Restat 2d of Contracts, § 15

• Restatement of the Law, Second, Contracts
• Chapter 2- Formation of Contracts -- Parties and Capacity
• § 15 Mental Illness or Defect

(1)  A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect

(a)  he is unable to understand in a reasonable manner the nature and consequences of the transaction, or

(b)  he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition.
(2)  Where the contract is made on fair terms and the other party is without knowledge of the mental illness or defect, the power of avoidance under Subsection (1) terminates to the extent that the contract has been so performed in whole or in part or the circumstances have so changed that avoidance would be unjust. In such a case a court may grant relief as justice requires.

Comment:

a.  Rationale.  A contract made by a person who is mentally incompetent requires the reconciliation of two conflicting policies: the protection of justifiable expectations and of the security of transactions, and the protection of persons unable to protect themselves against imposition. Each policy has sometimes prevailed to a greater extent than is stated in this Section. At one extreme, it has been said that a lunatic has no capacity to contract because he has no mind; this view has given way to a better understanding of mental phenomena and to the doctrine that contractual obligation depends on manifestation of assent rather than on mental assent. See §§ 2, 19. At the other extreme, it has been asserted that mental incompetency has no effect on a contract unless other grounds of avoidance are present, such as fraud, undue influence, or gross inadequacy of consideration; it is now widely believed that such a rule gives inadequate protection to the incompetent and his family, particularly where the contract is entirely executory.

b.  The standard of competency.  It is now recognized that there is a wide variety of types and degrees of mental incompetency. Among them are congenital deficiencies in intelligence, the mental deterioration of old age, the effects of brain damage caused by accident or organic disease, and mental illnesses evidenced by such symptoms as delusions, hallucinations, delirium, confusion and depression. Where no guardian has been appointed, there is full contractual capacity in any case unless the mental illness or defect has affected the particular transaction: a person may be able to understand almost nothing, or only simple or routine transactions, or he may be incompetent only with respect to a particular type of transaction. Even though understanding is complete, he may lack the ability to control his acts in the way that the normal individual can and does control them; in such cases the inability makes the contract voidable only if the other party has reason to know of his condition. Where a person has some understanding of a particular transaction which is affected by mental illness or defect, the controlling consideration is whether the transaction in its result is one which a reasonably competent person might have made.

Illustration:

1. A, a school teacher, is a member of a retirement plan and has elected a lower monthly benefit in order to provide a benefit to her husband if she dies first. At age 60 she suffers a "nervous breakdown," takes a leave of absence, and is treated for cerebral arteriosclerosis. When the leave expires she applies for retirement, revokes her previous election, and elects a larger annuity with no death benefit. In view of her reduced life expectancy, the change is foolhardy, and there are no other circumstances to explain the change. She fully understands the plan, but by reason of mental illness is unable to make a decision based on the prospect of her dying before her husband. The officers of the plan have reason to know of her condition. Two months after the changed election she dies. The change of election is voidable.

c.  Proof of incompetency.  Where there has been no previous adjudication of incompetency, the burden of proof is on the party asserting incompetency. Proof of irrational or unintelligent behavior is essential; almost any conduct of the person may be relevant, as may lay and expert opinions and prior and subsequent adjudications of incompetency. Age, bodily infirmity or disease, use of alcohol or drugs, and illiteracy may bolster other evidence of incompetency. Other facts have significance when there is mental illness or defect but some understanding: absence of independent advice, confidential or fiduciary relationship, undue influence, fraud, or secrecy; in such cases the critical fact often is departure from the normal pattern of similar transactions, and particularly inadequacy of consideration.

d.  Operative effect of incompetency.  Where no guardian has been appointed, the effect on executory contracts of incompetency by reason of mental illness or defect is very much like that of infancy. Regardless of the other party's knowledge or good faith and regardless of the fairness of the terms, the incompetent person on regaining full capacity may affirm or disaffirm the contract, or the power to affirm or disaffirm may be exercised on his behalf by his guardian or after his death by his personal representative. There may, however, be related obligations imposed by law independently of contract which cannot be disaffirmed. See Comment f to § 12, Comment b to § 14. And if the other party did not know of the incompetency at the time of contracting he cannot be compelled to perform unless the contract is effectively affirmed.

