A party to a binding contract must have the legal capacity to enter into such an agreement. This will generally not depend on the subjective intention of the party but on an objective legal test of capacity that has historically been applied to certain categories of persons. The categories include:

• minors;

• corporations;

• mentally unsound and intoxicated persons;

• executors and administrators;

• trustees;

• bankrupts; and

• aliens.

The capacity of people under the age of 18 to enter into legally binding contracts is not governed by uniform law across Australia. Most states and territories follow the common law, which takes a benevolent attitude towards minors. Generally, contracts cannot be enforced against them unless they are contracts for “necessaries” (such as those for food, clothing, accommodation and other existential needs) or beneficial contracts of service (such as for education, training and apprenticeship). These are deemed to be for the minor's benefit. Contracts outside of these categories are considered voidable, and the minor's capacity depends on whether they provide a permanent or temporary benefit. In addition, some jurisdictions (such as Victoria and South Australia) that apply the common law also have specific statutory provisions that qualify the common law principles.

New South Wales has replaced the common law on minors' contracts with statute. Contracts are “civil acts” that are presumptively binding for the minor unless they are not for the minor's benefit. Other key provisions are aimed at ensuring the minor does not misunderstand the importance of the transaction because of their age, and that the price of any property bought or sold is not manifestly excessive or inadequate.

See Minors.

The capacity of corporations to enter into contracts may first be affected by corporation legislation, which proscribes the enforceability of certain contracts where the legislation is contravened. Such contraventions aside, a corporation may execute an enforceable written contract directly by one of its organs, or indirectly through a properly authorised agent.

The common law “ultra vires” rule has been abolished as far as corporate capacity is concerned, meaning that a company may be bound by contracts it forms notwithstanding that the contract has been entered into beyond the corporation's capacity or in contravention of its own rules. Company directors will have the apparent or ostensible authority to bind the company to a contract that falls within the express or implied powers conferred on it by the constitution. However, a party dealing in good faith with a company that is acting within its powers is entitled to assume that its directors are exercising those powers properly and in compliance with the constitution.

Finally, the Corporations Act 2001 (Cth) sets out a series of statutory assumptions that may be made by any person having “dealings” (such as forming contracts) with a corporation. These have the effect of deeming corporate capacity to undertake certain acts, including the formation of binding contracts, for the protection of the other contracting party.

See Corporations.

Other categories of persons occasionally present issues of capacity to contract. To set aside contracts for lack of capacity, mentally unsound or intoxicated parties need to establish their incapacity and the knowledge (actual or constructive) of that incapacity by the other party. This is so even if the contract itself may be unfair, although it may not be possible to set it aside where the “incapacitated” party has subsequently affirmed the contract.

The capacity of other special categories of persons — such as trustees, executors and administrators, bankrupts and aliens — to enter into valid and binding contracts may be subject to a variety of common law principles and statutory provisions.

See Other entities: Mentally unsound and intoxicated persons, trustees, executors, bankrupts and aliens.