Managing contracts efficiently is crucial for every business, especially for a growing one.
A well-organized contract management process not only helps reduce legal risk and improve compliance but also ensures smoother operations and better collaboration among departments.
However, one critical aspect is sometimes overlooked in this process: contractual capacity, or legal capacity, which is the legal ability of parties to enter into binding contracts.
With this article, we’ll delve into the importance of contractual capacity for streamlining your contract management process, define what it means to lack the capacity to sign contracts, discuss the factors affecting capacity, and, finally, provide insights into how you can overcome common contract management challenges related to insufficient attention to contractual capacity.
Key takeaways
- Contractual capacity means the legal competence of a person or organization to enter into binding agreements. For a contract to be valid, all parties involved must have the necessary capacity to understand and fulfill its terms and conditions.
- This is a highly important aspect of contract law: contracts agreed upon by any party deemed incapable to legally enter into a contract can be rendered void or voidable and disaffirmed.
- A person lacks contractual capacity if they are a minor, have a mental illness, were severely intoxicated during the contract signing, or are employees lacking authority to sign contracts on behalf of a company.
- Addressing contractual capacity can help tackle general challenges — inconsistencies, suboptimal collaboration, frequent human errors, and insufficient contract monitoring.
- Using tools and approaches like automated verification, compliance checks for industry-specific regulations, third-party integrations, and related workflows all assist the detection and management of contractual capacity.
- The benefits of including contractual capacity in your contract management strategy are faster and less costly paperwork, a better recipient experience, more consistent documents, and higher legal compliance.
What contractual capacity is
Contractual capacity refers to the legal competence of an individual or organization to enter into binding agreements.
In order for a contract to be considered valid, all parties involved must have the necessary capacity to understand and fulfill the terms and conditions set forth in the agreement.
In other words, having a contractual capacity means fully understanding the terms and conditions, the consequences of signing the contract, and having the ability to fulfill the contractual obligations without any legal or practical barriers.
When a person is lacking contractual capacity yet signs a contract, this contract must be considered invalid.
Why contractual capacity is important
Establishing and assessing contractual capacity is a critical aspect of contract law.
Contracts formed without the proper capacity of all involved parties can be deemed void or voidable.
This is quite different from the breach of contract which is a subject for damages. Deeming the contract void or voidable leads to:
- potential legal disputes with the parties
- delays in business operations,
- loss of both time and money.
Categories of contractual incapacity
There are several instances where people or organizations would be deemed legally incapable of signing contracts.
Minors
Minors are the most obvious category of individuals that lack contractual capacity.
And for reasons that are crystal clear: generally speaking, signing any contract with a child is not a thing.
For instance, if a company knowingly or unknowingly hires a minor for a full-time position, the employment contract could be deemed voidable, exposing that company to legal risks and other potential repercussions.
There are, however, some exceptions when persons aren’t required to reach the age of majority to sign legally binding contracts.
In some cases and jurisdictions, teenagers who reached a certain age can legally work part-time and be able to sign corresponding contracts.
Other exceptions possible here are educational contracts or necessities contracts, but only when such contracts are recognized as fair or beneficial for the minor signing them.
Persons with mental illness
When someone lacks mental capacity, they also lack contractual capacity.
Persons lack mental capacity when having certain mental or psychological disorders are such that they are declared mentally incapacitated.
The criteria for incapacity varies across different authoritative bodies.
For example, each state in the U.S. sets its own statewide criteria.
Some of them use quite complex tests; others use the “appreciate effects” test aimed at determining if the person being tested understands the details of their involvement and can accurately appreciate the effects of it.
Another method of determining capacity, called the “control test,” covers only the ability of a testee to control themselves, no matter whether they understand what’s happening.
The courts, however, always have the final word.
Intoxicated people
Intoxication does not necessarily mean a lack of mental and contractual capacity.
However, signing agreements in such a state can become a reason for voiding a contract.
For declaring the contract voidable, intoxication must be severe and the intoxicated party should argue for voidance once returning to “normal” consciousness and with the belief that the contract was signed mistakenly.
People without authority within an organization
With most companies, only selected employees have the authority to sign contracts on behalf of the entire firm.
Among them are usually top managers, department and branch heads, accountants, and so forth.
