AN INTRODUCTION TO CONTRACTS:
THE LAW OF TRANSACTIONS
PREVIEW OF THE SECOND SEMESTER
We begin the second half of the course by looking at various ways in
which the bargaining process might go wrong because of misbehavior by the parties
or because of serious disparities in bargaining power. Law will withhold
enforcement of contracts that are not fair and voluntary transactions between
competent parties because they do not reliably produce the “win-win” exchanges
that are valued by the basic theory of contract. Contracts that fail this test may be
“voidable” because of infancy, mental incapacity, fraud, duress, bad faith, undue
influence, and unconscionability.
We will then look more closely at the process of forming a Paradigm 2
contract through negotiation, drafting, and signing an agreement. This will involve
the role of the parol evidence rule in securing the finality and reliability of the
written agreements that emerge from this process. Along the way we will repeatedly
encounter the problems of contract interpretation and construction that we have
already met in the law of offer and acceptance.
Another recurring theme this semester will be the ways in which the law of
contracts deals with the problems of risk and uncertainty. Most of the problems
that contract parties encounter arise from their imperfect knowledge of the world,
as it is and as it becomes. The prospect of an ugly surprise is always lurking. It is
part of the role of contract agreements to allocate this risk between the parties. For
example, at the outset one or both parties may be laboring under a mistake about
the subject matter of the contract. They may allocate this risk by using the law of
conditions and warranty. If they fail to do so, the law must sometimes allocate the
risk by the law of mistake.
The primary way in which contract promisors deal with the risk of an
unknown is to protect themselves by using express conditions. Conditions relieve a
promisor from the duty of performance if certain events occur after the contract is
made. An example is the force majeure clause, which excuses non-performance in the
event of a disaster.
The semester will end with an introduction to judicial remedies for breach
of contract. The principles that govern the award of money damages are not unique
to contract law, but will also apply in tort and property law. One of the lessons of
these materials is that a legal dispute is never fully resolved by a finding of liability:
determining the appropriate remedy is critical to a just outcome.
While the first semester focused on litigation issues, you will increasingly be
asked to take the view of a transaction lawyer in the second semester. Rules of
contract law such as those relating to parol evidence and express conditions enable
attorneys to plan and design the legal structures that house their clients’
transactions, but they also present pitfalls that skillful attorneys must avoid.
Unit 29: Capacity to Contract: Rules and Standards
Read: Halbman v Lemke and Ortelere v Teachers Retirement Board in the SUPPLEMENT
RESTATEMENT (SECOND) OF CONTRACTS §§ 12, 14, and 15.
Key Concepts: Legal Capacity; Infancy; Rules and Standards.
The course began last semester by positing an idealized model of a contractual
exchange, exemplified by the Beer and Broccoli Deal. Legal enforcement of promises
was justified as a way of facilitating such exchanges on the assumption that they benefit
both parties. However, the assumption of mutual benefit requires that both parties are
able to protect their own interests and that they have roughly equal bargaining power. In
order to maximize their mutual benefits according to their own best judgment, such
parties should have complete freedom of contract to design their transaction and the
court should give legal effect to the deal they make.
The next few units examine the scope of freedom of contract when the
assumption of rationality and bargaining equality fails. An enforceable contract is a
privately-made law that binds the parties. Public laws that are created by legislatures are
subject to the constraints of the political process and the constitutional limits enforced
by the judiciary. Those structural elements provide some limits on the degree of
oppression and unfairness of public law.
Private contract parties are not constrained by constitutional or political limits,
however, and any limitation of their exercise of power over each other through the
device of contract must come from the courts or the legislatures in the form of the rules
and principles we are about to review. You may think of these rules as limitations on
private advantage-taking through the use of contracts and as corrections to a regime of
untrammeled freedom of contract.
These rules and principles rest on inherently value-laden ideas, with the values
more obvious than those that are implicit in the rules of contract that we have been
studying. The source of these values is harder to describe than the economic or
utilitarian justifications of law and economics reasoning. Indeed, some law and
economics scholars and judges reject traditionally-conceived values, such as good faith,
justice, and fairness, which have furnished the historical underpinning of these
doctrines. Lawyers who appear before such judges must be “bilingual,” able to speak
the language of tradition and of law and economics as the occasion may call for.
Rules and Standards
This Unit also introduces an important jurisprudential concept with a wide
application. The difference between rules and standards is a distinction that you will
encounter throughout your legal career. To illustrate it, consider the difference between
these two traffic regulations:
(1) "All motor vehicles traveling on a class two highway must not exceed 50
miles per hour."
(2) "All motor vehicles traveling on a class two highway must travel at a
reasonable rate of speed in light of road conditions."
Each of these is a common form of enforceable legal rule. They differ in the
degree of specificity with which they describe the prohibited conduct. The first refers
to a definite, measurable quantity, while the second uses a general, purposeful
description.
It has become common to refer to the sort of regulation exemplified in (1) as a
"rule" [or "bright-line rule" or "per se" rule] and to the sort of regulation exemplified in
(2) as a "standard." So the word "rule", somewhat confusingly, can refer either to any
sort of regulation or law or to a law framed in specific, quantifiable terms.
Here is an example of each kind of regulation from the UCC statute of frauds,
§ 2-201 (2):
Between merchants if within a reasonable time a writing in confirmation of
the contract and sufficient against the sender is received and the party
receiving it has reason to know its contents, it satisfies the requirements of
subsection (1) against such party unless written notice of objection to its
contents is given within ten days after it is received.
The first emphasized phrase is a standard, the second is a rule.
In tort law, you will encounter numerous examples of rules and standards.
"Negligence" is sometimes defined as conduct that is “unreasonably dangerous,” which
is a standard. But violation of some safety regulations is "Negligence per se", which is a
rule.
