WHAT EVERY OKLAHOMAELDER LAWYER SHOULD KNOW ABOUT
MENTAL CAPACITY FOR BUSINESS TRANSACTIONS
By John David Lackey
December 1, 2003
I. Introduction
Oklahoma lawyers serving elder clients face a myriad of challenges that do not normally surface for lawyers who do not serve the elderly. The concept of capacity is especially important, as it pervades every transaction an elderly client might attempt to make, and an attorney serving an older client would be well advised to have an understanding of the levels of competency for different types of transactions, as well as the solutions available when capacity becomes an issue. In this regard, the terms “capacity” and “competence” shall be used interchangeably.
The mental capacity of an older adult is not always easily determined. This problem can be made even more difficult by the reluctance or anger created by the suggestion that the client may need assistance. This problem is even more difficult for the elder lawyer, since the standard for capacity itself may change, depending on the type of transaction the client may be attempting to undertake. The standard for capacity in the ability to form contracts or dispose of real or personal property is different than the standard for determining capacity in testamentary bequests and donative transfers. Further, the standard for capacity in making medical decisions for the client is different than either the business transaction sense or the gift sense. There are social policy concerns that have helped shape and mold the standard of capacity for each of these situations.
This paper does not attempt to address all of these concerns. Rather, this paper will identify the standards for capacity in making business transactions (contractual competency) in Oklahoma, and will only briefly touch on other types of transactions. Pertinent Oklahoma case law and statutory material and commentary from other sources will be considered in order to gain a more complete understanding of where the law regarding contractual competency in Oklahoma stands at this time.
II. Oklahoma Law
A. Basic Definition of Capacity
The official definition of incapacity, found in the Oklahoma Guardian and Conservatorship Act,[1] is referenced by numerous other statutes when referring to incapacity. The statute holds a person incapable “whose ability to receive and evaluate information effectively or to make and to communicate responsible decisions is impaired to such an extent that said person either lacks the capacity to meet essential requirements for his physical health or safety, or is unable to manage his financial resources.”[2] The law holds adults incompetent if they are unable to manage their finances due to an inability to comprehend information relating to those decisions due to impairments such as mental disease or physical disability.[3]
B. Business Transactions
1. Contract Law
More applicable to business transactions, Title 15 of the Oklahoma Code, Contracts, §11, specifically states the legislative intent with regard to capacity in business transactions,[4] stating that persons of unsound mind are incapable of forming binding contracts.[5]
Another Oklahoma statute that bears on capacity to form contracts is found at 15 Okla. Stat. § 22, Persons Without Understanding,[6] stating that a contract is unenforceable against a person who lacks the ability to understand the transaction. This section may be important in the business transaction context, since it does not include the term capacity or competence, and does not cross reference the definition of incompetence as found in 30 Okla. Stat. § 1-111. As will be seen, Oklahoma courts have interpreted § 22 as referring to capacity, and not some other amorphous standard.[7]
A very similar provision in the Oklahoma Code to Persons Without Understanding is found in Rescission of Person with Unsound Mind,[8] holding that in contracts entered by incompetent persons, the third parties have the right of rescission without prejudice. This statute is similar to the language in § 22, but the difference is important, as § 22 makes contracts void as applied to incompetent persons, while § 23 only makes those contracts voidable.
2. Uniform Commercial Code
The Uniform Commercial Code (UCC) has been adopted by Oklahoma,[9] as it has by every other state. Article 2 of the Code, Sales of Goods, may apply to contracts in which an incompetent person might enter. While the UCC as it is adopted in Oklahoma makes no explicit mention of capacity of parties, there are still provisions that bear on capacity to contract. Specifically, Unconscionable Contract or Clause,[10] states that a court may void a contract if it finds a clause or even the entire contract to be unconscionable. Certainly this would apply to a contract entered into by an incompetent person. Other UCC provisions that are substantively the same include Article 2A’s lease clause, Unconscionability,[11] which deals with leases of goods and provides the same rule as for the sale of goods.
3. Property Law
From a property perspective, Oklahoma has established a standard for determining whether a party has capacity to convey title to real property. Entitled Mental Capacity to Convey,[12] the statute requires that incapacity be judicially determined either through a guardianship proceeding, a mental-health proceeding, or in some civil action. This is no method of determining capacity itself, but defers to standards of capacity found in other sections of the Oklahoma Code, such as the general provision found at 30 Okla. Stat. § 1-111.
