Capacity of Parties : Capacity to Contracts and Legal Requirements

What is Capacity of Parties?

Indian Contract Act, 1872 is a central law, and it validates the Contracts or Agreements between various parties. Contract Act regulates and oversees all the business in case of any deal or an agreement. The Indian Contract Act, 1872 defines the term “Contract” under its Section 2(h) as “An agreement enforceable by law”. Hence, a Contract is anything that is an agreement and enforceable by the law of the land.

Geeky Takeaways:

• The parties to a contract should understand the concept of Capacity to Contract to make informed decisions and save themselves from any loss or damages due to the consequences that might occur by contracting with a party who is incapacitated to contract.
• The competency of parties to a contract is an important requirement to make an agreement valid, and the contract will be enforceable in a court of law only if the parties to the contract are competent.
• In the business world, corporations pay important considerations while entering into contracts with another party to safeguard their interests. Representation and Indemnification are the two most commonly used clauses to make sure that both parties are competent to contract.

What Agreements are Contracts?

According to the provisions of Section 10 of the Indian Contract Act, 1872, an Agreement must satisfy the following conditions to be a valid contract:

• The parties in a contract must be Competent.
• The contract must be made by the Free Consent of the parties to the contract.
• The contract must be made for a Lawful Consideration, and there should be a Lawful Object.
• The contract should not have been expressly declared as a Void Contract.

Capacity to Contract

According to Section 11 of the Indian Contract Act, 1872 “Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind and is not disqualified from contracting by any law to which he is subject.”

So the three major points which are established under Section 11 are:

• Attaining the age of Majority (As per Indian Majority Act, 1875).
• Being a Person of Sound Mind.
• Not Disqualified from entering into a Contract by any Law.

Legal Requirements for a Person Entering into a Contract

1. Attaining the Age of Majority

In India, every domiciled person is considered to attain majority when he reaches the age of 18 years. The Majority Act, 1875 regulates the age of majority in India. In a legal aspect, if a person is a day less than attaining 18 years, he/she will be considered a minor in the eyes of the law. Any contract with a minor will be considered void from the beginning of entering the contract.

Famous Case Law: The case of Mohori Bibi vs. Dharmodas Ghose is a landmark case for establishing the ambit of the Minor Agreement. In this case, Dharmodar Ghose who was a minor, borrowed ₹20,000 from Brahmo Dutt and as a security for the same. Dharmodar Ghose, the minor executed a mortgage deed in his favour. Dharmodar Ghose attained the majority age a few months later, and he filed a suit on the fact that the mortgage executed by him was entered during his minority was void and shall be cancelled. The court held that a mortgage contract by a minor was void and Brahmo Dutt was not entitled to any repayment of money as Dharmodar Ghose was incompetent to contract, and the contract will be considered as Void-ab-initio.

Indian Contract Act has the following provisions related to a Minor or a person who is yet to attain Majority:

• Contract with a Minor will be considered as Void: As per the provisions of Indian Contract Act, 1872 a minor is not competent to enter into any contract with any party. Any contract which is made with a minor shall be considered Void-ab-inito; i.e., void from the very beginning of entering the contract.
• Contracts with a Minor can’t be Ratified even after Attaining Majority: In case a minor has entered into a contract with a party, he can’t rectify the agreement once he attains the age of majority. The contract shall be considered void-ab-initio even though the minor has attained the age of majority and is competent to contract. It is important to remember that void-ab-initio agreements can never be ratified.
• Can’t be Declared Insolvent: A minor can never be declared as Insolvent. As per law, he is not competent to contract any debts and no dues can be payable from the personal property of a minor. In any case, a minor cannot be held personally liable.
• Minor can be a Beneficiary in a Contract: As a minor is not competent to contract, nothing in the Contract Act prevents him from accepting benefits out of any contract. So, in a case where a promissory note is executed in the favour of a minor will not be considered void and can also be sued upon by him, as he might not be competent to be a party to a contract but he can accept benefits. Similarly, a minor cannot become a partner in a partnership firm, but in a case where all partners give their consent to admit a minor for the benefit of the partnership, he may be admitted.
• Contract by Guardian: The Minor’s agreement is considered void, but the guardians of the minor can enter into a contract under certain special circumstances to make sure the contract is a valid contract on behalf of the minor and is within the competence of the minor and is for the benefit of the minor. These contracts will be treated as valid, and minors can enforce them. However, the guardians of the minor can’t bind the minor for a contract of purchase of immovable property, but in case a guardian is appointed by the court he may sell the minor’s property.
• Minor as an Agent: A minor can be appointed as an agent. However, the minor will not be liable for his act to the principal. A minor will have the same duties and will have to act on behalf of the principal. A minor can also draw, deliver or endorse a negotiable instrument, but he can’t be held liable in any case.
• Minor as a Shareholder: A minor can’t be a Shareholder in the company as he is incompetent to contract. However, in any rare case, if he becomes a member, the company can remove him from the register of members and rescind the transaction. Also, a minor can become a shareholder by acting through his guardians by transfer or transmission of fully paid shares only.

