Introduction:
Most people know from movies and novels the legal issue of competency to create a Will or Trust. People understand that unless someone is of “sound mind and body” one cannot make a Will and the issue of the decedent’s competency is a common topic before the court as well as moviegoers.
What is less commonly known is that it is essential to be competent to enter into any type of binding agreement. Even temporary incompetency can void a contract entered into by an incompetent person. That would include signing an agreement when suffering from any disease or injury that interferes with the ability to think or under the influence of a drug or alcohol.
However, the criteria for determining competency to enter into a binding agreement is different than that for competency to make a Will. The courts want to give full freedom to create an estate plan even to those who may not have the type of rational powers normally expected. To sign a binding Will or Trust, all the courts require is the ability to know what one owns, and what one is doing in making a Will. One famous case allowed the estate plan to survive a man who commonly talked to mailboxes as he walked along the street since he knew what he owned and who he wanted to leave his assets to upon his death.
The freedom to contract while of questionable competency is another matter in California and is the topic of this article.
The Basic Law:
The two related areas of concern to a court are whether a person had the capacity to enter into a contract and who has the burden of proof to establish either capacity or lack of capacity.
Under California law, a person is presumed to have the capacity to make decisions. This is a rebuttable presumption (Prob. Code, § 810(a)). At the same time, there is a countervailing rebuttable presumption that that a person is of unsound mind if the person is substantially unable to manage his or her own financial resources or resist fraud or undue influence. (Civil Code §39(b).
What is a presumption? Under the law, a presumption is what the court must accept as true if there is no substantive evidence to the contrary. A presumption is either conclusive or rebuttable (Evidence Code §601). A conclusive presumption cannot be countered by contrary evidence. A rebuttable presumption is not conclusive and may be overcome by contrary evidence. “A presumption is an assumption of fact that the law requires to be made from another fact or group of facts found or otherwise established in the action. A presumption is not evidence.” (Evidence Code §600). A presumption is how evidence must be treated, not evidence in and of itself.
Capacity questions under California law are complicated and fact-specific. The nature of presumptions differs between the Probate Code (used for estate purposes) and the Civil Code (used for all civil matters aside from estate issues.) Put simply, the most difficult presumption to establish capacity exists in the context of proving capacity to contract.
In In re Marriage of Greenway, 217 Cal. App. 4th 628, 158 Cal. Rptr. 3d 364 (Ct. App. 2013), the court explained that “[t]he determination of a person's mental capacity is fact-specific, and the level of required mental capacity changes depending on the issue at hand.” Ibid at 639. The court explained further that mental capacity can be measured on a sliding scale, with “marital capacity requiring the least amount of capacity, followed by testamentary capacity, and on the high end of the scale is the mental capacity required to enter contracts.” Ibid.
The reason for the sliding scale, and the different burdens of proof, surmised the court, is because while there are many established safeguards to protect spouses and their assets (in the question of marital capacity), and there is more than ample statutory and case law that protects testators and their heirs (in the question of testamentary capacity), “[t]he same cannot be said for the parties to a contract.” When considering the capacity to contract, there is not a safety net of laws, and thus the burden of proof of the elder’s capacity to contract shifts to who is claiming the elder had capacity. Ibid at 643. Algo-Heyres v. Oxnard Manor LP, 88 Cal. App. 5th 1064, 305 Cal. Rptr. 3d 296 (Ct. App. 2023) (citing Greenway for the proposition that mental capacity is determined on a sliding scale, with the capacity to contract at the high end).
The court in Greenway untangled the laws found in the Probate Code, Welfare and Institutions Code, Civil Code, and the Family Code, regarding the question of an elder’s capacity. Considering all of these multiple and overlapping statutes, the court stated that burden of proof on mental capacity changes depending on the issue. “[T]here is a presumption in favor of the person seeking to marry or devise a will, but not so in the context of a person executing a contract.” Ibid at 639. In the context of a person executing a contract, the presumption is on the party claiming the contract is valid.
