Understanding Contractual Capacity
Contractual capacity refers to the minimum mental and legal ability the law requires a party to possess to enter into a binding contract. It ensures that parties undertake contractual obligations willingly, knowingly, and autonomously. It ensures that individuals and entities have the mental and legal competency to understand the terms and conditions, make informed decisions, and be held accountable for their contractual obligations.3 Contractual capacity serves as a protective shield, striking a balance between individual autonomy and safeguards against exploitation and unfair practices.
According to the Muluki Civil Code, 2074, a person is generally considered legally competent to enter into a contract if he is not a minor, a person of unsound mind, or a person disqualified by law. Hence, to be a competent party to a contract, one should have completed the age of majority, i.e., 18 years, be mentally sound, and have not been disqualified by law.
The concept of contractual capacity has evolved over many centuries. Early common law recognized the importance of free will and mental competence, and both parties to the contract should understand the nature and future effects of the contract. Later, the formalization of contract requirements and legal reforms further refined these rules, especially to protect vulnerable groups in society.
Person Incompetent to a Contract:
Section 506 of the Muluki Civil Code, 2074, states that every person other than the following persons shall be competent to conclude a contract. They are:
- One who is a minor,
- One who is of unsound mind,
- One who is disqualified by
This means that a minor who has not reached the age of 18 and is of unsound mind and disqualified by law shall be deemed incompetent to conclude a contract.
A person who is usually of unsound mind but occasionally of sound mind may conclude a contract when they are of sound mind; similarly, a person who is usually of sound mind but occasionally of unsound mind may not conclude a contract when they are of unsound mind.
If a person is incompetent or quasi-competent, their guardian or curator may enter into a contract on their behalf. A director or directors authorized for the management and operation of a legal person, or a person authorized by the director, can enter into a contract.
Minor:
A minor or infant is a person who has not attained the age of legal majority or is not a major. A valid agreement requires that both parties to the contract understand the legal implications of their contract. They must have mature minds and be of a significant age. According to Section 2(e) of the Muluki Civil Code, 2074, a minor refers to a child who has not yet reached the age of eighteen. Two fundamental principles govern the rules regarding agreements with minors. First, the law protects minors’ interests from adults taking unfair advantage of them. It safeguards their rights and estates, excuses their delays, and aids them in their pleadings; judges act as their counselors, juries as their servants, and the law as their guardian. The second principle is that the law protects adults who deal fairly with minors from hardship.
Rules Regarding the Agreement with a Minor:
Minors cannot enter into a contract, but depending on the circumstances, they may or must agree to one. The nature of minors’ agreements and the law relating to minors’ agreements are summarized as follows:
An agreement with a minor is void.
In the eyes of the law, a minor is considered incapable of entering into a contract. Even if he falsely represents himself as an adult and enters an agreement, he will not be held liable for performing it. Thus, any agreement made with a minor is held void.
In the case of Mohori Bibee v. Dharmodas Ghose,4 it was established that an agreement with a minor is void, not merely voidable. Dharmodas Ghose, who was a minor (under the age of 18), entered into a mortgage agreement to borrow money from a moneylender, Brahmo Dutt. He mortgaged his property as security for the loan. The moneylender’s attorney, who handled the
transaction, was aware that Dharmodas Ghose was a minor. The minor filed a suit through his legal guardian to declare the mortgage void and have it cancelled. The moneylender argued that the loan should be repaid.
The Privy Council (the highest court of appeal at the time) ruled decisively in favor of the minor. It held that an agreement entered into by a minor is void ab initio (void from the very beginning). Because a minor is not “competent to contract” under the Indian Contract Act, 1872, any such agreement is a legal nullity and cannot be enforced.
The minor was not required to repay the loan amount to the moneylender. The court found that the provisions for restitution (returning benefits) did not apply to a contract known to be void from the outset.
A minor can be a beneficiary.
While the law prevents minors from being bound by contractual obligations, it does not prevent them from receiving benefits. This principle is often summarized with the legal maxim: “The law acts as a shield for the minor, not as a sword.”5
If a contract is created for the benefit of a minor, that minor can be promised something and accept the proposal; such a contract shall be valid and enforceable under the law. However, if the agreement is designed to harm the minor, it becomes void and unenforceable.
