Commercial Law
(Mgmt 348)
Professor Charles H. Smith
Capacity and Legality (Chapter 13)
Spring 2009
Introduction to Voidable or
Void Contracts
• Most contracts that have offer,
acceptance and consideration are
enforced without further inquiry.
• However, further inquiry may show that
the contract is voidable or void due to
lack of capacity, illegality, mistake,
fraud, duress, undue influence or
unconscionability.
Introduction to Voidable or
Void Contracts cont.
• Voidable contract
– Can be disaffirmed by party who lacks capacity or
is victim of situations such as mistake or fraud.
– Other party must perform unless disaffirmance
takes place.
– If disaffirmed, voidable contract will be rescinded
(see Civil Code § 1689(b)(1)).
• Void contract (Civil Code §§ 1598 and 1599)
– Will not be enforced by the court due to illegal
purpose.
– Instead, court will dismiss case involving illegal
contract.
Introduction to Capacity to Enter Into
a Contract
• “All persons are capable of contracting, except
minors, persons of unsound mind, and persons
deprived of civil rights” (Civil Code § 1556).
• We will cover capacity issues relating to “minors”
and “persons of unsound mind.”
• Underlying notion here is minors and persons of
unsound mind are not capable of agreeing to
contracts; therefore, no contract can be formed due
to no mutual assent.
Capacity – Minors
• Capacity to contract accrues on 18th birthday (Civil Code
§1557(a); Family Code § 6500); while general rule is
minors may contract in same manner as adults (Family
Code § 6700), most contracts by minors are voidable
(Family Code § 6710).
• A few contracts by minors are void (Family Code § 6710)
such as contracts which purport to transfer personal
property not in minor’s “immediate possession or control”
– common example is minor’s wages before they are
paid.
• Some contracts are binding on minors such as contracts
for “necessaries” for support of minor or minor’s family;
minor cannot be under care of parent or guardian able to
provide (Family Code § 6712); case study – Yale
Diagnostic Radiology v. Estate of Harun Fountain (pages
267-68).
Capacity – Unsound Mind
• Civil Code §1557(b) refers to §§ 38-40
– “Person entirely without understanding” incapable of
contracting but still liable for reasonable value of
things furnished that are necessary for support of
person or family (§ 38).
– Contract by “person of unsound mind, but not entirely
without understanding” before judicial determination of
incapacity is subject to rescission.
– Contract is void if made after judicial determination of
incapacity.
– Student examples of “unsound mind” and “without
understanding.”
Introduction to Legality of a
Contract
• “The consideration of a contract must be
lawful within the meaning of [Civil Code]
Section 1667” (Civil Code § 1607); this
includes consideration contrary to the
express provision or policy of law, or
otherwise contrary to good morals.
• “If any part of a single consideration for one
or more objects, or of several considerations
for a single object, is unlawful, the entire
contract is void” (Civil Code § 1608).
Illegal Contracts – Usury
• California Constitution Art. XV, § 1 sets
maximum interest rates
– Household items – 10%
– Other – higher of (a) 10% or (b) 5% plus
Fed rate on 25th of preceding month.
– However, many exemptions; e.g., college
student loans (Finance Code § 22050(c)).
• If usurious interest rate, interest is still owed
but only at legal limit; a few statutes render
the entire contract void.
Illegal Contracts – Unlicensed
Persons
• Main purpose of licensing statutes is to regulate
profession.
• Unlicensed person who causes personal injury or
damage for providing goods or services when
license required liable for treble damages, costs and
attorney’s fees (C.C.P. § 1029.8).
• Unlicensed person barred from suing or recovering
in law or equity based on performance for which
license required (B & P Code § 143(a)).
Illegal Contracts – Covenants Not to
Compete in Employment Agreements
• Covenant not to compete – contract provision barring
employee from working in same type of job/profession
and/or in same area for certain time period.
• General rule – covenant must be “reasonable” in scope
as to geography and time.
• California rule – covenant is illegal and therefore
cannot be enforced in court (B & P Code § 16600);
exceptions – sale or dissolution of business (B & P
Code § 16601-02).
• Case studies – Stultz v. Safety and Compliance
Management, Inc. (pages 274-76); Case Problems 134 and 13-7 (pages 283-84).
Unconscionability
• Common challenge to enforceability of arbitration
agreements so that will be our emphasis in this area of
contract law.
• Both aspects of unconscionability must be present though
not necessarily to same degree
– Substantive unconscionability – harsh, one-sided nature
of contract; e.g., prohibition of or limits on remedies
otherwise available in court.
– Procedural unconscionability – manner on which contract
negotiated when there is unequal bargaining power;
contract presented on “take-it-or-leave-it” basis or
arbitration clause “buried in the fine print” (commonly
called “adhesion” contracts).
Unconscionability – Case
Studies
• Simpson v. MSA of Myrtle Beach, Inc. (pages 29798); please note this case is in Chapter 14.
• Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9th
Cir. 2002) (federal court of appeal case applying
California law).
• Gentry v. Superior Court, 64 Cal.Rptr.3d 773 (Cal.
2007) (California Supreme Court case applying
California law).