Property law too has its rules (e.g. the statutory period of time an adverse
possessor must satisfy to acquire title) and its standards (a residential landlord must
provide "habitable" premises.)
You will find numerous rules in Constitutional law (e.g. a candidate for
president must be 35 years old) but even more standards (no one may be deprived of
life, liberty, or property without "due process of law"; persons are to be secure in their
persons, houses, papers and effects against "unreasonable" searches and seizures.)
Although the "rules" of civil procedure contain mostly "rule" rules (e.g. 20
days to answer a complaint) even here one can find lurking a few "standard" rules (e.g.
Rule 11's requirement that a pleader's certification be formed after an inquiry
"reasonable under the circumstances.")
Rules and standards each have advantages and disadvantages. In light of their
purposes, rules can be under-inclusive over-inclusive: they can miss some of their
intended targets and hit some unintended targets. This problem results because rules
often must use something as an objective test that does not perfectly correlate with their
intended purpose. For example, speed limits are aimed at unsafe driving, but miles-perhour is an imperfect measure of unsafe driving. Some people might be able to drive
safely at over-the-limit speeds and some drivers are unsafe even within the speed limit.
For another example, some employees can work effectively well beyond the age of 65,
while others should retire at 50.
Because rules operate arbitrarily, they tend to beget exceptions that are
expressed as standards. Thus, we temper the contract infancy rule described in Halbman
with an exception for "necessaries," which is a flexible, context-specific term that a
court can use to achieve justice in cases in which operation of the rule might seem
arbitrary.
Other examples are the exceptions to bright-line rules where "justice"
requires.
An example appears the damages rule of RESTATEMENT (SECOND)
OF
CONTRACTS § 351 (3).
In a similar way, standards tend to beget bright-line rules that increase their
predictability and decrease the cost of litigation. Rule-like offspring of standards include
"safe harbors" and per se rules. For example, negligence is a standard turning on the
reasonableness of the defendant's conduct, but if the defendant violates a certain type of
statute she is negligent per se. This is a bright line drawn within a vague category.
Contract law offers another example: a contract offer lapses after a "reasonable time" (a
standard) but automatically upon the death of the offeror (a bright-line rule).
Today’s cases involve both a classic rule (Halbman) and a classic standard
(Ortolere) in the context of contractual incapacity. Capacity refers to the legal ability to
bind oneself to a contract. Here is what the Restatement of Contracts says about the
capacity to enter legally binding contracts:
SEC. 12: Capacity to Contract.
(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.
(2) A natural person who manifests assent to a contract 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.
The first thing to notice about the list in subsection (2) is that it is limited:
there is, for example, no exception for persons who are naive, overly-trusting,
unfamiliar with the dominant culture or language, impoverished, buzzed-but-not-drunk,
desperate, uneducated, unintelligent, or who have very poor judgment.
Second, this list purports to be exhaustive. Unlike the standard of good faith,
which is an excluder term that is never comprehensively defined, capacity is deemed to
exist unless one of four enumerated circumstances exists. This suggests that the concept
may be underinclusive because it will not reach some circumstances that would justify
avoidability.
Third, this list is historically contingent:
at certain times and in some
jurisdictions, it has included members of certain racial and national groups, married
women, and others who now have the full capacity to contract.
Finally, the list is dichotomous, not a continuum:
a person is either
competent or incompetent. If you are only somewhat subnormal in intelligence or
judgment, you are "fair game."
Advantage-taking through contracting is officially
approved unless a rather dramatic invalidating cause can be found. Nevertheless,
despite the rule-like nature of these categories, some of them lend themselves to
"standard-like" definitions, e.g. "intoxicated."
Is it an advantage or a disadvantage to be included in this list? (Trick question:
the answer is “yes.”)
THE JURISPRUDENCE OF RULES: INFANCY
Halbman v. Lemke
298 N.W.2d 562 (Wisc. 1980).
Callow, J. On this review we must decide whether a minor who disaffirms a
contract for the purchase of a vehicle which is not a necessity must make restitution to
the vendor for damage sustained by the vehicle prior to the time the contract was
disaffirmed. The court of appeals affirmed the judgment in part, reversed in part, and
remanded the cause to the [trial] court . . .
On or about July 13, 1973, James Halbman, Jr. (Halbman), a minor, entered
into an agreement with Michael Lemke (Lemke) whereby Lemke agreed to sell Halbman
a 1968 Oldsmobile for the sum of $1,250. Lemke was the manager of L & M Standard
Station in Greenfield, Wisconsin, and Halbman was an employee at L & M. At the time
the agreement was made Halbman paid Lemke $1,000 cash and took possession of the
car. Arrangements were made for Halbman to pay $25 per week until the balance was
paid, at which time title would be transferred.
About five weeks after the purchase agreement, and after Halbman had paid a
total of $1,100 of the purchase price, a connecting rod on the vehicle's engine broke.
Lemke, while denying any obligation, offered to assist Halbman in installing a used
engine in the vehicle if Halbman, at his expense, could secure one. Halbman declined
the offer and in September took the vehicle to a garage where it was repaired at a cost
of $637.40. Halbman did not pay the repair bill.
In October of 1973, Lemke endorsed the vehicle's title over to Halbman,
although the full purchase price had not been paid by Halbman, in an effort to avoid
any liability for the operation, maintenance, or use of the vehicle. On October 15, 1973,
Halbman returned the title to Lemke by letter which disaffirmed the purchase contract
and demanded the return of all money theretofore paid by Halbman. Lemke did not
return the money paid by Halbman.
