‘CAPACITAS’: CONTRACT LAW AND THE INSTITUTIONAL
PRECONDITIONS OF A MARKET ECONOMY
Centre for Business Research, University Of Cambridge
Working Paper No. 325
by
Simon Deakin
University of Cambridge
Centre for Business Research
Judge Business School Building
Trumpington Street
Cambridge CB2 1AG
Email:
s.deakin@cbr.cam.ac.uk
June 2006
This working paper forms part of the CBR Research Programme on Corporate
Governance.
Abstract
Capacity may be defined as a status conferred by law for the purpose of
empowering persons to participate in the operations of a market economy. This
paper argues that because of the confining influence of the classical private law
of the nineteenth century, we currently lack a convincing theory of the role of
law in enhancing and protecting the substantive contractual capacity of market
agents, a notion which resembles the economic concept of ‘capability’ as
developed by Amartya Sen. Re-examining the legal notion of capacity from the
perspective of Sen’s ‘capability approach’ is part of a process of understanding
the preconditions for a sustainable market order under modern conditions.
JEL Classification: K12, K31
Keywords: contract law, capacity, capability approach
Acknowledgements
This paper is based on the work of the ‘Capacitas’ project which was funded by
the European Union’s Fifth Framework Programme, as part of a wider research
network examining the politics of capabilities in Europe (‘Eurocap’). I am
grateful to fellow project-members who took part in meetings in Nantes and
Cambridge in 2003 and 2005 respectively and whose work I draw on here, in
particular Wiebke Brose, Sandrine Godelain, Jean Hauser, Martin Hesselink,
Alain Supiot and Aurora Vimercati.
Further information about the Centre for Business Research can be found at the
following address:
www.cbr.cam.ac.uk
1
1. Introduction
The concept of capacitas, whose roots lie in Roman law, signifies a status
conferred upon citizens for the purpose of enabling them to participate in the
economic life of the polity. In modern legal systems, ‘capacity’ is the principal
juridical mechanism by which individuals and entities are empowered to enter
into legally binding agreements and, more generally, to arrange their affairs
using the instruments of private law. The legal concept of capacity is thereby
the gateway to involvement in the operations of a market economy. In its
traditional form, originating in the ‘classical’ contract law of the nineteenth
century, capacity is defined negatively, that is to say, by its absence: the very
young, very old or very ill are deemed, to varying degrees according to
particular contexts, to lack the ability to make legally enforceable contracts.
This is because they are understood not to possess the power to make rational
assessments of their own self-interest of the kind required for market-based
exchange. The concept of capacity is a doctrine of selective contract
enforcement, which both protects the incapable from exploitation, but, equally
importantly, protects the market against the incapable. In this way the classical
core of contract law gives expression to a certain theory of the institutional
preconditions of a market economy, albeit a rather minimalist one.
Incapacity is not the only occasion for invalidating contractual agreements
made at arm’s length between consenting parties. Contract law recognizes that
certain types of transaction can be denied contractual force on the grounds that
they infringe particular values which, exceptionally, take priority over the value
of freedom of contract. In the common law, these go under the heading of
‘public policy’, and their effect is to qualify the power to make binding
agreements which is otherwise generally vested in economic agents. This body
of law therefore offers fragments of a theory of functional limits to freedom of
contract: these limits are necessary both to preserve the market against anti-
competitive behaviour (as in the case, for example, of the doctrine of ‘restraint
of trade’), and also to preserve society itself against the market (for example,
the rules against the enforcement of certain illegal or oppressive contracts).
These are no more than fragments, though; the common law notion of public
policy is an extremely limited one which was frozen in time at the end of the
nineteenth century. Social or regulatory legislation has become a far more
significant source of contractual regulation. However, its relationship to the
notion of contractual capacity is highly contested: does a law inserting
mandatory or default norms into consumer or employment contracts constrain
the autonomy of the contracting parties, with negative effects upon the
operation of the market; or does it establish a new contractual equilibrium
2
which, by reducing transaction costs and reallocating risks, enhances
efficiency?