C. Other Law
1. Testamentary Law
As opposed to contractual capacity, testamentary capacity is a concept that many people are aware of. Generally, a person is found competent for testamentary reasons if they know what they have, know to whom they are giving it, and know why they are giving it to them. In Oklahoma, the applicable law is found in Title 84, Wills and Succession.[13] Regarding capacity, 15 Okla. Stat. §41 provides that even those declared incompetent by a court may still effectively dispose of their possessions, so long as the will is approved by a court. Importantly, there is no ability by the court to amend or disapprove of the contents of the will; the requirement is merely a safeguard. So long as this safeguard is used, the traditional “fruit of one’s bounty”[14] test still applies.
2. Medical Decisions
The test for capacity in medical decision making is found in Title 63 of the Oklahoma Code. 63 Okla. Stat. § 3131.3, part of the Oklahoma Do-Not-Resuscitate Act, defines incapacity as the inability “to appreciate the nature and implications of a health care decision, to make an informed choice regarding the alternatives presented, and to communicate that choice in an unambiguous manner.”[15] This differs from business transactions in that the DNR Act envisions some individuals who are incapable to make business transactions and have been appointed guardians or conservators may still be capable of making a medical choice for themselves, especially as they pertain to life prolonging procedures.
Another law that relates to capacity is the Oklahoma Rights of the Terminally Ill or Persistently Unconscious Act, found at 63 Okla. Stat. §§3101 et seq. Included in the Act is the authorization and guided forms for health care proxies, organ donations, and living wills. Under the advance directive forms, the subject of capacity is determined by the attending physician. As an example, in 63 Okla. Stat. § 3101.4, the form for advance directives provides: “If my attending physician and another physician determine that I am no longer able to make decisions regarding my medical treatment, I direct my attending physician and other health care providers, pursuant to the Oklahoma Rights of the Terminally Ill or Persistently Unconscious Act, to withhold or withdraw treatment from me under the circumstances I have indicated below by my signature.”[16]
The standard for capacity in medical decisions is different from that in business transactions primarily for policy reasons. There is a significant presumption of personal autonomy with regard to one’s own body, and the state has been reluctant, barring clear evidence of incapacity, to prevent an individual from making their own choices, especially with regard to end of life issues such as DNR and Advance Directives.
III. Case Law
A. Prior to Incapacity Determination
There are a number of Oklahoma cases that bear on capacity to perform business transactions. The total number of cases in this context is relatively slight when compared with a search of capacity for testamentary transfers. The most likely reason for this disparity may lie in the fact that many business transactions involve relatively small amounts of money, and may not be challenged later by a guardian or other conservator. Additionally, testamentary capacity involves substantially higher emotions for those involved, and at least the perception that a more significant amount of money is in play.
In Loman v. Paullin,[17] the Supreme Court of Oklahoma found that incompetence could not be founded solely upon the facts that a man was an illiterate, uneducated Indian with no business skills. The Court held that competence was to be determined by the following question: “Did he possess sufficient intelligence to understand what he was doing; that is, the effect of his acts? In this case, that he was parting with the particular property he was disposing of, the disposition he was making of it, and the person to whom he was conveying it?”[18] Certainly this is not a very objective test for determining a person’s ability to understand and complete business transactions, especially since the court found that an uneducated illiterate did sufficiently understand what he was doing when conveying a deed to property.[19]
In Harris v. Commerce Trust Co.[20], the court held that capacity was to be determined at the time of the transaction.[21] In this case, the court found that despite a prior adjudication of incompetency, the person in question “was at the time of the transaction in question a person of unsound mind, but not entirely without understanding.”[22] Following this analysis of the entire record before the court, it was held that the ward did possess the requisite level of awareness in order to effectively contract.[23] The court in this case set aside a prior judicial determination that the ward was incompetent to enter into contracts and found competency.[24] Certainly from this evidence, it appears that at the very least, early Oklahoma courts were willing to find competency to contract, especially where the opposing party was held to have proceeded in good faith.
In re Woodward[25] continued the trend toward legitimizing business transactions occurring before a judicial determination of incapacity. In Woodward, an elderly person conveyed a deed after being forced to leave the family farm and enter a nursing home.[26] There was evidence that the person was not fully aware of the ramifications of the transfer, but the court held: “The test of capacity to make a deed is that the grantor shall have the ability to understand the nature and effect of the act in which he is engaged and the business he is transacting. To invalidate a deed it must appear that the grantor was incapable of comprehending that the effect of the deed, when made, executed and delivered would be to divest him of the title to the land set forth in the deed.”[27] This test makes it extremely difficult to prove to a court in retrospect that incapacity for the purpose of that conveyance existed.
