Topic 6 – Contract Law – Capacity, Consent and Illegality
Recommended Readings
Gibson & Fraser – Chapters 16-18
At the completion of this topic students should be able to describe the:
Enforceability of Contracts
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Capacity
Consent
Illegality
Introduction
The previous topics outlined the principles for the formation of a valid contract. This
topic is concerned with the enforceability of contracts and the grounds upon which a
contract can be rendered void, voidable, illegal or simply unenforceable. Capacity
refers to the ability of the parties to contract and the law recognises limits on the
contractual capacity of some persons and entities to contract, either for their own
protection or for the protection of society. The principles in this area are outlined.
Contracts must be the outcome of each party’s genuine consent and consent will not
be real or genuine if any vitiating factors are present, including duress, undue
influence, mistake, misrepresentation and unconscionable conduct. The elements for
each of these vitiating factors are outlined with cases in support. Where a contract
has the aim or intention of committing an illegal act it will also be unenforceable. The
rules concerned with illegality are briefly discussed with reference to construction
contracts.
Void, voidable and unenforceable
A contract that is legally binding is described as valid and enforceable. Sometimes
contracts have impediments to their enforceability. The terms ‘void’, ‘voidable’ and
‘unenforceable’ are used to describe these contracts.
Void - the contract may be void from the beginning (ab initio) or become void. As a
result neither party can enforce its rights and obligations. Promises made are
unenforceable and neither party can recover damages from the other under a void
contract. For example, a contract entered into for the construction of a building in
contravention of building regulations.
Voidable - the contract is valid and binding upon the parties but one of the parties,
usually the innocent party, has the option of repudiating/rescinding or terminating the
contract. For example, a real estate agent who intentionally misleads a prospective
purchaser of land into believing that council permission will be given for the
purchaser’s planned development.
Unenforceable - the contract is valid but will not be enforced by the courts due to
some procedural or statutory requirement that has not been fulfilled. For example, an
oral contract for the sale of land is unenforceable because it is required by statute to
be evidenced in writing: see Law of Property Act 1936 (SA), s 26.
Capacity
Capacity to contract refers to the ability of the parties to enter into a legally binding
agreement. While capacity is not an element in the formation of a contract, it will
affect a contract’s validity. The general rule is that only an adult, sober person who
is of sound mind has full contractual capacity.
The law recognises that certain classes of people in society have limited or no
capacity to contract for their own protection:
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Minors
The intellectually impaired; and
Intoxicated persons
There are other groups whose contractual capacity is limited usually for society’s
protection:
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Aliens
Bankrupts; and
Corporations (in certain circumstances)
Prisoners
1. Minors
People under the age of 18 are referred to as minors and there are limitations
upon their capacity to contract under the law of each State and Territory. While
the law may vary in some jurisdictions it is mainly common law based, though
supplemented with legislation: for example, the Minors Contracts (Miscellaneous
Provisions) Act 1979 (SA).
In general, minors have limited capacity to enter into contracts. Contracts with
minors can be valid and enforceable, voidable and void.
Valid and Enforceable Contracts
The following contracts with minors are valid and enforceable. They are contracts
for necessaries and beneficial contracts of service.
a. Contracts for Necessaries
Contracts for necessaries mean a contract for items “suitable to the condition of
the infant and to his actual requirements at the time of sale or delivery” (Sale
of Goods Act 1895 (SA)). If the goods or services are not necessaries then
the minor will not be bound by the contract and therefore will not be liable for
the contract price.
b. Beneficial Contracts of Service
Contracts of service such as apprenticeship contracts or contracts relating to
education and training are valid and binding on the minor because they
provide the minor with the advantage of obtaining a livelihood. Unless they
are contracts for necessaries pure trading contracts are not legally
enforceable against a minor: Perform Sports v Proactive Sports [2007] 1 All
ER
542.
Voidable Contracts
There is a further category of contracts in relation to a minor that are called
voidable contracts where the minor has an option to repudiate the contract before
attaining the age of majority or shortly thereafter. These are contracts of
continuing obligation such as contracts to lease land, to acquire a business, to
take shares in a company and to become a business partner.
Void and unenforceable
All other contracts entered into by minors are void and unenforceable, unless they
are ratified by the minor upon turning 18. If the minor chooses to do nothing, then
generally speaking the contract will remain unenforceable. For example, a
contract to purchase or sell land with a minor is void, unless ratified by the minor
in writing upon reaching the age of majority.