The repair bill remained unpaid, and the vehicle remained in the garage where
the repairs had been made. In the spring of 1974, in satisfaction of a garageman's lien
for the outstanding amount, the garage elected to remove the vehicle's engine and
transmission and then towed the vehicle to the residence of James Halbman, Sr., the
father of the plaintiff minor. Lemke was asked several times to remove the vehicle
from the senior Halbman's home, but he declined to do so, claiming he was under no
legal obligation to remove it. During the period when the vehicle was at the garage and
then subsequently at the home of the plaintiff's father, it was subjected to vandalism,
making it unsalvageable.
Halbman initiated this action seeking the return of the $1,100 he had paid
toward the purchase of the vehicle, and Lemke counterclaimed for $150, the amount
still owing on the contract. Based upon the uncontroverted facts, the trial court granted
judgment in favor of Halbman, concluding that when a minor disaffirms a contract for
the purchase of an item, he need only offer to return the property remaining in his
hands without making restitution for any use or depreciation. In the order granting
judgment, the trial court also allowed interest to the plaintiff dating from the
disaffirmance of the contract. On post-judgment motions, the court amended its order
for judgment to allow interest to the plaintiff from the date of the original order for
judgment, July 26, 1978.
Lemke appealed to the court of appeals, and Halbman cross-appealed from
the disallowance of prejudgment interest. The appellate court affirmed the trial court
with respect to the question of restitution for depreciation, but reversed on the question
of prejudgment interest, remanding the cause for re-imposition of interest dating from
the date of disaffirmance. The question of prejudgment interest is not before us on this
review.
The sole issue before us is whether a minor, having disaffirmed a contract for
the purchase of an item which is not a necessity and having tendered the property back
to the vendor, must make restitution to the vendor for damage to the property prior to
the disaffirmance. Lemke argues that he should be entitled to recover for the damage to
the vehicle up to the time of disaffirmance, which he claims equals the amount of the
repair bill.
Neither party challenges the absolute right of a minor to disaffirm a contract
for the purchase of items which are not necessities. That right, variously known as the
doctrine of incapacity or the "infancy doctrine," is one of the oldest and most venerable
of our common law traditions. c\o Although the origins of the doctrine are somewhat
obscure, it is generally recognized that its purpose is the protection of minors from
foolishly squandering their wealth through improvident contracts with crafty adults who
would take advantage of them in the marketplace. Thus it is settled law in this state that
a contract of a minor for items which are not necessities is void or voidable at the
minor's option. c/o
Once there has been a disaffirmance, however, as in this case between a minor
vendee and an adult vendor, unresolved problems arise regarding the rights and
responsibilities of the parties relative to the disposition of the consideration exchanged
on the contract. As a general rule a minor who disaffirms a contract is entitled to
recover all consideration he has conferred incident to the transaction. In return the
minor is expected to restore as much of the consideration as, at the time of
disaffirmance, remains in the minor's possession. c\o The minor's right to disaffirm is
not contingent upon the return of the property, however, as disaffirmance is permitted
even where such return cannot be made. c\o
The return of property remaining in the hands of the minor is not the issue
presented here. In this case we have a situation where the property cannot be returned
to the vendor in its entirety because it has been damaged and therefore diminished in
value, and the vendor seeks to recover the depreciation. Although this court has been
cognizant of this issue on previous occasions, we have not heretofore resolved it. c\o
The law regarding the rights and responsibilities of the parties relative to the
consideration exchanged on a disaffirmed contract is characterized by confusion,
inconsistency, and a general lack of uniformity as jurisdictions attempt to reach a fair
application of the infancy doctrine in today's marketplace. c\o That both parties rely
on this court's decision in Olson v. Veum, supra, is symptomatic of the problem.
In Olson a minor, with his brother, an adult, purchased farm implements and
materials, paying by signing notes payable at a future date. Prior to the maturity of the
first note, the brothers ceased their joint farming business, and the minor abandoned his
interest in the material purchased by leaving it with his brother. The vendor initiated an
action against the minor to recover on the note, and the minor (who had by then
reached majority) disaffirmed. The trial court ordered judgment for the plaintiff on the
note, finding there had been insufficient disaffirmance to sustain the plea of infancy.
This court reversed, holding that the contract of a minor for the purchase of items
which are not necessities may be disaffirmed even when the minor cannot make
restitution. Lemke calls our attention to the following language in that decision:
To sustain the judgment below is to overlook the substantial distinction
between a mere denial by an infant of contract liability where the other party is
seeking to enforce it and those cases where he who was the minor not only
disaffirms such contract but seeks the aid of the court to restore to him that
with which he has parted at the making of the contract. In the one case he is
using his infancy merely as a shield, in the other also as a sword.
From this Lemke infers that when a minor, as a plaintiff, seeks to disaffirm a
contract and recover his consideration, different rules should apply than if the minor is
defending against an action on the contract by the other party. This theory is not
without some support among scholars. c\o
Additionally, Lemke advances the thesis in the dissenting opinion by court of
appeals Judge Cannon, arguing that a disaffirming minor's obligation to make restitution
turns upon his ability to do so. For this proposition, the following language in Olson is
cited:
The authorities are clear that when it is shown, as it is here, that the infant
cannot make restitution, then his absolute right to disaffirm is not to be
questioned.
In this case Lemke argues that the Olson language excuses the minor only when
restitution is not possible. Here Lemke holds Halbman's $1,100, and accordingly there
is no question as to Halbman's ability to make restitution.
Halbman argues in response that, while the "sword-shield" dichotomy may
apply where the minor has misrepresented his age to induce the contract, that did not
occur here and he may avoid the contract without making restitution notwithstanding
his ability to do so.
