What is Capacity in Contract Law?

Under Australian contract law, capacity is an essential element for a legally binding contract.

Capacity is something that all parties to the contract must have, otherwise the contract may not be legally binding. It is only when there is a lack of capacity that the binding nature of a contract is called into question.

Below are the general legal principles regarding capacity under Australian contract law:

1. The law assumes that the parties to a contract have capacity

2. There may be a lack of capacity when a party is in a particular circumstance or has a characteristic that requires the law to step in and release that party from contractual obligations which might otherwise have applied

3. A lack of capacity may arise if a party is a minor (a person under 18 years of age), is mentally disabled or is bankrupt

4. A minor who is claimed to have entered into a contract may still be considered to have capacity if the contract is for necessary goods or services (that is, goods or services that are capable of being necessary and are actually necessary in the circumstances - Ref: Ryder v Wombwell)

5. Some contracts will be binding on a minor, but capable of being brought to an end by a minor either while the minor is still under 18 years of age or (if over) within a reasonable time of turning 18

6. Some contracts are not binding on a minor unless the minor subsequently takes a positive step to confirm the contract (in most States, this confirmation must be in writing and signed by the minor)

7. A mentally disabled person is assumed to have capacity unless, when entering into the contract, they were incapable of understanding the agreement and the other party knew or ought to have known about this

8. A person who is extremely intoxicated by drugs or alcohol is treated the same as a mentally disabled person when it comes to capacity, but mild (not extreme) intoxication is not considered to give rise to a lack of capacity

9. A bankrupt is themselves considered to lack capacity, however contracts entered into prior to the bankruptcy are still value but vest in the trustee of the bankruptcy

What is Capacity in Contract Law

Author: Farrah Motley, Legal Principal of Prosper Law and an Australian contract lawyer.