Ratification of the Minor’s Agreement
Ratification refers to the act of accepting and confirming a contract or transaction that was initially unauthorized or voidable.6 It validates a previously invalid agreement, provided the party confirms it has full knowledge of its terms and intends to be bound by them. As we know, a contract with a minor is void. He cannot ratify a minor agreement on attaining the age of majority because a void agreement cannot be ratified.
However, if he wants to provide validity, he must always make a fresh promise supported by new consideration after attaining the age of majority, in terms of the promise made during minority.
Minor’s liability for necessities
All contracts relating to the necessities supplied to a minor, according to their status in life, are valid and enforceable. However, only the minor’s property is liable for necessities, and he incurs no personal liability. A minor who enters into a contract to purchase food, shelter, clothing, medical attention, or other goods or services necessary to maintain his well-being will generally be liable for the reasonable value of those goods and services even if he disaffirms the contract. Luxurious and expensive commodities and services are not considered necessary.7
No Estoppel against a minor
The evidence rule of estoppel means a person cannot deny what they stated previously in a legal transaction; however, this rule does not apply to minors, as a contract entered into by a minor is not binding. If a minor misrepresents their age and induces the other party to agree, they cannot be held liable for that contract.
Minor as Agent
A minor can be appointed as an agent. He can represent his principal in dealings with other parties. Since a minor does not incur any personal liability, he cannot be held responsible for any negligence or fault. Therefore, the principal will be accountable to the third parties for the acts of his minor agent. He cannot hold the minor agent personally liable for any wrongful acts.
Minor as a partner
A minor is legally prohibited from becoming a full partner in a partnership firm. Nonetheless, he may still be eligible for the benefits of the partnership. When a minor is granted such benefits, he acquires the right to share in the property and profits of the firm. However, this minor is not personally liable to third parties for any actions the firm takes; only his share in the partnership is subject to liability.
Minor as a member of a company
Minors cannot be company members, as they are not legally capable of entering into a contract. But a minor may be allotted shares. His name may remain on a company’s register of members, but during minority, he incurs no liability. When attaining majority and becoming aware of his name’s presence in the members’ register, the major can renounce his shares within a reasonable time. Where he does not do so, he may safely be taken to have accepted his position. His liability as a shareholder then commences.
Surety for a minor
A minor (someone under the legal age of majority) generally cannot be held liable for contracts they enter into. Still, a surety who guarantees the minor’s obligations can be held liable. If a minor enters into an agreement and fails to fulfill their obligations, the surety, typically an adult, will be responsible for fulfilling the minor’s debts or obligations.
Example: If a minor takes out a loan, and an adult cosigns as a surety, the bank can hold the surety liable for the loan repayment if the minor defaults.
Minor cannot declare insolvent.
A minor cannot be declared insolvent since they cannot incur debts. Any dues or debts would be payable from the minor’s personal property, and the minor is not personally liable.
Joint contract by minor and adult
If a minor and an adult person jointly enter into a contract with a third party, the minor is not liable to fulfill their promise, but the promise can enforce the whole contract against the adult.
Contract entered into by the guardian of a minor
A minor’s act cannot bind their parent or guardian. Guardians can contract on behalf of a minor due to a lack of capacity for a minor to enter into contracts within the doctrine of legal necessity or benefit. A minor may not be answerable for the fraud of his guardian, but he cannot take advantage of it. The act done by a minor, except as provided, cannot bind his parent or guardian even for his necessities. The only case where the parent may be liable is when the child is contracting as an agent for the parent.8
Person of Unsound Mind
A sound mind is a necessary element for a person to be able to contract. As a minor person, a person of unsound mind is also regarded as incompetent to contract, and if such a person makes any contract, that contract is void.9
A sound mind refers to a person’s mental capacity to understand their actions and their consequences, particularly when making decisions such as creating a will or entering into contracts. It implies the ability to reason and to make sound judgments.