The principal problem is the use of the word "restitution" in Olson. A minor,
as we have stated, is under an enforceable duty to return to the vendor, upon
disaffirmance, as much of the consideration as remains in his possession. When the
contract is disaffirmed, title to that part of the purchased property which is retained by
the minor revests in the vendor; it no longer belongs to the minor. The rationale for
the rule is plain: a minor who disaffirms a purchase and recovers his purchase price
should not also be permitted to profit by retaining the property purchased. The infancy
doctrine is designed to protect the minor, sometimes at the expense of an innocent
vendor, but it is not to be used to bilk merchants out of property as well as proceeds of
the sale. Consequently, it is clear that, when the minor no longer possesses the property
which was the subject matter of the contract, the rule requiring the return of property
does not apply.1 The minor will not be required to give up what he does not have. We
conclude that Olson does no more than set forth the foregoing rationale and that the
word "restitution" as it is used in that opinion is limited to the return of the property to
the vendor. We do not agree with Lemke and the court of appeals dissent that Olson
requires a minor to make restitution for loss or damage to the property if he is capable
of doing so.
. Although we are not presented with the question here, we recognize there is
1
considerable disagreement among the authorities on whether a minor who
disposes of the property should be made to restore the vendor with something in
its stead.
The general rule appears to limit the minor's responsibility for
restoration to specie only. c/o But see: Boyce v. Doyle, adopting a "status quo"
theory which requires the minor to restore the precontract status quo, even if it
means returning proceeds or other value; Fisher v. Taylor Motor Co., requiring
the minor to restore only the property remaining in the hands of the minor, "'or
account for so much of its value as may have been invested in other property
which he has in hand or owns and controls.'" Finally, some attention is given to
the "New Hampshire Rule" or benefits theory which requires the disaffirming
minor to pay for the contract to the extent he benefited from it.c/o
Here Lemke seeks restitution of the value of the depreciation by virtue of the
damage to the vehicle prior to disaffirmance. Such a recovery would require Halbman
to return more than that remaining in his possession. It seeks compensatory value for
that which he cannot return. Where there is misrepresentation by a minor or willful
destruction of property, the vendor may be able to recover damages in tort. c/o But
absent these factors, as in the present case, we believe that to require a disaffirming
minor to make restitution for diminished value is, in effect, to bind the minor to a part
of the obligation which by law he is privileged to avoid.
The cases upon which the petitioner relies for the proposition that a
disaffirming minor must make restitution for loss and depreciation serve to illustrate
some of the ways other jurisdictions have approached this problem of balancing the
needs of minors against the rights of innocent merchants. In Barber v. Gross, the South
Dakota Supreme Court held that a minor could disaffirm a contract as a defense to an
action by the merchant to enforce the contract but that the minor was obligated by a
South Dakota statute, upon sufficient proof of loss by the plaintiff, to make restitution
for depreciation. Cain v. Coleman, involved a minor seeking to disaffirm a contract for
the purchase of a used car where the dealer claimed the minor had misrepresented his
age.
In reversing summary judgment granted in favor of the minor, the court
recognized the minor's obligation to make restitution for the depreciation of the vehicle.
In a case where there was no issue of misrepresentation, the Texas court has also ruled
that upon disaffirmance and tender by a minor the vendor is obligated to take the
property "as is."
Scalone v. Talley Motors and Rose v. Sheehan Buick represent the
proposition that a disaffirming minor must do equity in the form of restitution for loss
or depreciation of the property returned. Because these cases would at some point
force the minor to bear the cost of the very improvidence from which the infancy
doctrine is supposed to protect him, we cannot follow them.
As we noted in Kiefer, modifications of the rules governing the capacity of
infants to contract are best left to the legislature. Until such changes are forthcoming,
however, we hold that, absent misrepresentation or tortious damage to the property, a
minor who disaffirms a contract for the purchase of an item which is not a necessity
may recover his purchase price without liability for use, depreciation, damage, or other
diminution in value. . . .
QUESTIONS
The rule that a minor may avoid any contract entered before the age of
majority is a classic example of a "bright line" legal rule. We know exactly to what cases
it applies and exactly how it applies in such cases. One minute before one's eighteenth
birthday, one can enter only voidable obligations; one minute afterward, one's contracts
are fully enforceable. The contracts are either completely voidable (regardless of their
fairness) or they are completely enforceable.
The infancy rule exhibits all the typical strengths and weaknesses of a bright
line rule. What are they? Could you recast the infancy rule into a standard? If so,
how? Could you recast the remedy into a standard? If so, how? Which would
be better, the rule we have or the standard you have devised?
Would Halbman be liable to Lemke, either in tort or contract, if he had,
as a minor,:
(1) borrowed Lemke's car and destroyed it while driving negligently?
(2) intentionally misrepresented his age to Lemke at the time of the
contract?
(3) made a promise that forseeably induced Lemke's reliance?
(4) having purchased the car from Lemke, he had sold it to a third party
for $1100? If he disaffirms, must he turn over the money? What if he spent the
money before disaffirming?
(5) had received an insurance payment for the vandalism?
(6) intentionally destroyed the car before disaffirming? What if he only
negligently destroyed it?
Does making Halbman liable for negligent harm "in effect, . . bind the
minor to a part of the obligation which by law he is privileged to avoid"? Would
it "at some point force the minor to bear the cost of the very improvidence from
which the infancy doctrine is supposed to protect him"?
Under the infancy rule, a minor who enters a contract with an adult may
disaffirm or avoid the contract unless he ratifies it after gaining majority. Even if the
contract has been fully performed on both sides, as e.g. when goods have been
delivered and accepted and the price has been paid, the minor may rescind the
transaction. The adult's promise is, however, enforceable if the minor chooses not to
disaffirm.
