Contractual Capacity: What It Takes To Sign A Valid Contract

A 90-year-old woman with moderate dementia signs a contract to buy a new car. A man with Schizophrenia wants to buy his first house. A woman with severe mania signs divorce documents.

Are any of these contracts legal in Colorado? Or, would an attorney have a strong case to argue that any of these individuals did not have the capacity to sign a valid contract?

From time to time, psychologists are asked to conduct neuropsychological evaluations and to render opinions on a person’s capacity to sign a contract at some point in the past. I have discovered that most psychologists, even forensic psychologists, do not know how to do these evaluations, or even what the standard is that we are looking at when forming this type of an opinion. In fact, the vast majority of evaluations of contractual capacity I’ve read have included a completely made-up standard; it is always slightly different, and it is clear the psychologist was just winging it, relying on whatever he/she thinks is important (and probably also being swayed by what the retaining attorney thinks is important).

With that in mind, I want to write a series of blog posts about contractual capacity evaluations. In this first post, I will address the standard in Colorado so that attorneys and psychologists can agree on what the evaluator’s focus should be. In subsequent posts, I’ll write about how to evaluate contractual capacity retrospectively.

So, here is the standard:

First, the person must be over the age of 18. This one is easy to prove/disprove and it should not take a doctoral degree in psychology…

Next, the person must be of sound mind at the time of the contract execution (i.e. the person must have had capacity). To be of sound mind, a person must be free from insane delusions. He or she can be a “protected person,” meaning under the care of a guardian and still have contractual capacity. He or she can even be in need of a conservator and have the capacity to sign a contract that has financial implications.

The legal presumption is that the person signing the contract had the capacity to do so, and it is up to the party asserting incompetence to prove so by a preponderance of the evidence.

To summarize:

1. The person must be at least 18;

2. The person must be free of insane delusions (defined below);

3. The insane delusion must have materially affected the decision-making process in signing the contract, otherwise the person still has capacity;

4. Contractual capacity is similar to testamentary capacity;

5. Contractual capacity is a significantly lower standard than the need for a guardian or conservator;

6. A person can have a guardian and/or a conservator and still have contractual capacity;

7. Everyone is presumed to have contractual capacity;

8. It doesn’t matter what the person’s mental state is right now. What matters is their mental state at the time the contract was signed; and

9. It really doesn’t take much to have contractual capacity

The three hypothetical individuals I mentioned at the beginning of the blog post all may have had the capacity to sign their contracts. Each case would need to be evaluated using the criteria mentioned above, and in future posts I will explain how such evaluations are done.

In the meantime, following is case law, jury instructions, and statutes that psychologists should be aware of prior to starting a contractual capacity evaluation.

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Contractual Capacity Guidelines In Colorado

Colorado Jury Instruction 30:22 Mental Incapacity

The defendant is not legally responsible to the plaintiff on the plaintiff’s claim of breach of contract if the affirmative defense of lack of mental capacity is proved. This defense is proved if you find at the time the defendant entered into the contract, she was suffering from an insane delusion that made her unable to understand the terms or effect of the contract or to act rationally in the transaction.

Colorado Jury Instruction 34:12 Insane Delusion Defined

An insane delusion is a persistent belief, resulting from illness or disorder, in the existence or non-existence of something that is contrary to all evidence.

In re Estate of Romero 126 P.3rd 228 at 233 (Colo.App. 2005)

The Colorado Supreme Court has held that “contractual capacity and testamentary capacity are the same.” (Citing Breeden v. Stone, supra, 992 P.2nd 1167 at 1170 (Citing Hanks v. McNeil Coal Corp., 114 Colo. 578, 168 P.2nd 256 (1946))

Further, the Romero court held that the appointment of a conservator or the entry of another protective order is not a determination of the testamentary incapacity of the protected person, and that the fact that a person has been rated as incompetent by a third party nor the fact that a guardian has been appointed for the person shall be construed as a legal adjudication of insanity or mental incompetency. Thus, Colorado statutes explicitly state that the findings that warrant appointment of a guardian or conservator do not equate to a determination of testamentary (or contractual) incapacity. (Citing In re Estate of Gallavan, supra, 89 P.3rd at 523)

C.R.S. § 15-14-409(4)

The appointment of a conservator or the entry of another protective order is not a determination of incapacity of the protected person.