With an immature mind, any person cannot fully understand the nature of their actions and form a rational judgment on their interests in creating a contract. They are incompetent to give consent due to their defective state of mind; there can be no consensus ad idem, which is a sine qua non for a contract, and consent flows from a mature or sound mind, which these persons lack. Therefore, the law attributes to them a disability that is inherent in them.10
Section 506 of the Muluki Civil Code, 2074, states that a person of unsound mind is incompetent to conclude a contract. It has also explicitly mentioned that a person who is usually of unsound mind but occasionally of sound mind may agree when they are of sound mind; similarly, a person who is usually of sound mind but occasionally of unsound mind may not conclude a contract when they are of unsound mind. The guardian or curator of an unsound person may conclude a contract on their behalf.
Who Are The Persons of Unsound Mind?
Generally, it is seen that conditions like idiocy, madness, alcoholism, and mental degeneration are usually seen as a person with an unsound mind, where the ability to form rational judgments is absent to enter into contractual capacity. Thus, it can be categorised as follows:
Lunatic:
Lunatics refer to individuals who have a mental illness that impairs their cognitive functions. Unlike an idiot, a “lunatic” is not someone with a permanent lack of mind but someone whose mind is unsound. Such a person’s incapacity may be temporary or a lucid interval.
A lucid interval is a temporary period of clarity and sanity during which the person’s mental illness subsides, and they regain the ability to understand their actions and their consequences.
- Contract during an interval of unsoundness of mind: An agreement made by a person in a state of mind is voidable at their option (or by their legal guardian).
- Contract during a lucid interval: A contract made during a lucid interval is perfectly valid and binding, as the person possessed the necessary contractual capacity at that moment.
Drunken or Intoxicated Person:
The term “Drunken or Intoxicated Person” denotes individuals whose mental capacity is significantly compromised by the consumption of alcohol or other intoxicants. For a state of intoxication to render a contract voidable, it must be sufficiently severe such that the individual cannot comprehend the nature of the agreement and its associated legal implications. Merely experiencing some degree of intoxication that results in impaired judgment or diminished inhibition is inadequate to annul a contract. The level of impairment must be absolute, such that the individual is entirely unaware of their actions.
Any contract made by any drunken person is voidable, not void. The contract is valid until the intoxicated party chooses to disaffirm it (declare it void). The onus is upon the person who alleges that he was incapable of understanding the contract made by him due to extreme drunkenness.
Idiot
An “idiot” is defined as an individual possessing a profound and irreversible mental deficiency, frequently of congenital origin. The incapacity of such individuals is characterized by its permanence, devoid of temporary or fluctuating states. Consequently, any contract entered into by an individual judicially recognized as an idiot is deemed void ab initio (void from the outset), as these individuals cannot provide informed consent. Furthermore, a permanently designated idiot is assigned a guardian or curator to oversee all legal affairs; thus, any contracts made by or with the idiot must be conducted through the appointed guardian.11
Persons with Senile Dementia / Old Age:
Individuals in old age often experience a decline in vigor and mental acuity, which affects their cognitive capacity and understanding during specific tasks. Consequently, contracts entered into by older individuals may be considered voidable at their discretion. Although it is commonly asserted that extreme old age can impair mental soundness, judicial findings recognize that the loss of energy associated with aging does not automatically negate a person’s legal capacity, provided that additional considerations are considered. It has been established that memory loss or absent-mindedness does not necessarily conflict with the behavior of someone of sound mind. Therefore, even an older person showing signs of declining mental and physical faculties can still be deemed competent if they can rationalize and make independent decisions about their actions. Moreover, temporary lapses in memory do not inherently indicate a lack of mental capacity. While older individuals who have dementia or “mental decay” are not separately defined in the legal code, they are subject to the same general rules. Severe age-related dementia is viewed as a form of chronic mental unsoundness under the Civil Code. Individuals unable to comprehend a transaction at the time of contracting cannot enter into contracts; therefore, agreements with a demented person are void unless a guardian or appointed curator validly contracts on their behalf.12
Effects of a Contract with an Unsound-Minded Person
Generally, the impact of a contract with a person of unsound mind is void and unenforceable, similar to that of a minor; however, a contract made for the interest or benefit of such a person is valid and enforceable by law.