DISCUSSION PROBLEM: After graduating from SU law school and passing
the bar you are approached by the parents of a student at SAS, the high school a few
blocks north of here on 12th. They want to file a class action on behalf of the graduating
seniors at SAS against Starbucks, seeking return of all the money the students have
spent at Starbucks during their years at SAS. Can the students disaffirm and avoid
their purchase contracts as the minor did in Halbman? (If this suit is successful,
their next target will be Nordstrom’s.)
Is it time to change the minority rule by lowering the age at which
people can make binding contracts? Prepare a brief argument to the Washington
Legislature on the point. You may imagine that the committee you are addressing is
considering legislation lowering the age from 18, but has no specific legislation pending.
In many states, by statute the contracts of certain minors are enforceable
against them: emancipated or married minors, sports or entertainment performers, etc.
The Juvenile Justice Standards recommended by the Criminal Justice Section
of the American Bar Association contain the following:
MINORS' CONTRACTS. The validity of contracts of minors [defined as
persons below the age of 18], . . . should be governed by the following principles:
A. The contract of a minor who is at least twelve years of age should be valid
and enforceable by and against the minor, as long as such a contract of an adult would
be valid and enforceable, if:
1. the minor's parent or duly constituted guardian consented in writing to the
contract; or
2. the minor represented to the other party that he or she was at least eighteen
years of age and a reasonable person under the circumstances would have believed the
representation; or
3. the minor was a purchaser and is unable to return the goods to the seller in
substantially the condition they were in when purchased because the minor lost or
caused them to be damaged, the minor consumed them, or the minor gave them away.
B. The contract of a minor who has not reached the age of twelve should be
void.
C. Release of a tort claim by a minor should be valid, if an adult's release
would be valid under the same circumstances:
1. if the minor is at least twelve years of age, if the release is approved by the
minor, the minor's parent, and, if suit is pending, by the court; or
2. if the minor has not reached the age of twelve, if the release is approved by
the minor's parent, and, if suit is pending, by the court.
In tort law children as young as six years old are liable for their intentional and
negligent torts. You should also be aware that an infant charged with a crime is
competent to waive constitutional rights, such as the right to counsel or the right to
remain silent, and to plead guilty to crimes, including capital crimes. Are these rules
consistent with the infancy rule in contract law?
THE JURISPRUDENCE OF STANDARDS: MENTAL INCAPACITY
Ortelere v. Teachers' Retirement Board
250 N.E.2d 460; (NY.Ct. App. 1969)
Breitel, J. This appeal involves the revocability of an election of benefits
under a public employees' retirement system and suggests the need for a renewed
examination of the kinds of mental incompetency which may render voidable the
exercise of contractual rights. The particular issue arises on the evidently unwise and
foolhardy selection of benefits by a 60-year-old teacher, on leave for mental illness and
suffering from cerebral arteriosclerosis, after service as a public schoolteacher and
participation in a public retirement system for over 40 years. The teacher died a little
less than two months after making her election of maximum benefits, payable to her
during her life, thus causing the entire reserve to fall in. She left surviving her husband
of 38 years of marriage and two grown children.
There is no doubt that any retirement system depends for its soundness on an
actuarial experience based on the purely prospective selections of benefits and mortality
rates among the covered group, and that retrospective or adverse selection after the fact
would be destructive of a sound system. It is also true that members of retirement
systems are free to make choices which to others may seem unwise or foolhardy.
The issue here is narrower than any suggested by these basic principles. It is
whether an otherwise irrevocable election may be avoided for incapacity because of
known mental illness which resulted in the election when, except in the barest actuarial
sense, the system would sustain no unfavorable consequences.
The husband and executor of Grace W. Ortelere, the deceased New York City
schoolteacher, sues to set aside her application for retirement without option, in the
event of her death. It is alleged that Mrs. Ortelere, on February 11, 1965, two months
before her death from natural causes, was not mentally competent to execute a
retirement application. By this application, effective the next day, she elected the
maximum retirement allowance She thus revoked her earlier election of benefits under
which she named her husband a beneficiary of the unexhausted reserve upon her death.
Selection of the maximum allowance extinguished all interests upon her death.
Following a nonjury trial in Supreme Court, it was held that Grace Ortelere
had been mentally incompetent at the time of her February 11 application, thus
rendering it "null and void and of no legal effect". The Appellate Division, by a divided
court, reversed the judgment of the Supreme Court and held that, as a matter of law,
there was insufficient proof of mental incompetency as to this transaction.
Mrs. Ortelere's mental illness, indeed, psychosis, is undisputed. It is not
seriously disputable, however, that she had complete cognitive judgment or awareness
when she made her selection. A modern understanding of mental illness, however,
suggests that incapacity to contract or exercise contractual rights may exist, because of
volitional and affective impediments or disruptions in the personality, despite the
intellectual or cognitive ability to understand. It will be recognized as the civil law
parallel to the question of criminal responsibility which has been the recent concern of
so many and has resulted in statutory and decisional changes in the criminal law.
Mrs. Ortelere, an elementary schoolteacher since 1924, suffered a "nervous
breakdown" in March, 1964 and went on a leave of absence expiring February 5, 1965.
She was then 60 years old and had been happily married for 38 years. On July 1, 1964
she came under the care of Dr. D'Angelo, a psychiatrist, who diagnosed her breakdown
as involutional psychosis, melancholia type. Dr. D'Angelo prescribed, and for about six
weeks decedent underwent, tranquilizer and shock therapy. Although moderately
successful, the therapy was not continued since it was suspected that she also suffered
from cerebral arteriosclerosis, an ailment later confirmed. However, the psychiatrist
continued to see her at monthly intervals until March, 1965. On March 28, 1965 she was
hospitalized after collapsing at home from an aneurysm. She died 10 days later; the
cause of death was "Cerebral thrombosis due to [Hypertensive] [Heart] [Disease]."
