R2d § 15
Mental Illness or Defect
(1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition. (2) Where the contract is made on fair terms and the other party is without knowledge of the mental illness or defect, the power of avoidance under Subsection (1) terminates to the extent that the contract has been so performed in whole or in part or the circumstances have so changed that avoidance would be unjust. In such a case a court may grant relief as justice requires.
Professor's notes
Elements: (1) a person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect (a) he is unable to understand in a reasonable manner the nature and consequences of the transaction (cognitive test); or (b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition (volitional test); (2) where the contract is made on fair terms and the other party is without knowledge, avoidance is barred to the extent performance has been such that avoidance would be unjust.
Estate of McGovern operationalizes: pension election by a mentally declining retiree.
Common misunderstanding: students apply only the cognitive test (1)(a). § 15 adds the volitional test (1)(b): even understanding parties may lack capacity if they cannot act rationally AND the other party knew. The volitional prong was the Restatement's modern addition; older common law required only cognitive incapacity.
Text
R2d § 15. Mental Illness or Defect.
(1) A person incurs only voidable contractual duties by entering into a transaction if by reason of mental illness or defect
(a) he is unable to understand in a reasonable manner the nature and consequences of the transaction, or
(b) he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of his condition.
(2) Where the contract is made on fair terms and the other party is without knowledge of the mental illness or defect, the power of avoidance under Subsection (1) terminates to the extent that the contract has been so performed in whole or in part or the circumstances have so changed that avoidance would be unjust. In such a case a court may grant relief as justice requires.