As per section 506(3) of the Muluki Civil Code, 2074, the guardian of an unsound-minded person can contract with another person for the interest or benefit of such person.
Person Disqualified by Law
A “person disqualified by law” refers to an individual legally prohibited from entering into contracts or performing certain legal acts due to specific statutory restrictions or judicial determinations. Under Section 11 of the Indian Contract Act, 1872, every person is competent to contract who is of the age of majority, of sound mind, and is not disqualified from contracting by any law to which they are subject. Section 506(2) of Muluki Civil Code, 2074, states that any person who is deemed incompetent to make a particular contract under the law is not considered competent to make a contract.
It establishes that disqualification is an exception to the general rule of contractual capacity, creating legal incapacity based on various policy considerations, including protecting vulnerable individuals, national security, and public interest.
Who are The Persons Disqualified by Law?
Alien Enemies
A person from a foreign country is an ‘alien’. When war is declared with that country, the alien person belonging to that country is regarded as an alien enemy.13 A contract with an alien enemy is void, but a contract with an alien friend is valid. Alien enemies residing in Nepal with the permission of the federal government, and alien friends, may sue in any Court
otherwise competent to try the suit as if they were citizens of Nepal, but alien enemies residing in Nepal without such permission, or residing in a foreign country, shall not sue in any court.
Felons/ Convicts
If a person is convicted and punished by the court or a competent authority for a criminal charge, that person is known as a convicted criminal.14 The Criminal Offences (Sentencing and Execution) Act, 2074 (2017) defines an “offender” as a person who is convicted by a court of any offense. The convicted criminal does not enter into a contract while serving their sentence. He may be competent after serving their punishment or sentence.
Sections 89 and 112 of the Company Act, 2063 disqualified anyone convicted of an offense involving corruption or moral turpitude from being appointed as a company director or an auditor for five years after the sentence, respectively.15
Insolvent
Insolvent refers to a person (individual or corporate entity) who cannot pay debts due and payable to creditors or whose liabilities exceed the value of their assets. The Insolvency Act, 2063 (2006) defines explicitly “being insolvent” as “a state of being unable, or appearing to be unable, to pay any or all of the debts due and payable to or payable in the future to creditors or a situation where the amount of liabilities of a company exceeds the value of the assets”.16 Section 7 of the Insolvency Act 2063 establishes the specific circumstances under which a company shall be deemed to have become insolvent. The person or company declared insolvent by the law during the insolvency process has no right to enter into a contract. The law presumed that an insolvent person is disqualified from making contracts.17
Foreign Sovereigns/ Ambassador
A Foreign sovereign generally refers to a foreign government or a head of state, such as a king or president of another country. An ambassador is the accredited diplomatic representative (head of mission) of a foreign state to Nepal. Foreign sovereigns and ambassadors are disqualified by law because they enjoy sovereign or diplomatic immunity that prevents Nepalese courts from enforcing contractual obligations against them. Any contract with a
foreign sovereign or ambassador is treated as void. They are primarily governed by the Vienna Convention on Diplomatic Relations (VCDR, 1961).
Companies/ Corporations
A company or corporation is an artificial person in the eyes of the law, operated with the help of a natural person. Section 2(a) of the Companies Act, 2063 defines a “company” as a body corporate formed, incorporated, or registered under the Act. 18
Once registered, corporations acquire legal personality, which means they can own property, enter into contracts, sue, and be sued in their name. Section 17(1) of the Companies Act requires that a company only carry out activities mentioned in its MoA. It means that a company can only enter into contracts that fall within the scope of its objectives, as set out in its Memorandum of Association (MoA). Any act outside this scope is considered ultra vires and is void.19
Example:
If a company registered to operate educational institutions enters into a contract to run a casino, the contract is ultra vires and void under Nepalese law.
Case Laws and Critical Analysis
According to Muluki Civil Code, 2074, Section 504, a contract is deemed to be concluded when two or more parties agree, enforceable by law, to do or not to do any act. The following are the cases in which the Supreme Court has given precedents in favour of the contract.