As a teacher she had been a member of the Teachers' Retirement System of
the City of New York (Administrative Code, § B20-30). This entitled her to certain
annuity and pension rights, preretirement death benefits, and empowered her to
exercise various options concerning the payment of her retirement allowance.
Some years before, on June 28, 1958, she had executed a "Selection of Benefits
under Option One" naming her husband as beneficiary of the unexhausted reserve.
Under this option upon retirement her allowance would be less by way of periodic
retirement allowances, but if she died before receipt of her full reserve the balance of
the reserve would be payable to her husband. On June 16, 1960, two years later, she had
designated her husband as beneficiary of her service death benefits in the event of her
death prior to retirement.
Then on February 11, 1965, when her leave of absence had just expired and
she was still under treatment, she executed a retirement application, the one here
involved, selecting the maximum retirement allowance payable during her lifetime with
nothing payable on or after death. She also, at this time, borrowed from the system the
maximum cash withdrawal permitted, namely, $8,760. Three days earlier she had written
the board, stating that she intended to retire on February 12 or 15 or as soon as she
received "the information I need in order to decide whether to take an option or
maximum allowance." She then listed eight specific questions, reflecting great
understanding of the retirement system, concerning the various alternatives available.
An extremely detailed reply was sent, by letter of February 15, 1965, although by that
date it was technically impossible for her to change her selection. However, the board's
chief clerk, before whom Mrs. Ortelere executed the application, testified that the
questions were "answered verbally by me on February 11th." Her retirement reserve
totalled $62,165 (after deducting the $8,760 withdrawal), and the difference between
electing the maximum retirement allowance (no option) and the allowance under
"option one" was $901 per year or $75 per month. That is, had the teacher selected
"option one" she would have received an annual allowance of $4,494 or $375 per
month, while if no option had been selected she would have received an annual
allowance of $5,395 or $450 per month. Had she not withdrawn the cash the annual
figures would be $5,247 and $6,148 respectively.
Following her taking a leave of absence for her condition, Mrs. Ortelere had
become very depressed and was unable to care for herself. As a result, her husband gave
up his electrician's job, in which he earned $222 per week, to stay home and take care of
her on a full-time basis. She left their home only when he accompanied her. Although
he took her to the Retirement Board on February 11, 1965, he did not know why she
went, and did not question her for fear "she'd start crying hysterically that I was scolding
her. That's the way she was. And I wouldn't upset her."
The Orteleres were in quite modest circumstances. They owned their own
home, valued at $20,000, and had $8,000 in a savings account. They also owned some
farm land worth about $5,000. Under these circumstances, as revealed in this record,
retirement for both of the Orteleres or the survivor of them had to be provided, as a
practical matter, largely out of Mrs. Ortelere's retirement benefits.
According to Dr. D'Angelo, the psychiatrist who treated her, Mrs. Ortelere
never improved enough to "warrant my sending her back [to teaching]." A physician for
the Board of Education examined her on February 2, 1965 to determine her fitness to
return to teaching. Although not a psychiatrist but rather a specialist in internal
medicine, this physician "judged that she had apparently recovered from the
depression" and that she appeared rational. However, before allowing her to return to
teaching, a report was requested from Dr. D'Angelo concerning her condition. It is
notable that the Medical Division of the Board of Education on February 24, 1965
requested that Mrs. Ortelere report to the board's "panel psychiatrist" on March 11,
1965.
Dr. D'Angelo stated "[at] no time since she was under my care was she ever
mentally competent"; that "[mentally] she couldn't make a decision of any kind, actually,
of any kind, small or large." He also described how involutional melancholia affects the
judgment process: "They can't think rationally, no matter what the situation is. They will
even tell you, 'I used to be able to think of anything and make any decision. Now,' they
say, 'even getting up, I don't know whether I should get up or whether I should stay in
bed.' Or, 'I don't even know how to make a slice of toast any more.' Everything is
impossible to decide, and everything is too great an effort to even think of doing. They
just don't have the effort, actually, because their nervous breakdown drains them of all
their physical energies."
While the psychiatrist used terms referring to "rationality", it is quite evident
that Mrs. Ortelere's psychopathology did not lend itself to a classification under the
legal test of irrationality. It is undoubtedly, for this reason, that the Appellate Division
was unable to accept his testimony and the trial court's finding of irrationality in the
light of the prevailing rules as they have been formulated.
The well-established rule is that contracts of a mentally incompetent person
who has not been adjudicated insane are voidable. Even where the contract has been
partly or fully performed it will still be avoided upon restoration of the status quo.
Traditionally, in this State and elsewhere, contractual mental capacity has been
measured by what is largely a cognitive standard. Under this standard the "inquiry" is
whether the mind was "so affected as to render him wholly and absolutely incompetent
to comprehend and understand the nature of the transaction" A requirement that the
party also be able to make a rational judgment concerning the particular transaction
qualified the cognitive test. Conversely, it is also well recognized that contractual ability
would be affected by insane delusions intimately related to the particular transaction
These traditional standards governing competency to contract were formulated
when psychiatric knowledge was quite primitive. They fail to account for one who by
reason of mental illness is unable to control his conduct even though his cognitive
ability seems unimpaired. When these standards were evolving it was thought that all
the mental faculties were simultaneously affected by mental illness. This is no longer
the prevailing view.
Of course, the greatest movement in revamping legal notions of mental
responsibility has occurred in the criminal law. The nineteenth century cognitive test
embraced in the M'Naghten rules has long been criticized and changed by statute and
decision in many jurisdictions. While the policy considerations for the criminal law and
the civil law are different, both share in common the premise that policy considerations
must be based on a sound understanding of the human mind and, therefore, its
illnesses. Hence, because the cognitive rules are, for the most part, too restrictive and
rest on a false factual basis they must be re-examined. Once it is understood that,
accepting plaintiff's proof, Mrs. Ortelere was psychotic and because of that psychosis
could have been incapable of making a voluntary selection of her retirement system
benefits, there is an issue that a modern jurisprudence should not exclude, merely
because her mind could pass a "cognition" test based on nineteenth century psychology.