B. Post Incapacity Determination
While it would appear from the brief sample of cases presented thus far that Oklahoma courts lean heavily in the favor of capacity, not all cases have held such transactions valid. In fact, in a significantly more recent decision, the Supreme Court of Oklahoma held in Sooner Federal Savings and Loan Association v. Smoot[28] that a contract entered into by an incompetent person was void. The court stated:
The just and correct rule to be applied in determining the competency of a grantor to execute a deed requires that the test to be applied in such circumstances is that the grantor shall have the ability to understand the nature and effect of the act in which he is engaged and the business he is transacting, and that in order to invalidate the deed it must be shown that the grantor was incapable of comprehending that the effect of the deed when made, executed, and delivered would be to divest him of the title to the land set forth in the deed.[29]
This holding demonstrates the conflict between § 22 and § 23 of Title 15 of the Oklahoma Code, as discussed above. In this case, both parties in the action admitted incompetence,[30] but were basing their opinion on different statutes,[31] and the court was forced to determine which statute controlled. The court found that § 22 controlled, with the result that the contract was automatically void.[32]
IV. Outside Source Material
A. IntroDuction
For purposes of this paper, information not contained within a statute or case arising in Oklahoma is considered an outside source. As will be seen, some “outside sources” arise from sources within Oklahoma but are not legal in nature, and serve only as a guide for evaluating those legal sources found in the Oklahoma Code or common law.
B. American Bar Association
Governed by the rules of professional responsibility, Oklahoma lawyers must be aware of the ethical duties prescribed when dealing with an elderly client. ABA Rule 1.14, Client Under A Disability,[33] adopted by Oklahoma, states in the comments that even elderly clients of advanced ages may be competent for most transactions, and only need protection for major transactions. Further, Rule 1.4, Communication,[34] also provides special rules for the normal standard of full disclosure to a client with special mental disabilities that would prevent a reasoned response.
C. Oklahoma Bar Association
Another important source of information is the Oklahoma Senior Citizens Handbook.[35] Containing an enormous amount of information for seniors or lawyers serving elderly clients, the senior handbook contains a section on guardianship,[36] conservatorship,[37] durable powers of attorney,[38] and health care proxies,[39] all of which relate directly to the subject of capacity. With regard to capacity, the handbook states the basic rule regarding capacity; namely that normally a person has the right to make decisions for themselves so long as they are not incapable due to some illness or disability, especially when those decisions can not harm other persons.[40] Going further, the handbook also provides:
In order for the court to appoint a guardian, the court must be convinced by evidence presented at the hearing that you are not capable of making informed decisions about your own care or the management of your property. A guardian cannot be appointed just because of your age or because you are physically disabled. For example, a general guardianship of the person is not appropriate merely because a person is wheelchair-bound due to severe arthritis. A limited guardianship may be imposed if a disability affects the individual's ability in some way to care for himself or manage his property.[41]
D. Restatement of Contracts
The Restatement (Second) of Contracts also has a section on capacity.[42] The Restatement basically holds that incompetent persons are unable to legally contract, and that contracts formed by incompetent persons may be voidable, but are not necessarily void.[43] Further, the Restatement recognizes that capacity may be different depending upon the type of transaction or contract entered into.[44] Certainly a contract for lawn care services may be given a different standard than a contract for sale of real property. In the situation where the contract is voidable, evidence of good faith, misrepresentation, and duress would all tell in an evaluation of the efficacy of the contract in question.[45]
E. Corbin on Contracts
Yet another source of outside material that bears on capacity to enter business transactions is the analytical treatise Corbin on Contracts.[46] Within the treatise, Chapter 27 specifically deals with the capacity of parties to contract, and states the following: “It is generally held that incapacity exists when a party does not understand the nature and consequences of what is happening at the time of the transaction.”[47] Further, Corbin goes on to deal with contracts that have been formed by the incompetent. In this regard, he states “According to older authority, transactions of the mentally infirm are void, but under the overwhelming weight of modern authority, the contracts and executed transactions of the mentally infirm are, with one exception, merely voidable.”[48] This outside source once again affirms the common law approach of the Restatement, and also shows that Oklahoma courts, in their reluctance to automatically void contracts entered into by the incompetent are following the current trend in the law.
F. American Jurisprudence 2d
American Jurisprudence 2d also weighs in on the capacity of parties, stating in Capacity to Contract [49] that capacity is the ability to understand the nature of the transaction taking place. In this respect, it offers substantively the same guidance as is found in the Restatement and Corbin, but then continues, finding it is the mental state when the contract is executed that is relevant. A contract may not be voided based on previous incompetence or for alleged incompetence arising after the execution of the contract, though a party's capacity before or after execution of an agreement is relevant in determining competency at the time the contract was executed.[50] This reinforcement is important, especially in light of the reticence Oklahoma courts have shown to retroactively voiding contracts for supposed incompetent individuals.