In contractual disputes it is sometimes argued that a contract should not be binding because one of the parties lacked the mental capacity to enter into the contract in the first place. This can potentially render a contract void and unenforceable because you cannot enforce a contract against someone who lacked the capacity to enter into it. Whether a party lacked capacity at the relevant time or not will of course depend on the circumstances of each case and probably the medical evidence. The High Court has recently provided some useful guidance however in the recent case of Fehily v Atkinson which sets out a useful test for determining whether a party had the necessary capacity to enter into a contract.
Following some financial difficulties, Mrs Fehily entered into an Individual Voluntary Arrangement (IVA) with her creditors in order to avoid being made bankrupt. Mrs Fehily failed to abide by the terms of the IVA and was subsequently made bankrupt. Mrs Fehily brought annulment proceedings in the County Court seeking an order that the bankruptcy order be annulled because she lacked the mental capacity to enter into the IVA. Those proceedings were unsuccessful and Mrs Fehily appealed to the High Court.
The High Court dismissed Mrs Fehily’s appeal and found that there was insufficient medical evidence to support Mrs Fehily’s claim that she lacked the necessary capacity to enter into an IVA.
In reaching its decision, the High Court reviewed the existing authorities and identified 5 general principles as relevant to the issue of capacity:
- A person needs the mental capacity to recognise the issues that must be considered, to obtain, receive, understand and retain relevant information, and to weigh the information in the balance in reaching a decision.
- Whether a person lacks capacity is issue specific. A person may have capacity for one type of decision but not another. For example, a person may have capacity to authorise someone to deal with their property on their behalf, but insufficient capacity to then decide what should actually be done with it.
- A person’s capacity may vary over time and should be assessed at the specific time when the decision was made.
- The key issue is whether the person has the ability to understand the transaction, not whether they actually understood it.
- Although help might be needed to understand the transaction, this does not prevent the person having the capacity to understand it. Essentially, the person needs to have:
- the insight and understanding to realise that advice is needed;
- the ability to find and instruct an appropriate adviser; and
- the capacity to understand and make decisions based on that advice.
This case provides an accessible summary of the key principles on capacity in the context of entering into contracts. Interestingly, a party does not have to actually understand all the detail of a proposed contract but they should have the ability to “absorb, retain, understand, process and weigh information about the key features and effects of the contract, and the alternatives to it, if explained in broad terms and simple language”.
In other words, it’s not a question of did they actually understand it but more could they have done if it had been explained to them properly.
Jeremy Crook works in our disputes legal team. If you have any questions about the issues raised in this article or any others get in touch by telephone 0345 450 5558 or email firstname.lastname@example.org