There has also been some movement on the civil law side to achieve a modern
posture. For the most part, the movement has been glacial and has been disguised under
traditional formulations. Various devices have been used to avoid unacceptable results
under the old rules by finding unfairness or overreaching in order to avoid transactions.
In this State there has been at least one candid approach. In Faber v. Sweet Style
Mfg. Co., Justice Meyer wrote: "[incompetence] to contract also exists when a contract is
entered into under the compulsion of a mental disease or disorder but for which the
contract would not have been made". This is the first known time a court has
recognized that the traditional standards of incompetency for contractual capacity are
inadequate in light of contemporary psychiatric learning and applied modern standards.
Prior to this, courts applied the cognitive standard giving great weight to objective
evidence of rationality.
It is quite significant that Restatement, 2d, Contracts, states the modern rule
on competency to contract. This is in evident recognition, and the Reporter's Notes
support this inference, that, regardless of how the cases formulated their reasoning, the
old cognitive test no longer explains the results. Thus, the new Restatement section
reads: "(1) A person incurs only voidable contractual duties by entering into a
transaction if by reason of mental illness or defect (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." (RESTATEMENT, 2D, CONTRACTS § 18C.) (C/o “a complete test for
contractual incapacity should provide protection to those persons whose contracts are
merely uncontrolled reactions to their mental illness, as well as for those who could not
understand the nature and consequences of their actions".)
The avoidance of duties under an agreement entered into by those who have
done so by reason of mental illness, but who have understanding, depends on balancing
competing policy considerations. There must be stability in contractual relations and
protection of the expectations of parties who bargain in good faith. On the other hand,
it is also desirable to protect persons who may understand the nature of the transaction
but who, due to mental illness, cannot control their conduct. Hence, there should be
relief only if the other party knew or was put on notice as to the contractor's mental
illness. Thus, the Restatement provision for avoidance contemplates that "the other
party has reason to know" of the mental illness.
When, however, the other party is without knowledge of the contractor's
mental illness and the agreement is made on fair terms, the proposed Restatement rule
is: "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 inequitable. In such a case a court may grant relief on
such equitable terms as the situation requires."
The system was, or should have been, fully aware of Mrs. Ortelere's condition.
They, or the Board of Education, knew of her leave of absence for medical reasons and
the resort to staff psychiatrists by the Board of Education. Hence, the other of the
conditions for avoidance is satisfied.
Lastly, there are no significant changes of position by the system other than
those that flow from the barest actuarial consequences of benefit selection.
Nor should one ignore that in the relationship between retirement system and
member, and especially in a public system, there is not involved a commercial, let alone
an ordinary commercial, transaction. Instead the nature of the system and its announced
goal is the protection of its members and those in whom its members have an interest.
It is not a sound scheme which would permit 40 years of contribution and participation
in the system to be nullified by a one-instant act committed by one known to be
mentally ill. This is especially true if there would be no substantial harm to the system if
the act were avoided. On the record none may gainsay that her selection of a "no
option" retirement while under psychiatric care, ill with cerebral arteriosclerosis, aged
60, and with a family in which she had always manifested concern, was so unwise and
foolhardy that a factfinder might conclude that it was explainable only as a product of
psychosis.
On this analysis it is not difficult to see that plaintiff's evidence was sufficient
to sustain a finding that, when she acted as she did on February 11, 1965, she did so
solely as a result of serious mental illness, namely, psychosis. Of course, nothing less
serious than medically classified psychosis should suffice or else few contracts would be
invulnerable to some kind of psychological attack. Mrs. Ortelere's psychiatrist testified
quite flatly that as an involutional melancholiac in depression she was incapable of
making a voluntary "rational" decision. Of course, as noted earlier, the trial court's
finding and perhaps some of the testimony attempted to fit into the rubrics of the
traditional rules. For that reason rather than reinstatement of the judgment at Trial
Term there should be a new trial under the proper standards frankly considered and
applied.
Accordingly, the order of the Appellate Division should be reversed, without
costs, and the action remanded to Trial Term for a new trial.
Jasen, J. (dissenting). Where there has been no previous adjudication of
incompetency, the burden of proving mental incompetence is upon the party alleging it.
I agree with the majority at the Appellate Division that the plaintiff, the husband of the
decedent, failed to sustain the burden incumbent upon him of proving deceased's
incompetence.
The evidence conclusively establishes that the decedent, at the time she made
her application to retire, understood not only that she was retiring, but also that she had
selected the maximum payment during her lifetime.
Indeed, the letter written by the deceased to the Teachers' Retirement System
prior to her retirement demonstrates her full mental capacity to understand and to
decide whether to take an option or the maximum allowance. The full text of the letter
reads as follows:
February 8, 1965.
Gentlemen:
I would like to retire on Feb. 12 or Feb. 15. In other words, just as soon as
possible after I receive the information I need in order to decide whether to
take an option or maximum allowance. Following are the questions I would
like to have answered:
1. What is my 'average' five-year salary?
2. What is my maximum allowance?
3. I am 60 years old. If I select option four-a with a beneficiary (female) 27
years younger, what is my allowance?
4. If I select four-a on the pension part only, and take the maximum annuity,
what is my allowance?
5. If I take a loan of 89% of my year's salary before retirement, what would my
maixmum allowance be?
6. If I take a loan of $5,000 before retiring, and select option four-a on both
the pension and annuity, what would my allowance be?
7. What is my total service credit? I have been on a leave without pay since
Oct. 26, 1964.