Illustration:

2. A, an incompetent not under guardianship, contracts to sell land to B, who does not know of the incompetency. A continues to be incompetent. On discovering the incompetency, B may refuse to perform until a guardian is appointed, and if none is appointed within a reasonable time may obtain a decree canceling the contract.

e.  Effect of performance.  Where the contract has been performed in whole or in part, avoidance is permitted only on equitable terms. In the traditional action at law, the doing of equity by or on behalf of the incompetent was accomplished by a tender before suit, but in equity or under modern merged procedure it is provided for in the decree. Any benefits still retained by the incompetent must be restored or paid for, and restitution must be made for any necessaries furnished under the contract. See Comment f to § 12. If the other party knew of the incompetency at the time of contracting, or if he took unfair advantage of the incompetent, consideration not received by the incompetent or dissipated without benefit to him need not be restored.

Illustrations:

3. A, an incompetent not under guardianship, contracts to buy land for a fair price from B, who does not know of the incompetency. Shortly after transfer of title to A and part payment by A, A dies. A's personal representative may recover A's part payment on reconveying the land to B.

4. The facts being otherwise as stated in Illustration 3, C, with knowledge of A's incompetency, renders legal services to A in the transaction; after learning of A's incompetency, B pays $ 500 to C pursuant to the contract. A's personal representative need not reimburse B for the payment.

f.  When avoidance is inequitable.  If the contract is made on fair terms and the other party has no reason to know of the incompetency, performance in whole or in part may so change the situation that the parties cannot be restored to their previous positions or may otherwise render avoidance inequitable. The contract then ceases to be voidable. Where the other party, though acting in good faith, had reason to know of the incompetency at the time of contracting or performance, or where the equities can be partially adjusted by the decree, the court may grant or deny relief as the situation requires. Factors to be taken into account in such cases include not only benefits conferred and received on both sides but also the extent to which avoidance will benefit the incompetent and the extent to which others who will benefit from avoidance had opportunities to prevent the situation from arising.

Illustrations:

5. A, an incompetent spouse not under guardianship, mortgages land on fair terms to B, a bank which has no knowledge or reason to know of the incompetency, for a loan of $ 2,000. At A's request the money is paid to the other spouse, C, who absconds with it. The contract is not voidable.

6. A, a congenital imbecile not under guardianship, has an interest in unimproved land which is contingent on his surviving his father B. A joins B and C, a cousin, in leasing the land on fair terms for 25 years to D, who has no reason to know of the incompetency. Subsequently A assigns his interest in the rent to C in return for C's agreement to support A for life, which C duly performs. Five years later A joins B and C in an outright sale of the land to D. On B's death avoidance of the sale of A's interest may be equitable if D can be assured ofrepayment of the price and of retaining improvements made by him after the sale; avoidance of the lease would be inequitable.

7. A, an incompetent not under guardianship, lives on a homestead with his mother B and brother C. A also holds a mortgage on a second tract of land owned by C. To prevent foreclosure of a mortgage on the homestead, A, B and C join in borrowing money from D on a mortgage of both tracts on fair terms. D acts in good faith but has reason to know of A's incompetency. A dies, leaving B his sole heir. The mortgage to D is not voidable for the benefit of B.

This Section is new. See 2 Williston, Contracts §§ 249-56 (3d ed. 1959); 1 Corbin, Contracts § 6 (1963 & Supp. 1980); Allen, Ferster & Weihofen, Mental Impairment and Legal Incompetency 263-82 (1968); Brakel & Rock, The Mentally Disabled and the Law 304-05, 315-21 (rev. ed. 1971); Madden, Persons and Domestic Relations §§ 235-40 (1931); Smoot, Insanity §§ 333-49 (1929); Weihofen, Mental Incompetency to Contract or Convey, 39 So. Cal. L. Rev. 211 (1966); Green, Public Policies Underlying the Law of Mental Incompetency, 38 Mich. L. Rev. 1189 (1940); Green, Proof of Mental Incompetency, 6 Mo. L. Rev. 141 (1941); Green, Proof of Mental Incompetency and the Unexpressed Major Premise, 53 Yale L.J. 271 (1944); Green, The Operative Effect of Mental Incompetency on Agreements and Wills, 21 Tex. L. Rev. 554 (1943); Virtue, Restitution from the Mentally Infirm, 26 N.Y.U.L. Rev. 132, 291 (1951); Comment, 45 N.Y.U.L. Rev. 585 (1970); Note, 16 Wayne L. Rev. 1188 (1970); Note, Mental Illness and the Law of Contracts, 57 Mich. L. Rev. 1020 (1959); Annots., 46 A.L.R. 416 (1927), 95 A.L.R. 1442 (1935). Additional readings through 1974 may be found in Brooks, Law, Psychiatry and the Mental Health System 999-1000 (1974).