Legislation and Minors
Given the obvious complications that the restrictions on the ability of minors to
contract can cause, legislation was introduced to outline the ‘rules’ relating to the
ability of minors to enter into binding contracts. For example: the Minors
Contracts (Miscellaneous Provisions) Act 1979 (SA) provides as follows:
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If an adult acts as guarantor such guarantee is enforceable against the
adult irrespective of fact that contract is unenforceable against the infant
(s 5)
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Any contract which is unenforceable against a minor at common law will
remain unenforceable unless it is ratified in writing on or after the day on
which the minor attains majority (s 4)
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A minor or any other party may apply to the court to approve a contract
which the minor otherwise would have lacked capacity to enter into (s 6)
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A court may, if it sees fit, appoint an agent to act on a minor’s behalf for
the purposes of entering into contracts and any liabilities incurred will be
enforceable against a minor (s 8).
2. Intellectually Impaired and Mentally Disabled Persons
At common law the mentally ill and intoxicated persons are treated in basically
the same way as minors. They are liable under contracts for the provision of
necessaries to pay a reasonable price, unless the necessaries have been
supplied as an act of charity: see: Re Rhodes (1890) 44 Ch D 94. However, the
contract will be voidable if it can be proved that at the time of entering into the
agreement the impaired person was:
(a) incapable of understanding the nature of the contract: and
(b) the other party knew, or ought reasonably to have known of that
party’s incapacity.
This rule also applies to persons incapacitated through alcohol and drugs where
they can show that they were so intoxicated at the time that they were incapable
of understanding the nature of the agreement, and the other party was aware of
their condition: ee Blomley v Ryan (1956) 99 CLR 362.
3. Aliens
An alien is simply a person who is not an Australian citizen or ordinarily resident
in Australia. There are specific restrictions on contracts involving foreign
investment, exports, imports and certain professional qualifications but these are
imposed by statute at State and federal levels. For example, where a foreign
citizen seeks to purchase established or newly built residential property or vacant
land, they must obtain approval from the Foreign Investment Review Board.
Otherwise aliens have full contractual capacity.
Contracts, however, with enemy aliens are illegal. An “alien enemy” includes
subjects of a foreign country with whom one’s country is at war and persons who
voluntarily reside or carry on business in enemy occupied territory. A company is
regarded as an alien enemy if it is directed by persons described as alien
enemies.
4. Corporations
Once a company is incorporated it is a separate legal entity from its members.
Under s 124 of the Corporations Act 2001 (Cth) companies now have effectively
the same contractual capacity as a natural person, therefore a company is
capable of suing, being sued and acquiring and owning property.
Section 125 provides that, even if a company’s constitution contains an express
restriction on, or a prohibition of, the company exercising any power that, by
itself, will not invalidate any exercise of that power. A company’s contracts and
arrangements will not be invalidated simply because they are “ultra vires”.
Therefore, a contract entered into by the company may be enforceable against its
directors even if under the company’s memorandum and articles the company
has entered into contracts that are outside of its powers.
5. Bankrupts
As a general rule bankrupts can still contract but limitations are placed on their
ability to enter into certain types of contracts under the Bankruptcy Act 1966
(Cth).
Section 269 of the Act provides that an undischarged bankrupt may not obtain
credit, obtain goods or services, and enter into a hire-purchase, leasing or hiring
agreement if the amount is equal to or greater than $3000 in credit. They must
not carry on business unless disclosing that they are a bankrupt.
The trustee in bankruptcy has discretion to disallow any contracts made by the
bankrupt. Upon bankruptcy all the bankrupt’s property passes to the trustee and
so in the sale of bankrupt’s property it is the trustee who is the vendor.
6. Convicts or Prisoners
Under the Criminal Law Consolidation Act 1935 (SA) a prisoner can enter into a
contract but the Controller of Prisons has the discretion to disallow such contract.
Consent
A contract may appear on the face of it to be properly formed, however, its
enforceability may be affected if certain factors prevail.
There is no real agreement if the consent of one of the parties has not been freely
given. One or both parties may have made a mistake. One party may have been
induced into entering the contract by another’s misrepresentation. A party may be
forced into contracting through threatened or actual violence, or they may have been
pressured into entering a contract. Factors affecting the enforceability of contracts
are referred to as vitiating factors and they include:
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Misrepresentation
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Mistake
Duress
Undue Influence
Unconscionable conduct
Misrepresentation
In pre-contractual negotiations statements and promises may be made regarding the
subject matter of the proposed contract. Such statements or promises are usually
made to induce the other person to enter into the contract. Some statements may
become terms of the contract. If the statement does not become a term it is a
representation. If it is false it then becomes a misrepresentation which may be
actionable at common law and/or under legislation.