Forman v. Brown 994 P.2d 559 [Colo. 1996]

In this appeal, the Colorado Court of Appeals ruled that the plaintiff’s claim that her mental illness kept her from reading a contract, thus incapacitating her at the time, was without merit, and they upheld the trial court’s summary judgment in favor of the defendants.

The Forman Court also ruled that a contract may not be voided when the alleged incompetence arose after the execution of the contract, and that emotional distress or severe mental depression generally is insufficient to negate the capacity to contract.

Hanks v. McNeil Coal Corp., 114 Colo. 578, 168 P.2d 256 [Colo. 1946]

A person is incompetent to contract when the subject matter of the contract is so connected with an insane delusion as to render the afflicted party incapable of understanding the nature and effect of the agreement or of acting rationally in the transaction.

The Hanks court also ruled that competency to contract is determined by a party’s mental state at the time of the execution of the agreement.

Drewry v. Drewry, 8 Va.App. 460, 383 S.E.2d 12 [Virg. 1989] (Cited in Forman v. Brown 994 P.2d 559 [Colo. 1996])

Severe mental depression did not render a party to the marital separation agreement legally incompetent where there was no evidence that the party did not understand the nature and consequences of her acts.

Davis v. Colorado Kenworth Corp. 156 Colo. 98, 396 P.2d 958 [Colo. 1964]

A party can be insane for some purposes and still have the capacity to contract.

In re Marriage of Seely 689 P.2d 1154 [Colo.App. 1984]

The appeals court upheld the trial court’s decision to vacate a previous divorce decree because one party was in an extremely agitated emotional state at the time the separation agreement was executed, and the other party perpetrated a fraud upon the court.

May v. Colorado Civil Rights Commission 43 P.3d 750 [Colo.App. 2002]

In this decision, the May Court wrote, “The term ‘incompetent person’ includes one who is ‘mentally unfit to the degree of being incapable of effectively participating’ in legal proceedings,” citing People in Interest of M.M. 726 P2.d 1108, 1119 [Colo. 1986].

However, they misquoted the intention of the M.M. Court, which actually wrote, “The term ‘incompetent person’ includes one who is mentally unfit to the degree of being incapable of effectively participating in a termination proceeding and thus need the assistance of a fiduciary representative.” In this case, the parent in question was facing the possibility of having her parental rights terminated, and the M.M. Court ruled it was up to the discretion of the trial court as to whether a Guardian Ad Litem was needed due to potential mental incapacity. The May case is sometimes cited as justification for contractual incapacity, but it uses reasoning that has nothing to do with contract law.

People in the Interest of M.M. 726 P2.d 1108, 1119 [Colo. 1986]

A person who labors under some degree of mental impairment is not necessarily legally incompetent to sue or be sued.

Cunningham v. Stender 255 P.2d 997 [Colo. 1953]

To be of sound mind, the testator must:

1. Understand the nature of her act in making a will;

2. Know the extent of her property;

3. Understand the proposed testamentary disposition;

4. Know the natural objects of her or her bounty; and

5. Understand that the will represents her wishes.

Breeden v. Stone 992 P.2nd 1167 [Colo. 2000]

In addition to examining a testator’s soundness of mind under the Cunningham criteria, it is appropriate to, at the same time, examine whether or not a defendant possesses an insane delusion, which is defined as follows:

1. The testator has a persistent belief “which has no existence in fact and which is adhered to against all evidence;” and

2. This persistent belief must materially affect the dispositions in the estate plan.