Achyut Prasad Kharel v. Prime Minister and Council of Ministers (N.K.P.) 2064, Decision No. 7842
Brief Facts:
Advocate Achyut Prasad Kharel filed a writ petition in Nepal’s Supreme Court (2064/Asar/28) seeking to declare specific Muluki Ain provisions (Punishment Chapter, Section 42(2); Transaction Chapter, Section 19; Partition Chapter, Section 10; Non-Payment of Debt Chapter, Section 10) unconstitutional, arguing they violated ICCPR Article 11 by permitting imprisonment for unfulfilled contractual obligations. Respondents contended that these provisions cover broader civil liabilities rather than just contracts.
Legal Issues
- Are the provisions of the Muluki Ain (Punishment Chapter, Section 42(2); Transaction Chapter, Section 19; Partition Chapter, Section 10; Non-Payment of Debt Chapter, Section 10) related to contractual obligations, thereby conflicting with Article 11 of the ICCPR?
- Do these provisions create purely contractual obligations, or do they encompass broader civil liabilities?
- Should these provisions be declared unconstitutional under Article 88(1) of the Constitution of Nepal, 2047, and Section 1(1) of the Nepal Treaty Act, 2047, for being inconsistent with the ICCPR?
Holdings: The Court dismissed the petition, ruling the provisions address civil liabilities, not solely contractual ones, and are not inconsistent with ICCPR Article 11.
Reasoning: Contracts require competent parties, mutual consent, lawful object, and consideration per the Contract Act, 2056. The Muluki Ain provisions cover non-contractual civil liabilities (e.g., debt repayment, misappropriation), which do not violate ICCPR Article 11. The petitioner’s claim failed to prove that these were purely contractual.20
Legal Gap Analysis: The Court distinguished between contractual and civil liabilities but did not clarify the status of incompetent parties (e.g., those disqualified by law).
Shortcomings: The definitions of terms like “disqualified by law” (including insolvents and felons) and “unsound mind” are unclear, leading to inconsistent enforcement and difficulties in assessing mental capacity. Additionally, there is insufficient protection for quasi-competent individuals, such as the elderly with partial incapacity. Confusion between civil and contractual liability can also result in severe consequences, such as imprisonment for unpaid debts.
Judicial Struggles: Courts consistently protect minors (e.g., the Mohori Bibee case), but lack clarity on protecting individuals with an unsound mind or those who are disqualified, resulting in varied rulings. Tension exists with ICCPR compliance.
Saki Kami v. Kancho Kami, (N.K.P.) 2048, Decision No. 4370
Brief Facts:
Saki Kami (plaintiff) sued Kancho Kami (defendant) in Nepal’s Supreme Court (2048/Marg/29) to enforce a 2036/12/25 agreement to transfer land for NPR 6,300. The defendant refused payment and transfer in 2040/10/15, claiming the land was registered in their name and the agreement was invalid. Lower courts had issued conflicting rulings, leading to an appeal to the Supreme Court.
Legal Issues:
- Is the 2036/12/25 agreement a valid contract under the Contract Act, 2023?
- Is the plaintiff’s claim time-barred?
- Does the defendant’s land registration bar the plaintiff’s claim?
- Does the agreement meet contract essentials (offer, acceptance, consideration)?
Holdings: The Court upheld the plaintiff’s claim, ruling the agreement is a valid contract, not time-barred, and enforceable despite the defendant’s registration. The defendant must transfer the land upon payment.
Reasoning: The agreement meets Contract Act, 2023 requirements (offer, acceptance, consideration). The cause of action arose in 2040/10/15, within the limitation period. The defendant’s registration does not override the contract (Evidence Act, 2031, Section 34). Section 10(1) mandates performance, and the defendant’s refusal is a breach.