In analyzing the code more deeply, the court found that the “basic starting point for any mental capacity determination is the Due Process in Competence Determinations Act found in Probate Code §§810 to 813, 1801, 1881, 3201, and 3204 (the Act).” The Act establishes that while there is a presumption that a person has capacity, the presumption is rebuttable, and it affects the burden of proof. Prob. Code, § 810(a) (“There shall exist a rebuttable presumption affecting the burden of proof that all persons have the capacity to make decisions and to be responsible for their acts or decisions.”)
In analyzing the even more specific question of the capacity to contract, the court held that while the baseline presumption of capacity is found in Probate Code §§811 and 812, Civil Code §39(b) provides more specific guidelines for determining the burden of proof when it comes to the capacity to contract. That section of the Civil Code states, “A rebuttable presumption affecting the burden of proof that a person is of unsound mind shall exist for purposes of this section if the person is substantially unable to manage his or her own financial resources or resist fraud or undue influence.” (Civil Code §39(b), italics added). Following through, the court in Greenway found that if the presumption under Civil Code §39(b) arises, then the burden of proof in showing the validity of a contract, the burden of proof in showing that a party to the contract had capacity, belongs to the party seeking to show that the contract is valid.
In Greenway, the court clearly held that once there is evidence demonstrating that a party to a contract is unable to manage their own financial affairs, the burden of proof to show that the party nonetheless had sufficient mental capacity to enter into a contract is on the party claiming the contract is valid. Note that it is possible to prove that even a person without the ability to handle their own finances may still be found to have entered into a binding contract, but it is up to the person alleging the validity of the contract to prove competence on that particular issue.
To find the Respondent’s contract valid, the court must ultimately determine that the party sought to be bound had the capacity to contract. The court cannot presume or conclude that said party had such capacity, or that the contract is valid. The capacity to contract (as opposed to other acts or decisions a person might take) requires the highest level of mental capacity. Absent a finding one way or the other, the court cannot conclude that the contract is valid since the presumption would be it is not assuming it is proven the party to be bound did not have the ability to handle their own financial resources. The burden is placed squarely on the party claiming the contract is valid, and to show that the party has the capacity to contract. Greenway at 643.
The Burden of Proof:
Keep in mind that the burden does not shift to the party seeking to enforce the contract until the other side has established the person is not capable of handling their own financial affairs or is subject to undue influence or fraud. That is usually established by medical experts testifying as to the lack of capacity.
The difficulty for the person trying to enforce the contract is that unless one can counter the medical evidence as to the inability to handle financial affairs, one must somehow show that for the particular contract, the person somehow had that ability. This may sound impossible, but it should be recalled that incompetency is not always a permanent matter. Often, especially during the early periods of disease or age-related incompetence, one can have times of lucidity. There are good days and bad days for most of those people, and if sufficient witnesses can demonstrate that on the day of executing the contract the person was having a good day and clearly understood what he or she was doing, then the contract may still be enforced.
Related to this is the nature of the contract. Any unfair contract or contract transferring sizable sums to another person is going to be examined far more closely by the court. And a contract involving a truly expensive purchase or sale is going to be examined carefully.
The courts of appeal made it clear that the issue is “fact-specific” which means that the court has very wide discretion as to what facts to consider and ignore in determining whether the contract is valid. As a wise experienced litigator once stated, “The gut reaction matters a lot. Unless the contract is one the court would sign, himself, you can expect to have to jump through a dozen hoops to carry that burden of proof.”
Conclusion:
It is vital for someone entering into any agreement with someone with a history of mental illness or addiction or injury or physical illness to carefully determine if there is any reason to assume incompetence that could later void the agreement. This is equally true for any contract with an elderly person who may be suffering from dementia or Alzheimer’s. If there is reason to be concerned, then bringing in a family member, lawyer, or doctor of that person to confirm competency makes good sense. When drafting an estate plan for persons whose condition may be questionable, it is common to conduct a voir dire of them under video to establish their state of mind. The same could be done for contract execution.
Remember, the issue of competency is not dependent on the motives of the party seeking to enforce the contract or their state of knowledge of the other person’s disability. One can, in good faith, assume competency and then find out that one’s contract is void.
With more and more contracts being entered into online, this is an even more present danger for those entities relying on that method to enter into binding arrangements. Luckily for them, the defense of competency is relatively rare and clearly, they can still prosper having no true knowledge of the state of mind of the other party. As the population ages, this issue may become more prevalent.