Capacity and loan agreements

A loan is an agreement between a lender and a borrower for a sum of money, where the borrower is obligated to repay the full amount, usually with interest. The terms of the loan are set by the lender and agreed to by the borrower. Typically, a loan will be repaid over a set period and in regular instalments. A loan is therefore a financial transaction between two parties, forming a binding contract once agreed, either in writing or verbally.

There are many grounds where a loan can be challenged and made void. One significant ground is when one of the parties to the loan lacks mental capacity at the time the loan was made.

The legal term “capacity” refers to a person’s ability to understand the nature and consequences of a specific decision or action. It is possible for someone to have capacity in some areas but lack capacity in others.

The case Imperial Loan Co v Stone [1892] 1 QB 599 established that a person lacks the requisite capacity to validly enter into a loan agreement or a contract when it can be evidenced that:

• They did not understand the nature and the effect of the agreement at the time because of their lack of capacity, and
• It was reasonable to the other party that they would have known of the incapacity.

In order to prove that a loan agreement should be made void on the grounds established in Imperial Loan Co v Stone, the burden of proof that the person lacked capacity lies with the person alleging incapacity. This can be the individual but is usually their Litigation Friend if they do not have litigation capacity. For a discussion of around the appointment of Litigation Friends, please see an earlier blog on that topic here.

To prove that a loan was entered into whilst the person lacked capacity, the court will require evidence which illustrates this. This can be done in the following ways:

1. Medical Records which show the history of any diagnoses which may have resulted in an impaired understanding.
2. Reports from experts such as psychiatrists or clinical psychologists who are able to prepare retrospective reports on a person’s capacity at the time they entered into the loan agreement.
3. Witness statements from those close to the person, such as their friends, family or caregivers, who can provide a detailed recollection of events around the time of the loan agreement.

If it is established that the person lacked capacity when they entered into the loan, then the loan may be voidable. In England and Wales, the following remedies are usually available:

• Rescission: Set aside the loan agreement.
• Restitution: Return the parties to their pre-contract positions.
• Injunction: Prevent enforcement actions (like repossession).
• Damages: Potentially, if misconduct or negligence by the lender is proven.

At Anthony Gold Solicitors, we are experienced in dealing with vulnerable clients, especially in circumstances where a person has been subject to financial abuse or taken advantage of. If a person you know or act for may have entered into a loan agreement when they lacked capacity, please do not hesitate to contact us on 020 7940 4000 or mail@anthonygold.co.uk to discuss your concerns and obtain specialist advice from our experts.