Conclusion
The study of persons incompetent to contract under Nepal’s Muluki Civil Code, 2074, reveals a robust yet incomplete legal framework aimed at protecting vulnerable individuals while ensuring contractual fairness. Section 506 of the Code identifies minors, persons of unsound mind, and those disqualified by law as incompetent, safeguarding them from exploitation by rendering their contracts void or voidable. This aligns with global principles, as seen in cases like Mohori Bibee v. Dharmodas Ghose, which voided a minor’s contract, and is reinforced by Nepalese precedents such as Achyut Prasad Kharel v. Prime Minister and Saki Kami v. Kancho Kami. These cases, analyzed in Chapter Two, demonstrate judicial efforts to uphold contract validity while navigating capacity-related ambiguities. However, significant gaps persist, undermining the framework’s effectiveness and consistency.
The Muluki Civil Code’s failure to define “unsound mind” and “disqualified by law” comprehensively creates ambiguity, complicating judicial assessments of mental capacity and legal disqualification. For instance, Saki Kami v. Kancho Kami assumed party competence without verifying mental soundness or legal status, risking enforcement of contracts involving incompetent parties. Similarly, Achyut Prasad Kharel sidestepped capacity issues, focusing on distinguishing civil from contractual liabilities, yet failed to clarify protections for disqualified persons like insolvents. These gaps lead to inconsistent rulings, particularly for persons of unsound mind or quasi-competent individuals (e.g., elderly with partial incapacity), as courts lack clear guidelines on assessing lucid intervals or temporary incapacity. The absence of mandatory capacity verification in contract formation further exacerbates risks of exploitation, especially in oral agreements, where competence is harder to ascertain.
The law’s protective intent is evident in provisions allowing guardians to contract for incompetent parties and exceptions for minors’ beneficial contracts or necessities. However, without explicit mechanisms to verify capacity or protect quasi-competent individuals, the framework falls short of ensuring equitable enforcement. Judicial reliance on foreign precedents, like Mohori Bibee, highlights the scarcity of Nepalese case law addressing unsound mind or disqualified persons, forcing courts to exercise discretion that may lead to varied outcomes. Additionally, the tension in Achyut Prasad Kharel with ICCPR Article 11 underscores the need to align domestic laws with international standards, particularly regarding civil liabilities mistaken for contractual obligations.
To address these shortcomings, the Muluki Civil Code should mandate capacity verification, define “unsound mind” in terms of medical criteria, and explicitly list disqualified persons (e.g., felons, insolvents). Provisions for quasi-competent parties, along with a Nepalese case law database, would enhance judicial consistency and fairness. By bridging these gaps, Nepal can strengthen its contractual framework, ensuring it protects vulnerable individuals while upholding the integrity of legally binding agreements.
References
Constitution of Nepal, 2072
Muluki Civil Code, 2074
Company Act, 2063
Insolvency Act, 2063
Contracts with People who are Incapable of Contracting, Drishti Judiciary, (Jun 6, 2025), https://www.drishtijudiciary.com/ttp-indian-contract-act/contracts-with- people-who-are-incapable-of-contracting.
Suresh Kumar Dhungana, Law of Contract, 268 (2079).
S Pandey, MINORS ‘ AGREEMENTS IN INDIA AND THE U.K- A COMPARATIVE SURVEY, Journal of the Indian Law Institute, 1972, pp.205-52. JSTOR, (Jun 6, 2025), http://www.jstor.org/stable/43950180
Bijay Satyal, Person of Unsound Mind, Bench Partner, (Jun 6, 2025), https://benchpartner.com/person-of-unsound-mind.
Shafaq Gupta, Minors’ Capacity to Contract, ipleaders (June 20,2025), https://blog.ipleaders.in/minors-capacity-enter-contract/
What is Contractual Capacity?, Juro (June 20,2025),https://juro.com/learn/contractual-capacity#
Capacity to Contract, Manupatra (June 20, 2025), http://student.manupatra.com/Academic/
Abk/Law-of-Contract-and-Specific-Relief/Chapter-5and6.htm
Achyut Prasad Kharel Prime Minister and Council of Ministers (N.K.P.) 2064, Shrawan, Decision No. 7843
Saki Kami Kancho Kami, (N.K.P.) 2048, Mangsir, Decision No. 4370
Mohri Bibee Dharmodas Ghose, (1903) ILR 30 Cal 539 (PC)