Comment b.  For a discussion of the types of incompetency and analysis of the authorities indicating that the cognitive test has been supplanted by the standard of the fairness of the particular transaction, see Green, Proof of Mental Incompetency and the Unexpressed Major Premise, 53 Yale L.J. 271 (1944).

An additional and major distinction has been made between the cognitive test and one which also considers the impact of psychosis on judgment and control of behavior even though a party understands the nature of an "unwise and foolhardy" transaction. This "affective" or "motivational" approach is found in Ortelere v. Teachers' Retirement Bd., 25 N.Y.2d 196, 303 N.Y.S.2d 362, 250 N.E.2d 460 (1969) (Breitel, J.), 45 N.Y.U.L. Rev. 585 (1970), 16 Wayne L. Rev. 1188 (1970), upon which Illustration 1 is based, and which relied in substantial part on the Tentative Draft of Subsection (1) (b). A contract entered into during the manic phase of manic-depressive illness was invalidated without a finding of unfairness in the important case of Faber v. Sweet Style Mfg. Corp., 40 Misc. 2d 212, 242 N.Y.S.2d 763 (Sup. Ct. 1963), 39 N.Y.U.L. Rev. 356 (1964). The general approach of Faber was approved of by the New York Court of Appeals in Ortelere, but Faber was limited by a lower court in Fingerhut v. Kralyn Enterprises, 71 Misc. 2d 846, 337 N.Y.S.2d 394 (Sup. Ct. 1971), aff'd, 40 A.D.2d 595, 335 N.Y.S.2d 926 (1972), to psychotic mania, in accordance with a dictum in Ortelere limiting relief to medically classified psychoses. This psychosis-neurosis distinction is criticized in Note, 16 Wayne L. Rev. 1188, 1194-96 (1970), and (implicitly) in Danzig, The Capability Problem in Contract Law 202-03 (1978).

The Faber-Ortelere motivational approach was approved of, and the Tentative Draft of this Section quoted in support, in Nohra v. Evans, 509 S.W.2d 648 (Tex. Civ. App. 1974). See also Krasner v. Berk, 366 Mass. 464, 319 N.E.2d 897 (1974), and Gore v. Gadd, 268 Or. 527, 522 P.2d 212 (1974). The approach is criticized in Alexander & Szasz, From Contract to Status Via Psychiatry, 13 Santa Clara Law. 537 (1973), and a California court refused to follow Faber, relying, however, on the text of a state statute, which the court interpreted as mandating a cognitive approach only. See Smalley v. Baker, 262 Cal. App.2d 824, 69 Cal. Rptr. 521 (1968). Compare discussion of the analogous problem of the criminal law in United States v. Brawner, 471 F.2d 969 (D.C. Cir. 1972); Model Penal Code § 4.01 and Comment.

Comment c.  A substantial excerpt from the trial in Ortelere v. Teachers' Retirement Bd., supra, is reprinted in Danzig, The Capability Problem in Contract Law 161-200 (1978). Procedural and evidentiary problems in mental incapacity cases are discussed in Note, Mental Illness and the Law of Contracts, 57 Mich. L. Rev. 1020, 1038-58 (1959).

Comments d-f.  Illustrations 2-7 are new.

ALR Annotations:

Termination of continuing guaranty by appointment of guardian or conservator for guarantor. 55 A.L.R.3d 344.
Commitment of grantor to institution for insane as ground for setting aside conveyance in consideration of support. 18 A.L.R.2d 906.
Rights, duties, and liability of corporation in connection with transfer of stock of infant or incompetent. 3 A.L.R.2d 881.

Digest System Key Numbers:

Contracts 92
Mental Health 372