Unit 7 AS: Analyze a Contractual Situation

BLAW 2051 Unit 5

Consideration, Capacity & Legality

Elements of Contract

In Unit Four, we were introduced to contract principles and terminology, as well as the first of four elements of contract – the agreement. This Unit explores the remaining three elements of contract – consideration, capacity, and legality.

The Second Element: Consideration

Consideration in contracting is the exchange that takes place between the parties to the contract. Consideration must be legally sufficient which involves the exchange of benefits and detriments for each of the contracting parties. For example, in a bilateral contract, parties exchange a promise for a promise – so legally sufficient consideration could involve the exchange the promise of work for the promise of salary. These are the benefits of the contract, but to the party that owes the other, they are also the detriments. In other words, the employer in this scenario would receive the benefit of the work, but would be responsible for the detriment of payment. These same requirements would apply in a unilateral contract, but instead the exchange would be a promise for an action.

It is also essential that consideration be adequate. Ordinarily, courts don't question the equivalency of an exchange. This means it is possible to sell a highly valued item, such as a house, for a small amount of money, like $1.00. Courts will only review the adequacy of consideration when there is a suggestion that an imbalance in consideration has resulted from factors that call into question the fairness of the entire transaction – such as an extreme difference in the bargaining power of the parties.

When there is a lack of consideration, it is ordinarily the case that a court will not enforce a contract, declaring it void. However, there is an exception to this principle called promissory estoppel. If there is a promise made, that is reasonably relied on by the other party, and the party relying on the promise would be harmed if the promise wasn't enforced, a court may elect to enforce that promise despite a lack of consideration.

There are some common scenarios which can appear to students of contract law to satisfy the requirements of consideration, but really lack consideration. Three common scenarios are:

Past Consideration – This is an issue when one of the contracting parties is promising something in the contract that has already occurred. If consideration is in the past, it cannot be consideration for a new contract. For instance, a promise today to pay a worker for work completed last month would lack consideration.

Pre-existing Duty – This is an issue when one of the contracting parties has a pre-existing duty to perform. If a party already has a duty to do something, that duty cannot supply consideration for a new contract. For instance, a police officer in your community cannot charge you a weekly fee to patrol your neighbor since they already have a duty to protect and serve that same community.

Illusory Promises – This is an issue when a promise may sound like a promise, but is actually conditioned on another factor. A good signal that a promise may be illusory is the use of the word "if" in making the promise. An illusory promise cannot supply the benefits and detriments necessary to support consideration in a contract.

The Third Element: Capacity

Capacity, the third element required for a binding legal contract, requires that the person seeking to contract have the mental capability to understand the rights and obligations that come with the contract. Most people who enter contracts have capacity. This is why capacity, in a contracting situation, is presumed, unless capacity is questioned. For questions of capacity, it is possible to have either limited capacity or limited competency, or be incapable of contracting at all due to a lack of capacity, or incompetency.

Minors, those under the age of 18, can contract, subject to the right to disaffirm. Minors have limited capacity, and thus most of the contracts they enter into are voidable. A voidable contract is a contract that is legally enforceable unless the minor decides they no longer want the contract. The minor can then choose to disaffirm the contract, which means the minor is no longer legally responsible for the rights and obligations of the contract. This right, the right to disaffirm,

belongs only to the minor. If the other party in the contract is an adult, the adult cannot disaffirm.

Once the minor reaches the age of majority, or in some cases a reasonable time thereafter, the disability of minority is lifted, and the contract is no longer voidable. At this time, the minor can expressly ratify the contract, which involves making a statement that the now former minor still wants to receive the benefit of the contract. The former minor may also imply their ratification. This happens when the former minor takes actions consistent with wanting to continue to benefit from the contract, such as a minor continuing to drive a car after their 18th birthday.

There are some limitations on the minor's right to disaffirm, including contract for necessaries. Under the law, necessaries are items that are required for life, such as food and shelter, when an adult doesn't provide these things to the minor. A minor's contract for necessaries can still be disaffirmed, but the minor will be liable for the reasonable value of the necessary.

Intoxicated persons are those under the influence of alcohol, drugs, or another intoxicating substance to the extent that they can no longer understand the rights and obligations that come with a contract. This is a higher standard than just legally drunk or impaired. If someone who is so intoxicated that they do not understand the legal consequences of their actions manages to enter a contract anyway, that contract is voidable, and can be disaffirmed. Unlike the situation with the minor, the intoxicated person must give back the benefits of the contract they entered.

Finally, mentally incapacitated persons who cannot understand the rights and obligations of a contract may also have a right to disaffirm. In this situation, the right to disaffirm will depend on several factors. A medical diagnosis of mental or other illness impacting one's ability to think and reason is not enough. The person claiming mental incapacity must have been laboring under the defect at the time the contract is entered to render the contract voidable. If a person has had their right to contract taken away in a judicial proceeding, or adjudicated incompetent with a guardian appointed, any contracts entered by the mentally incapacitated person are void.

The Fourth Element: Legality

The final element of contract is legality, which requires that the contract have a lawful purpose. Some contracts are illegal because they are entered for the purpose of violating a state or federal law. For instance, a contract to gamble in a state where gambling is prohibited is an unlawful contract. A contract for a loan with an interest rate that violates the state usury rate is an unlawful contract. A contract to commit a crime is void as it lacks the element of legality.

In addition to contracts that violate a statute, some contracts are unlawful because they violate public policy. Such contracts are unlawful because a court will not enforce them. Some examples of contracts that violate public policy include:

Contracts in Restraint of Trade – Contracts in restraint of trade have the effect of limiting competition, so these are scrutinized by courts for their reasonableness. These contracts tend to be of two types – those that accompany the sale of a business, and those that are a part of an individual employment contract. Both types of contracts must be reasonable in terms of the length of time they limit competition, and the geographic areas in which the contract applies. If the contract is unreasonable in terms of time or location, a court may strike that contract as an unreasonable restraint of trade.

Unconscionable Contracts – Unconscionable contracts are contracts that disproportionately favor one side in the contract over the other. Normally, courts do not review contracts for their fairness outside of the determination that consideration is adequate (see above) but some contracts can be so one-sided and unfair that a court may refuse to enforce it and consider it void.

Contracts with Exculpatory Clauses – An exculpatory clause is a clause in a written contract that releases one party, usually the party that drafted the contract, from all liability to the other. When the contracting party using the exculpatory clause is in a business directly related to the public interest, courts usually favor holding such parties responsible to the public and may decline to enforce the exculpatory clause.

Valid contracts must have four elements – agreement, consideration, capacity and legality. If all four of these elements are present, the parties to the contract have created a legally binding agreement. If any one of these elements has failed, the contract is void and has failed to come into existence (or is voidable in the case of capacity).

(CSLO 2, CSLO 5)

References

Kubasek, N., Browne, M. N., Dhooge, L. J., Herron, D. J., Williamson, C., & Barkacs, L. L. (2015). Dynamic business law.

Chapter 15 – Consideration Chapter 16 – Capacity and Legality