Misrepresentation defined
A misrepresentation refers to a statement of material fact made during negotiations
that is false, has induced the innocent party to enter the contract and which has
caused damage or loss
A statement of fact
For the misrepresentation to be actionable the statement must relate to a past or
existing fact. At common law statements of law, promises, opinions, silence and
puffs are not actionable, though there are some exceptions.
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A misstatement of the law is not a misrepresentation because we are all
assumed to know the law. Only when the statement of law is made without
any genuine belief in its truth will it become actionable as misrepresentation.
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Promises or statements of future intention are not actionable as
misrepresentation unless at the time of making the promise there was no real
intention to do what was promised. In these circumstances the statement
becomes one of existing fact and liability arises in the tort of deceit (fraudulent
misrepresentation): See Edgington v Fitzmaurice (1885) 29 Ch D 450.
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Statements of opinion are not actionable as misrepresentation except where
the opinion was expressed with no genuine or actual belief in its truth; or no
reasonable person could have held the opinion; or the person stating the
opinion was in a better position to know the true facts.
Silence as misrepresentation
Silence can constitute misrepresentation if it distorts a representation made. It can
have legal consequences in the following circumstances:
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Distortion of a positive representation; that is, a statement made that is a halftruth: see Krakowski v Eurolynx (1995) 183 CLR 563.
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If a statement was true but became false before the contract was settled: see
With v O’Flanagan [1936] 1 Ch 575.
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Subsequent discovery that the statement is false: see Lockhart v Osman
[1981] VR 57.
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If there is a fiduciary relationship between the parties;
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If the contract is a contract of the utmost good faith (or contracts uberrimae
fidei), such as insurance contracts.
Fiduciary relationships
Where a statement is made by a party in a fiduciary relationship, there is a positive
duty to disclose all material facts whether or not that person is asked about them.
These are relationships of trust and confidence well recognised at common law,
such as the relationship between a professional and their client; for example, an
architect or engineer and the principal.
Classes of misrepresentation
At common law actionable misrepresentation can be divided into three classes:
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Innocent
Fraudulent
Negligent
Innocent misrepresentation
An innocent misrepresentation is a false statement made with reasonable grounds
for believing it to be true both at the time it was made and at the time the contract
was entered into. If it is not a term of the contract, no damages can be claimed,
however, the remedy of rescission will be available.
Fraudulent misrepresentation
A fraudulent misrepresentation is a false representation of material fact made:
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knowingly, or
without believing in its truth,
or recklessly, careless whether it be true or false
Whether or not the representation has become a term of the contract, the injured
party can sue for damages in the tort of deceit. There is also the option of avoiding or
rescinding the contract.
Negligent misrepresentation
Negligent misrepresentation is a relatively new area of misrepresentation. It is a tort
which if proven will entitle the innocent party to sue for damages and in cases where
negligence leads to a contract being formed, to rescission of that contract.
To establish negligent misrepresentation all the above elements required to establish
misrepresentation must be proved and in addition the plaintiff must prove that there
is a duty of care owed by the defendant to the plaintiff and that duty was breached.
A duty of care exists when there is a fiduciary relationship between the parties and
where there is a special relationship: see Shaddock v Council of the City of
Parramatta (1981) 150 VLR 225. The duty applies to experts and non-experts.
Experts are professionals who are expected to observe the standard of care of
reasonable professionals in their chosen field, such as architects, engineers and
lawyers. Non-experts refer to persons who provide information in a business context,
though not professing to possess any actual skill or judgement, knowing that the
information they provide will be reasonably relied upon.
This duty especially relates to public bodies, such as councils, who have access to
specific information not generally available to the public. In Shaddock v Council of
the City of Parramatta a land developer relied on information supplied by a council
employee in relation to land he was proposing to develop. The information was
incorrect causing the developer to suffer financial loss. The High Court held that a
“special relationship” existed between the developer and the Council giving rise to a
duty of care to exercise reasonable care in providing the information and advice.
Misrepresentation under statute
The Misrepresentation Act 1971 (SA) and the Civil Law (Wrongs) Act 2002 (ACT)
modify the common law position by providing an action for damages for innocent
misrepresentation and a defence to an action for misrepresentation if the
representative can prove that they had reasonable grounds for believing that the
statement was true.