Each organization should have clear guidelines on who has the authority to enter into contracts on behalf of the company to avoid confusion and potential legal issues.
Legal restrictions on certain types of contracts
Some contracts may be subject to specific legal restrictions, like gambling or usurious loans within certain jurisdictions.
Such contracts, when signed, will likely be deemed void and may lead to financial and/or reputational harm for the company initiating the contract.
Compliance with industry-specific regulations
Businesses may need to comply with certain business sector or industry-wide regulations and restrictions that can affect contractual capacity.
For example, in the healthcare sector, contracts involving the sharing of protected health information (PHI) must adhere to strict HIPAA regulations.
Failure to consider these regulations when entering into contracts may ruin the reputation of the provider or clinic, cause fines and other issues with legal authorities, as well as lawsuits from affected victims if a HIPAA violation occurs.
The role of contractual capacity in contract management challenges
Addressing contractual capacity is integral to a successful contract management process.
Let’s highlight some of the challenges companies face, and how to mitigate them via a strong policy on contractual capacity.
Inconsistencies
Establishing a standardized approach to contractual capacity means having clear guidelines on who can sign contracts on behalf of the company and under what circumstances.
Standard processes eliminate confusion between the parties, making clear that they all have the necessary authority.
This standardization is a way to utilize more consistent templates and language, as well as to reduce the chance for misunderstandings between parties.
Insufficient collaboration
Adhering to the requirements of contractual capacity spurs involved departments to collaborate more actively.
Clear guidelines and roles for each employee increase motivation and performance of collaborative work, reducing delays in delivery and enhancing overall efficiency.
Frequent human errors
Once something has become automated, the number of human errors reliably heads toward zero.
Automation of document creation and management can be implemented related to the verification of a party’s authority within an organization or checking for compliance with industry-specific regulations.
As a result, the likelihood of legal disputes arising from errors drops in the same way.
Unsystematic contract monitoring and tracking
By including such an essential aspect in your contract monitoring and tracking process, you’ll make your approach more systematic.
This results in identifying and cutting down potential risks vis-à-vis meeting contractual capacity standards, and preventing missed deadlines, unmet obligations, and compliance issues.
The benefits of streamlining contract management with contractual capacity
Below are the concrete benefits of including contractual capacity control in your contract management strategy:
| Benefit | Positive outcomes |
|---|---|
| Faster and less costly paperwork | Reduced time and effort for handling legal disputes, renegotiations, void and voidable contracts management |
| Optimal recipient experience | Seamless and hassle-free experiences lead to better relationships between your business and your clients or partners and enhanced reputation of your brand |
| Consistent documents across the company | Fewer errors, misunderstandings, higher clarity, higher contract management efficiency |
| Higher legal compliance | Fewer legal disputes and fines, lower reputational damage, better-mitigated risks, contribution into a long-term success |
Tools and technologies to support contractual capacity
Leveraging tools and technologies can greatly assist in determining and managing contractual capacity, further streamlining your contract management process.
Here are some features and integrations to consider when selecting a contract management solution:
Automated verification
Contract management software solutions offer features that can automatically verify a party’s authority within an organization.
This helps reduce the risk of void or voidable contracts.
Compliance checks for industry-specific regulations
Contract management tools with built-in compliance checks can help ensure that your contracts adhere to industry-specific or local regulations, like HIPAA for healthcare or GDPR within the European Union for data protection.
Third-party integrations
To create a seamless contract management experience, it’s essential to choose a solution that integrates well with your existing technology stack.
For example, if your organization uses a CRM like HubSpot or Salesforce, choose a contract management solution that has seamless and error-free integrations with the software you’re using.
Collaboration and approval workflows
Contract management solutions that support collaboration and approval workflows can help ensure that all necessary parties are involved in the contract creation and review process.
This can help address contractual capacity concerns and facilitate better communication among departments.
Conclusion
Ensuring the validity and enforceability of your contracts is crucial for successful growth.
Contractual capacity is a component that should be proactively addressed in order to help your organization overcome common contract management challenges, minimize legal risks, and streamline operations.
The factors that affect and can negate contractual capacity are being underage, being mentally or psychologically unwell, lack or proper authority within an organization, and nonadherence to industry-specific regulations.
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