8. What is the 'factor' used for calculating option four-a with the above
beneficiary?
Thank you for your promptness in making the necessary calculations. I will
come to your office on Thursday afternoon of this week.
It seems clear that this detailed, explicit and extremely pertinent list of queries
reveals a mind fully in command of the salient features of the Teachers' Retirement
System. Certainly, it cannot be said that the decedent could possess sufficient capacity
to compose a letter indicating such a comprehensive understanding of the retirement
system, and yet lack the capacity to understand the answers.
As I read the record, the evidence establishes that the decedent's election to
receive maximum payments was predicated on the need for a higher income to support
two retired persons -- her husband and herself. Since the only source of income
available to decedent and her husband was decedent's retirement pay, the additional
payment of $75 per month which she would receive by electing the maximal payment
was a necessity. Indeed, the additional payments represented an increase of 20% over
the benefits payable under option 1. Under these circumstances, an election of maximal
income during decedent's lifetime was not only a rational, but a necessary decision.
Further indication of decedent's knowledge of the financial needs of her family
is evidenced by the fact that she took a loan for the maximum amount ($8,760)
permitted by the retirement system, at the time she made application for retirement.
Moreover, there is nothing in the record to indicate that the decedent had any
warning, premonition, knowledge or indication at the time of retirement that her life
expectancy was, in any way, reduced by her condition.
Decedent's election of the maximum retirement benefits, therefore, was not so
contrary to her best interests so as to create an inference of her mental incompetence.
Indeed, concerning election of options under a retirement system, it has been
held: "Even where no previous election has been made, the court must make the
election for an incompetent which would be in accordance with what would have been
his manifest and reasonable choice if he were sane, and, in the absence of convincing
evidence that the incompetent would have made a different selection, it is presumed that
he would have chosen the option yielding the largest returns in his lifetime."
Nor can I agree with the majority's view that the traditional rules governing
competency to contract "are, for the most part, too restrictive and rest on a false factual
basis".
The issue confronting the courts concerning mental capacity to contract is
under what circumstances and conditions should a party be relieved of contractual
obligations freely entered. This is peculiarly a legal decision, although, of course,
available medical knowledge forms a datum which influences the legal choice. It is
common knowledge that the present state of psychiatric knowledge is inadequate to
provide a fixed rule for each and every type of mental disorder. Thus, the generally
accepted rules which have evolved to determine mental responsibility are general
enough in application to encompass all types of mental disorders, and phrased in a
manner which can be understood and practically applied by juries composed of laymen.
The generally accepted test of mental competency to contract which has thus
evolved is whether the party attempting to avoid the contract was capable of
understanding and appreciating the nature and consequences of the particular act or
transaction which he challenges. This rule represents a balance struck between policies
to protect the security of transactions between individuals and freedom of contract on
the one hand, and protection of those mentally handicapped on the other hand. In my
opinion, this rule has proven workable in practice and fair in result. A broad range of
evidence including psychiatric testimony is admissible under the existing rules to
establish a party's mental condition. In the final analysis, the lay jury will infer the state
of the party's mind from his observed behavior as indicated by the evidence presented
at trial. Each juror instinctively judges what is normal and what is abnormal conduct
from his own experience, and the generally accepted test harmonizes the competing
policy considerations with human experience to achieve the fairest result in the greatest
number of cases.
As in every situation where the law must draw a line between liability and
nonliability, between responsibility and nonresponsibility, there will be borderline cases,
and injustices may occur by deciding erroneously that an individual belongs on one side
of the line or the other. To minimize the chances of such injustices occurring, the line
should be drawn as clearly as possible.
The Appellate Division correctly found that the deceased was capable of
understanding the nature and effect of her retirement benefits, and exercised rational
judgment in electing to receive the maximum allowance during her lifetime. I fear that
the majority's refinement of the generally accepted rules will prove unworkable in
practice, and make many contracts vulnerable to psychological attack. Any benefit to
those who understand what they are doing, but are unable to exercise self-discipline, will
be outweighed by frivolous claims which will burden our courts and undermine the
security of contracts. The reasonable expectations of those who innocently deal with
persons who appear rational and who understand what they are doing should be
protected.
Accordingly, I would affirm the order appealed from.
QUESTIONS
1. Judge Brietel condemns as “unwise and foolhardy” Ortelere’s election
to receive greater pension benefits during her lifetime in lieu of her spouse’s
entitlement to receive post-death benefits under the plan. Was it?
2. In what way was the traditional test of mental capacity based on
“nineteenth century psychology”?
3. Is Judge Brietel applying “twentieth century psychology”?
4. What policy arguments does the dissent make concerning the
appropriate test to be applied?
5. Is Ortelere governed by a rule or a standard? In either case, state it as
simply as you can.
6. What would the Restatement outcome have been if the Retirement
Board had not known of Ortolere’s condition?
7. Was the Retirement Board at fault, according to the majority?
Suppose they had consulted you after receiving a letter from another retired
teacher similar to the one written by Mrs. Ortelere? Would you advise them to
require her to prove that she was mentally competent before they implemented
her decision?
8. Does the majority articulate a rule/standard that ordinary people can
implement in their business transactions?
9. Summarize the argument of the dissent. Which argument is more
compelling?
Clearly, the choice between rules and standards has many policy implications.
As practicing lawyers, you should become skilled at making arguments both (1) for and
(2) against both (3) rules and (4) standards. Lawyers often are engaged in the drafting of
legislation; administrative regulation; public and private codes of conduct; organizational
policies; and contracts. You will often have to choose the optimum regulatory term,
whether rule or standard. You should be able to advise your clients about the costs and
benefits of each kind of term. Your knowledge about the differences between rules and
standards will grow with your experience.