The Competition and Consumer Act 2010 (Cth) and the Fair Trading Acts of the
various States and Territories provide civil remedies, including damages, for conduct
in trade or commerce that is misleading or deceptive or likely to mislead or deceive.
(Refer to Topic 11 – Australian Consumer Law)
Mistake
Mistake in contract law has a much narrower and technical meaning than in its
general sense. The effect of an ‘operative mistake’ at common law is to make a
contract void ab initio (from the beginning) so that the rights of third parties who have
acquired an interest in the subject matter of the contract would be affected.
Unlike common law, equity recognises mistakes as to the value, nature or quality of
the goods or property under the contract. Mistake in equity only makes the contract
voidable, so that the mistaken party must exercise their option to avoid within a
reasonable time or before an innocent third party acquires an interest in the subjectmatter of the agreement.
There are four areas of mistake:
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common mistake
mutual mistake
unilateral mistake
mistake as to the nature of the document: Non est factum
Common Mistake
In this type of mistake the parties make the same mistake as to some underlying or
fundamental fact. For example, where the subject matter of the contract has ceased
to exist without the fault or knowledge of either party at the time the contract was
formed. However, this plea will not be available where a party has impliedly
warranted the existence of the subject-matter: see Mc Rae v Commonwealth
Disposals Commission (1951) 84 CLR 395.
Equity will avoid a contract where it would be unconscionable for one party to benefit
from the mistake and there is no bar to rescission: see Solle v Butcher [1950] 1 KB
671.
Mutual Mistake
In the case of mutual mistake, unlike common mistake, the parties are talking about
different things, that is, they misunderstand each other; they each make different
mistakes. There is no real agreement because the parties are at cross purposes and
there is no meeting of the minds.
For example, A offers to sell his 1990 Holden to B and B accepts believing it is a
1991 Holden when in fact it is a 1988 Holden.
Where mutual mistake has been pleaded, the courts apply the objective test: what
would a reasonable person believe was the true intention of the parties? If upon a
reasonable construction of the conduct of the parties there could be inferred an
agreement between them, the contract is created and mutual mistake would not be
successfully pleaded: see Raffles v Wichelhaus 159 ER 375.
Unilateral Mistake
a. As to the terms
This is when one of the parties is mistaken as to some fundamental term of the
contract and the other party is aware or should be aware of the mistake.
Where one party is under a misapprehension as to the contents of a written contract
and the other party knows and has done nothing to correct that error the equitable
‘remedy of rectification’ may be available: see Taylor v Johnson (1893) 151 CLR 422
where the written contract did not correctly state the price the property was to be
sold for. It stated a total price of $15,000 for 10 acres when in fact it was meant to be
$15,000 per acre. As the purchaser knew that the vendor was mistaken the court
granted the remedy of rectification.
b. As to the identity of the party
Where the identity of the person is a material factor in the mind of the party and they
are mistaken about the identity, the contract will be void. At common law, if the
agreement is for the sale of goods, a subsequent purchaser will acquire no rights to
the property, even though innocent: see Ingram v Little [1961] 1 QB 31 the two
sisters succeeded in getting their car back from an innocent third party who had
bought it from a “rogue” who had impersonated a business man in the area to pay by
cheque
The courts have held that a contract is voidable in equity where the identity of the
other contracting party is not crucial and it can be proved that the mistaken party
would have contracted with anyone appeared credit worthy: see Lewis v Averay
[1972]1 QB 198.
Non Est Factum
When a person has signed a document believing it to be something different from
what it actually is s/he may be able to rely on the defence of “non est factum”, that is,
it is “not my deed”, and to have the document declared void for mistake. It is
important to note that this limited defence is only available for written contracts: see
Petelin v Cullen (1975) 132 CLR 355.
Duress
If a contract is entered into by one party as a result of illegitimate threat or pressure
the contract is defective as the affected party’s assent to it has not been freely given.
The onus of proof is on the party claiming duress and the effect of duress is to make
the contract voidable so the threatened party is entitled to rescind the contract.
Three forms of duress can be identified:
1. duress of the person
If a person enters into a contract because of actual or threatened violence or actual
or threatened unlawful imprisonment to his/her person or his/her immediate family or
near relative, then the contract is voidable.
2. duress of property
A party to a contract may rescind if s/he entered into a contract as a result of threats
made to seize, detain, damage or unlawfully destroy that party’s real or personal
property.
