Elements Of A Valid Contract

Halvard Brenn applies for a standard-rate policy and sends no premium with the application. Kestrelmoor Life underwrites him and issues a policy at a SUBSTANDARD rate carrying a higher premium than the one applied for. Under offer-and-acceptance analysis, who has made the operative OFFER at this point, and how is a contract formed?

1. A.Brenn made the offer when he applied, and the insurer accepted it by issuing a policy, so a contract already exists at the applied-for rate.Issuing a policy is an acceptance only if it matches what was requested. A rated policy at a higher premium differs materially from the application, so it cannot be an acceptance of Brenn's terms.
2. B.The insurer made a counteroffer by issuing a policy other than as applied for, and Brenn accepts by agreeing to the change and paying the higher premium.Correct. With no premium submitted, the applicant made no binding offer the insurer could accept. Issuing on different terms is a counteroffer, and the applicant becomes the accepting party when he takes the rated policy and pays.
3. C.No offer exists at all until the producer physically delivers the policy and collects a statement of good health.The counteroffer comes into existence when the insurer issues on different terms. Delivery and the health statement are how that counteroffer is communicated and accepted, not what creates it.
4. D.Both parties made simultaneous offers, and the contract is formed by the insurer's internal underwriting decision alone.An insurer's internal decision cannot form a contract. Contract formation always requires an offer met by an acceptance communicated to the other party.

Why: When no premium accompanies the application, the applicant's submission is an invitation, and the insurer's issue of a policy on terms other than those applied for is a COUNTEROFFER. A counteroffer terminates the original offer. No contract exists until the applicant accepts the new terms, which he does by agreeing to the rating and paying the higher premium, usually at delivery along with a statement of continued good health.

A producer takes an application at an applicant's kitchen table. The applicant is visibly and heavily intoxicated, cannot follow the questions, and signs where the producer points. The insurer later argues the contract is fully enforceable against him. Which statement about the COMPETENT PARTIES element applies?

1. A.Intoxication is never relevant; only minority or an adjudication of insanity can defeat capacity.Capacity is assessed functionally. A person so impaired by alcohol or drugs that he cannot understand the nature and effect of the transaction lacks capacity, whether or not any court has ever ruled on his competence.
2. B.A party so impaired that he cannot understand the nature and effect of the transaction lacks capacity, and the resulting contract is voidable at HIS election.Correct. Competent parties is an element of a valid contract. Incapacity of this kind gives the impaired party the power to disaffirm; he may also choose to affirm the contract once he is competent.
3. C.The contract is automatically void, and neither party may enforce it or recover any premium.Incapacity does not make an agreement void. It makes it voidable at the option of the party who lacked capacity, and premium is not forfeited if the contract is undone.
4. D.Capacity is measured only at the moment the policy is delivered, so the applicant's condition when he signed is irrelevant.Capacity matters whenever a party takes a contractual act, and signing the application is such an act. The application also becomes part of the entire contract, so the circumstances of signing are directly relevant.

Why: Competent parties means each party must have legal capacity: of legal age, mentally competent, and not so impaired by drugs or alcohol as to be unable to understand the nature and effect of the transaction. Incapacity of this kind does not destroy the contract automatically. It makes the agreement VOIDABLE at the election of the party who lacked capacity, who may instead choose to affirm it once sober or once competent.

A study group argues about why a policy procured by a complete stranger on a person he has never met is not merely unenforceable but offensive to public policy. Their instructor answers by reference to the LEGAL PURPOSE element of a valid contract. Which explanation is correct?

1. A.Without insurable interest the arrangement is a WAGERING contract, a bet on a human life, and a contract lacking a legal purpose is void rather than merely voidable.Correct. Legal purpose is an element of every valid contract. A policy procured by someone with no insurable interest is a wager and creates an incentive to profit from a death, so it is void from inception.
2. B.Legal purpose refers only to the requirement that the insurer hold a certificate of authority in the state where the policy is delivered.A certificate of authority is a licensing requirement imposed on the insurer by the state. It has nothing to do with whether the object of the contract itself is lawful.
3. C.Legal purpose is satisfied whenever the applicant pays the premium, because consideration cures any defect in purpose.Consideration and legal purpose are separate elements. Paying money for an unlawful object does not make the object lawful; a fully paid wagering contract is still void.
4. D.The arrangement is voidable at the insured's option, and becomes fully enforceable once the contestable period has run.The incontestable clause bars an insurer from contesting a valid contract after the contestable period. It does not breathe life into an agreement that was void from the beginning for want of a legal purpose.

Why: Legal purpose is one of the four elements of a valid contract, alongside offer and acceptance, consideration, and competent parties. Without insurable interest at inception, a policy on another life is a wager on how long that person will live, and it also creates an incentive for the owner to profit from a death. A contract lacking a legal purpose is VOID from the outset, so it never existed and cannot be cured by the passage of time.