The Chancery Division recently confirmed the principles in Imperial Loan Company v Stone that a contract will be binding unless the party claiming mental incapacity can prove that they lacked mental capacity at the relevant time and that the other party was aware of this.
In 2003 Mr Christopher Josife, the Claimant, suffered a stroke impairing his ability to comprehend written and verbal communication. The Claimant’s wife and solicitors however considered that the Claimant had sufficient capacity to grant a Power of Attorney in July 2004. Following this, the Claimant’s wife and son entered into a Share Option Agreement with Summertrot Holdings Limited, the Defendant. The Claimant’s son was the principal debtor and his wife the guarantor.
The Claimant’s son fell into financial difficulty and in 2006 the Claimant’s wife and the Claimant entered into a written Guarantee, the terms of which meant that the Claimant assumed the obligations of the primary obliger. The Claimant’s wife later also fell into financial difficulty and was declared bankrupt. In 2008 she entered into a Deed under which shares belonging to the Claimant were pledged and a charge was granted over the Claimant’s property. This Deed was executed in both the Claimant and his wife’s name, with the Claimant’s wife acting pursuant to her Power of Attorney (which had in fact been revoked by virtue of her bankruptcy).
The obligations under the Deed were not complied with and in 2012 the Defendant made a statutory demand of the Claimant under the Guarantee. The Claimant’s wife made an application to set aside the statutory demand on behalf of the Claimant, on the basis that he was ‘incapable of managing his affairs by reason of mental infirmity.’ It was submitted that the Claimant had lacked the requisite mental capacity since his stroke in 2003, and was undoubtedly without his faculties in 2006 when the Guarantee was signed. Further, the Defendant knew that the Claimant lacked mental capacity and was unaware of what he was signing.
The Claimant was refused permission to set aside the statutory demand. The Court referred to the decision in Imperial Loan Company v Stone which confirms that where a person enters a contract and later claims that they lacked mental capacity, the contract is binding unless they can prove that they did indeed lack mental capacity and that the other party was aware of this.
It was held that the Claimant would have a defence if it could be established that (a) he was completely incapable of understanding things like legal documents and (b) that he was so outwardly incapable of understanding the Guarantee that the Defendant should not be allowed to rely on it. It was accepted that it was possible that the Claimant did not understand what he had signed when agreeing to the Guarantee. However, it was held that, even if the Claimant did lack capacity, there was no reasonable prospect that his lack of capacity would have been apparent to the Defendant.
The decision was appealed on the basis that it applied the wrong legal test as to what the Claimant would be required to prove at trial to avoid the Guarantee. It was alleged that the Claimant should not be required to demonstrate that it was ‘obviously apparent’ that he lacked capacity but that the Defendant actually or constructively knew or suspected the Claimant’s incapacity.
The Claimant’s appeal was dismissed. It is accepted law that a contract made by a person lacking mental capacity was not void but could be avoided, provided the other party knew or ought to have known that the person lacked mental capacity.
It was held that the Deputy Registrar had demonstrably understood the law and the relevant legal test set out in Imperial Loan Company v Stone, the Deputy Registrar’s paraphrase of the legal test did not suggest that it had been incorrectly applied.
Further, on the facts of this case, the indicators on which the Deputy Registrar relied provided clear evidence that there was no real prospect of proving that the parties to the Guarantee were aware or should have been aware of the Claimant’s incapacity.
This case reinforces the test set out in Imperial Loan Company v Stone as to the elements that must be proved for a contract to be avoided on the basis of mental incapacity. It confirms that the application of this test is fact specific. This case is welcomed by lenders as it reinforces the fact that it is not enough for an individual to simply show that they lacked capacity. The lender must also have known or ought to have known that they lacked capacity in order for a contract to be avoided. This two stage test ensures a further layer of protection for lenders against borrowers trying to claim incapacity in order to avoid their debts.
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