Modern ‘law and economics’ analysis suggests that there is often no simple
answer to that question. Nevertheless, the efficiency of social legislation as a
mode of contractual regulation is increasingly being called into question. This
is the consequence of the unraveling of institutional forms which were designed
to for a world of protected national economies and stable economic
relationships; the principal example of this is the conceptual ‘crisis’ affecting
the institution of the employment relationship.
1
However, it unlikely that a
simple return to private law, through ‘deregulation’, could offer a sustainable
solution. This is because the classical or nineteenth century core of private law,
to which deregulation promises to return us, offers an under-developed account
of the basis for effective participation in economic life: this is one in which
form – an idealised notion of juridical equality and contractual autonomy –
prevails over substance – a reality of asymmetrical bargaining power and all-
pervasive externalities. The problem is epitomized by the paucity of the
modern legal concept of capacity and by the conceptual confusion surrounding
this notion. In particular, we lack a convincing theory of the role of law in
enhancing and protecting the substantive contractual capacity of market agents,
a notion which resembles the economic concept of ‘capability’.
2
Re-examining
the legal notion of capacity from the perspective of the economist’s ‘capability
approach’ is part of a process of understanding the preconditions for a
sustainable market order under today’s conditions.
To address that question, section 2 examines in more detail the implicit
economic logic of the concept of capacity, explores its links to notions of
individual rationality, and assesses the economic functionality of private law
rules limiting freedom of contract. Section 3 then looks at the relationship
between contractual capacity and regulatory legislation and section 4 considers
the deregulatory critique against the insertion of mandatory norms into
contractual relationships. Section 5 then addresses the following question: is it
possible to identify the elements of a new concept of capacitas, one which goes
beyond purely formal guarantees of market access, to encompass the conditions
needed for effective participation in the complex economic orders which are
now coming into being?
3
2. The economic logic of incapacity, public policy, and related grounds of
invalidity in contract law
In civil law systems, contractual capacity is stated to be one of the basic
conditions for the formation of a contract.
3
In the civil law, ‘capacity’ has two
meanings, one referring to the ability to hold rights,
4
the other to the ability to
exercise them.
5
Contractual incapacity is almost invariably an instance of
second of these two categories. The capacity to hold rights, which is in effect a
right to be treated as a legal subject and not as a mere object of legal relations,
vests today in all physical persons from the point of birth,
6
as a result of the
abolition of rules denying capacity to certain groups historically denied it,
7
such
as married women. This is equally the position in the common law, where the
formal distinction between the holding and exercising or rights is of no
relevance. In all systems, the remaining grounds of incapacity are tightly
defined; they mostly apply to agreements made by ‘minors’ (or ‘infants’), the
very old, and those suffering from mental illness. The question of contractual
capacity has been said to be of ‘reduced practical significance’ in the English
law of contract; although not without some theoretical interest, particularly
from the point of view of the interaction of contractual and restitutionary
remedies, it is essentially treated as a footnote to the main body of the law of
contract. The relative insignificance of the subject for English lawyers is
compounded by the absence of certain complex rules of French-origin civil law
systems, dealing with the circumstances under which lack of contractual
capacity can be offset by assistance (curatelle) or representation (tutelle).
8
These have no equivalent in the English common law, and even some civil law
systems, such as the German one, do not recognize the category of assistance.
9
In all systems, the effects of incapacity on a contract also differ according to
context; complete nullity is only one option, others including voidability, while
alternative remedies in tort or restitution may be available.
10
The limited and diminishing practical significance of the concept of capacity in
modern contract law should not however be confused with its structural
significance within contract doctrine. Indeed, there is case for saying that it is
still at the core what is meant by a contractual obligation. A simple exchange,
even between otherwise consenting parties, is not enough to found a contract. It
has to be shown, in addition, that each party is able to assess whether the
transaction is in their best interests. The law presumes that this may not be so
in the case of the young, on the grounds of their immaturity and inexperience,
and to those such as the very old or mentally ill who for one reason or another
may be unable to understand the consequences of their actions.