued. The trial court found for D, and P appeals.
§ Issue: May a minor rescind a contract for the purchase of a car which is not vital to his existence?
§ Holding: Yes. Judgment reversed.
§ Generally, contracts of minors are voidable and may be disaffirmed at any time during the minor’s minority, regardless of a failure to place the other party in status quo. The fact that P’s aunt accompanied him when he bought the car does not change the character of the contract, even though the aunt actually paid D the money. P had simply borrowed the money from her. D was fully aware of P’s age when he sold the car and the receipt was in P’s name alone.
§ D’s claim that P himself damaged the car is no defense to P’s suit; a minor is not required to tender back the money or property he has received, or to put D in the same position he was in before entering the contract.
§ There is an exception to the general rule for sales of things that are necessary to the support, use, or comfort of the person of the minor, such as food, clothing, lodging, medical care, and education. Whether goods are necessaries is a question of law. P introduced evidence that he had a summer job, but that he rode to work with other workers and used the car only for pleasure. While cars may be necessaries in some circumstances, here the car P bough was not so vital to P’s existence that it would be classified as a necessary. Therefore, the general rule applies in this case and P could rescind the contract.
o Mental Incapacity: A person lacks mental capacity to contract only if his mental processes are so deficient that he lacks understanding of the nature, purpose, and effect of the transaction.
o Restatement Position: The position of the Restatement (Second) section 18C is more liberal than this. Incapacity exists wherever a party is “unable to act in a reasonable manner, and the other party has reason to know of his condition.”
o Effect: A contract entered into by a person lacking mental capacity is voidable by him or his guardian (but not by the other party). In some states, contracts of those judged insane are entirely void.
o Quasi-contract for necessities: The incompetent’s estate is liable for the reasonable value of any necessaries furnished to him.
o Heights Realty, Ltd. v. Phillips, 749 P.2d 77 (N.M. 1988) – Reasonableness
§ Facts: Heights Realty, Ltd. (P) entered into an exclusive listing agreement with Gholson, who was 84 years old. The only terms were that the listing would last one year, the sale price was $250,000, and the minimum cash down payment would be $75,000. A few weeks later, Gholson raised the down payment requirement to $100,000 by addendum. A month later, Gholson refused an offer to sell the property for $255,000. P sued. Gholson was adjudicated incompetent, and Phillips (D) was appointed conservator of her estate. The trial court found for D after determining that Gholson lacked the mental capacity to validly enter the listing agreement. P appeals.
§ Issue: May a person be deemed incompetent when there is no evidence that the result of the transaction is not one which a reasonably competent person might have made?
§ Holding: Yes. Judgment affirmed.
§ A person is mentally competent if she is capable of understanding in a reasonable manner the nature and effect of the act in which the person is engaged. There is a presumption of competency that must be overcome by clear and convincing evidence. A showing of previous incompetency is presumed to continue unless overcome by evidence that proves the existence of a lucid interval at the time an instrument was executed.
§ Relevant evidence in a competency case includes: (i) the person’s prior or subsequent condition, (ii) the person’s physical condition, (iii) the adequacy of consideration, (iv) whether the transaction was improvident, and (v) the relation of trust and confidence between the parties to the transaction. In this case, P’s agent testified that Gholson was fully aware of what she was doing and even corrected a misspelling in her name after reading the addendum. Gholson herself testified that she guessed at the asking price and did not recall signing the addendum because she could not think of “anything in sequence” at the time. Gholson’s relatives testified that she had begun acting confused prior to the date she signed the contract with P; she had erratic eating habits, could not deal with bills, and was forgetful. Medical evidence was inconclusive.
§ The evidence presented was conflicting and could only be
pick-up truck while it was in the possession of the minor. The minor was 16 years of age at the time of purchase and used the vehicle for nine months without incident. After nine months, the vehicle had mechanical problems, but the minor continued to drive the truck until the truck’s engine “blew up” and the truck became inoperable. At the time of the purchase, there was no inquiry by defendant sellers and no misrepresentation by plaintiff minor concerning his minority. Based on previous common-law decisions, the trial court reluctantly granted rescission of the contract. The court remanded and adopted a new rule concerning contracts with minors. Where the minor did not overreach, there was no undue influence, and the contract was fair, the court held that the vender was entitled to reasonable compensation for the use, depreciation, and willful or negligent damage to the article purchased.
§ Outcome: The court remanded the action to the trial court for further proceedings.
o Hauer v. Union State Bank, 532 N.W.2d 456 (Wis. Ct. App. 1995)
§ Procedural Posture: Defendant bank appealed a judgment of the Circuit Court for Winnebago County (Wisconsin), which voided a loan made to plaintiff borrower, required the bank to return the borrower’s collateral, and dismissed the bank’s counterclaim to recover proceeds from the loan on the borrower’s claims that her mental incapacity voided the loan agreement. The borrower cross-appealed the denial of attorney’s fees and punitive damages.
§ Overview: The borrower had been formerly adjudicated incompetent. Her guardian was discharged pursuant to a physician’s recommendation. A third party induced the borrower to get a loan for him and use her mutual fund as collateral. The third party promised the borrower he would pay the interest and the loan. The borrower and the third party met with a bank employee who explained the terms. When the loan went into default, the borrower filed a claim, alleging the bank knew or should have known of her mental incapacity. The circuit court found for the borrower. On appeal, the court held that the borrower’s complaint properly stated a cause of action. The court concluded there was evidence in the record, which supported the jury’s findings that the borrower was incompetent at the time of the loan, and the jury must have reached that conclusion to reach a verdict for the borrower. The court held that the return of the collateral and holding the borrower not liable for the money was the proper remedy because the bank did not demonstrate good faith in the transaction, but rejected the circuit court’s application of the infancy doctrine to reach the same result.
§ Outcome: The court affirmed the circuit court’s orders, which voided the loan to the debtor and ordered the bank to return the borrower’s collateral. The court affirmed the dismissal of the bank’s claim for proceeds. The court affirmed the denial of attorney’s fees to the borrower.
B. Mutual Misunderstanding
· Restatement (Second) § 17. Requirement of a Bargain
o (1) Except as stated in Subsection (2), the formation of a contract requires a bargain in which there is a manifestation of mutual assent to the exchange and a consideration.
o (2) Whether or not there is a bargain a contract may be formed under special rules applicable to formal contracts or under the rules stated in §§ 82-94.
· Restatement (Second) § 20. Effect of Misunderstanding
o (1) There is no manifestation of mutual assent to an exchange if the parties attach materially different meanings to their manifestations and
§ (a) neither party knows or has reason to know the meaning attached by the other; or
§ (b) each party knows or each party has reason to know the meaning attached by the other.
o (2) The manifestations of the parties are operative in accordance with the meaning attached to them by one of the parties if
§ (a) that party does not know of any different meaning attached by the other, and the other knows the meaning attached by the first party; or