2. Person of Sound Mind

According to Section 12 of the Indian Contract Act, 1872, when a person is capable of understanding the contract and is able to form a rational judgement as to what is best for his interests, only then the person will be considered a Person of Sound Mind for the purpose of entering into a contract. As for any contract, it is important that both parties to the contract understand the transaction well and make informed decisions. But, here as a person is of unsound mind, he might not be able to make informed decisions, and this might lead to exploitation or undue advantage for the other party. A contract made by a person of an unsound mind is considered a void contract, but it is important to note that such a person cannot avail of any benefits from the contract. The property of such a person will always be liable.

There can be two cases under this provision:

• When a person is usually of unsound mind but occasionally of sound mind: In such a case, the person can enter into the contract at times when he is of sound mind.
• When a person is usually of sound mind, but occasionally of unsound mind: In such a case, the person can’t enter into a contract when is of unsound mind. In case, he made any contract at the time of being unsound, such contract will be considered void.

For example, A contracts with B, a person who is a drunkard and habitual to drugs to sell his car valued at ₹5,00,000 at a mere price of ₹100. As B was a person of unsound mind at the time of the contract, such a contract will be void contract and A can’t sue B for this contract.

3. Person not Disqualified by Law

There is another class of persons who are disqualified from entering a contract either wholly or partially, and any contract entered by such person is also considered void. This class might be declared incompetent from contracting due to their legal status, political status or corporate status. The person who falls under this class of disqualified person includes:

• Alien Enemy: Those people who have citizenship in countries that don’t have good bilateral relationships with India or who are a citizen where there is a war situation are called Alien enemies. People signing a contract during a war situation is not accepted. However, any contract entered during a peace situation will be considered valid.
• Corporations: For those corporations which are a Joint Stock Company or incorporated under any special law will be considered an artificial person who are formed by the law. They do not have the capacity to contract outside the powers as specified under the Memorandum of Association or the Special Act.
• Convicts: A person who is held guilty and is serving imprisonment as declared by the court does not have the capacity to enter into any contract. He cannot sue on the contracts that he entered before his conviction. After the expiry of his sentence, he is at liberty to enter into a contract and make a suit for the contracts.
• Insolvent: In case, a person is declared insolvent by the court, he will have limited capacity to enter into a contract of certain types. The insolvent can incur debts, can be an employee, and may also purchase a property, but he cannot sell the property. He also has certain disqualifications, like he cannot be a magistrate, he cannot be a director in a company, or he cannot be a member of a local body. The insolvent person has the capacity of a contract except for his attached property. He will be considered an ordinary citizen once the order of discharge has been initiated.

Conclusion

Thus, one of the most essential elements of a valid contract is to understand the competence of the parties to make a contract. Indian Contract Act, 1872 has specified three classes of persons who shall be considered incompetent to enter into a contract such as a person who is yet to attain the age of majority, a person of unsound mind, and a person who is disqualified from entering into a contract by any law that he is subjected to. A contract with a minor will be considered as void-ab-initio, validity of a contract with a person of unsound mind depends upon the condition in which he has made the contract. A convicted or insolvent person can enter into a contract once he is removed from such disqualification.

It is important for the parties to contract to identify that the parties to a contract are competent to contract, in order to ensure that they can be saved from any possible losses or damages by contracting with a person who is incompetent to contract. A full-fledged background check and due diligence are advised before entering into a contract.

Capacity of Parties – FAQs

What are the requirements for a contract to be valid apart from the basic requirements?

As per Section 10 of the Indian Contract Act, 1872 in order to be a Valid Contract:

• The parties to a contract must be Competent.
• The contract must be made by the Free Consent of the parties to the contract.
• The contract must be made for a Lawful Consideration and there should be a Lawful Object.
• The contract should not have been expressly declared as a Void Contract.

What is the class of person that is expressly declared incompetent to contract?

As per Indian Contract Act, 1872 following class of persons is Incompetent to enter a Contract:

• A person who is yet to attain the age of Majority (As per Indian Majority Act, 1875).
• A person of Unsound Mind.
• A person Disqualified from entering into a contract by any law.

Can a minor enter into a contract?

No, a minor cannot enter into a contract, any contract entered by a minor shall be treated as void-ab-initio. However, a minor can enter into a contract if represented by his guardians in certain conditions. Besides, a minor can never be held personally liable.

Can a person who is usually of sound mind but occasionally is of unsound mind enter into a contract?

In such a case, the person can enter into the contract at time only when he is of sound mind. If he makes a contract when he is of unsound mind such contracts will be treated as Void.

Can an insolvent person enter into a contract?

Such a person will have limited capacity to enter into a contract of certain types. The insolvent can incur debts, he can be an employee and he may also purchase a property, but he cannot sell the property. He also has certain disqualifications like he cannot be a magistrate, he cannot be a director in a company, or he cannot be a member in a local body. However, once he is discharged he can resume entering into contract.