First Principles of Business Law

6.1. The importance of capacity to contract

In the previous sections of this module, we have seen that, for a legally binding agreement to be made, various essential elements must be present - an intention to be bound, agreement on the essential aspects of a workable transaction, and either formal execution of the agreement in a deed or the exchange of consideration.

But, in addition to those things, it is necessary that the parties have the capacity, as individuals, to enter into legally binding agreements. Put another way, the parties must have the power to subject themselves to obligations that are enforceable at law. Adult persons of sound mind have full contractual capacity. Section 124 of the Corporations Act 2001 gives corporations the same legal capacity and powers as a natural adult person. Government bodies may also have the capacity to enter into contracts.

But not everybody has contractual capacity to the same extent. Some persons do not have any power (capacity) to enter into contractual relations. Others have a limited capacity to do so. It is therefore important to know what factors might affect a person's capacity to enter into a legally binding agreement.