3. duress of a person’s economic well being
The courts will not uphold a contract in which one party was induced to enter as a
result of illegitimate pressure exerted by another. Unlike duress of the person and
duress of property economic duress does not necessarily involve other civil and
criminal breaches.
The origins of economic duress can be seen in D& C Builders v Rees [1966] 2 QB 617
where the defendant’s wife, Mrs. Rees, after delaying a payment of £482 to the plaintiff
building company, D&C Builders for six months, knowingly took advantage of the
building company’s desperate financial position at the time by offering them either £300
in full settlement or nothing if they did not accept. The court held that the actions of Mrs.
Rees had amounted to improper pressure to compel D&C Builders to accept a sum
substantially less than what Rees truly owed. Mrs. Rees’ actions were inequitable (i.e.
unfair) because she was taking advantage of the situation where D&C Builders were in
need of money.
The issue of economic duress was considered in North Ocean Shipping Co Ltd v
Hyundai Construction Co. Ltd [1979] QB 705 and more recently by the English
Technology and Construction Court in the cases of DSND Subsea v Petroleum
GeoServices [2000] BLR 531 and Carillion Construction Limited v Felix (UK) Limited
[2001] BLR 1.
Undue Influence
As defined in Johnson v Buttress (1936) 56 CLR 113 “undue influence is the
improper use by the ascendant person of their ascendancy for the benefit of himself
or someone else” It is the abuse of a relationship of trust or dependence.
Undue influence is presumed where the parties are in a recognised pre-existing
relationship, such as a fiduciary relationship, and the party occupying the more
superior position has the burden of proving that the contract was the outcome of the
free and informed judgement of the other party: see Tate v Williamson (1866) LR 2
Ch 215.
Where there is no recognised pre-existing relationship it is up to the party claiming
undue influence to raise the evidence to prove that there is a relationship of
dependence, trust and confidence where the stronger party exerted mental
dominance over them to such an extent that they could not exercise any
independent judgement: see Johnson v Buttress and Re Craig [1971] Ch 95.
If undue influence is found to exist the weaker party has an option to avoid the
contract (subject to the bars to rescission),
Unconscionable Conduct
This refers to the inequality of bargaining power that sometimes exists between
contracting parties. Where duress or undue influence cannot be found then equity
may make an order to set aside a contract on the basis that the contract is
unconscionable. It is where one party has some ‘disability’ in the transaction about
which the other party knows or should have known and the stronger party takes
advantage of that weakness.
.
The leading case is CBA v Amadio (1983) 151 CLR 447 where the son was in
financial trouble and got his elderly Italian parents to sign a guarantee. The bank
took advantage of their lack of English and the fact that they did not understand the
documents they were signing. The Court set aside the guarantee because the
Bank’s actions were unconscionable.
In Blomley v Ryan (1956) 99 CLR 362 the unconscionable conduct consisted in one
party taking advantage of another party’s drunkenness to procure a contract.
Statutory Unconscionability
Both the State and Territory Fair Trading Acts and the Competition and Consumer
Act 2010 (Cth) provide civil remedies for unconscionable conduct in the supply of
goods and services: see Topic 10- Consumer Law.
Illegality
Contractual illegality may arise from a statutory prohibition of a particular type of
contract or the manner in which the contract is performed. In either situation the
contract is illegal and unenforceable. The parties may even incur further legal liability
where such breaches also carry penalty provisions.
If a contract is ‘illegal as formed’ it is void, regardless of the parties’ intention or
knowledge, and no action can be taken by either party to enforce the terms. For
example, a contract for the construction of a building in breach of planning
regulations will be illegal: see Re Mahmoud and Ispahani [1921] 2 KB 716 where an
official order prohibiting the sale of linseed oil rendered the contract between the
parties invalid and unenforceable.
If a contract is legal as formed but becomes ‘illegal as performed’ it will be
unenforceable by the offending party: for example, where a tenant leasing land uses
it for an illegal purpose. In this situation the landlord, as an innocent party, may
recover damages for breach of contract.
Further examples of contracts illegal as performed include the failure by a party to
obtain required approvals or permits for certain building work. Whether or not the
statute prohibits recovery for work done in these circumstances is a matter of
construction: see Hayes v Cable (1961) 62 SR (NSW) 1. In general, where a
contractor carries out certain work in breach of regulation on the request of the
principal, it would be very rare that the contractor would be barred from recovery for
the work done. The responsibility for the breach would rest with the contractor.