Hauer v. Union State Bank of Wautoma
532 N.W.2d 456 (1995)
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Rule of Law:
A contract with a mentally incompetent person is voidable; if the other party entered the contract in bad faith, meaning they knew or had reason to know of the incompetence, the incompetent party is not required to return consideration they no longer possess upon voiding the contract.
Facts:
- In 1987, Kathy Hauer suffered a brain injury in a motorcycle accident and was subsequently placed under a court-appointed guardianship.
- On September 20, 1988, Hauer's guardianship was terminated based on a physician's letter stating she could manage her own affairs. Her assets included an $80,000 mutual fund which generated interest income she used for living expenses.
- Ben Eilbes, who had a defaulted loan with Union State Bank, met Hauer and learned of her mutual fund.
- Eilbes persuaded Hauer to take out a loan, using her mutual fund as collateral, to invest in his business, promising to repay the loan and give her a job.
- Eilbes arranged the loan with Richard Schroeder at Union State Bank, informing Schroeder that part of the proceeds would be used to pay down Eilbes's own defaulted loan.
- Schroeder contacted Hauer's stockbroker, who advised against the loan, stating Hauer needed the income from the fund to live on. The stockbroker may also have informed Schroeder of Hauer's brain injury.
- On October 26, 1989, having never previously met or spoken with Hauer, Schroeder met with her and Eilbes, at which time Hauer signed a $30,000 single-payment note secured by her mutual fund.
- Hauer gave the entire $30,000 in loan proceeds to Eilbes.
Procedural Posture:
- Kathy Hauer filed suit against Union State Bank and Ben Eilbes in the trial court, seeking to void the loan.
- The Bank filed a counterclaim against Hauer for judgment on the defaulted loan.
- The trial court granted partial summary judgment for the Bank, dismissing Hauer's misrepresentation claims.
- Prior to trial, Hauer dismissed her claims against Eilbes.
- A jury found that Hauer lacked the mental capacity to enter the loan and that the Bank failed to act in good faith.
- The trial court entered judgment in favor of Hauer, voiding the contract, dismissing the Bank's counterclaim, and ordering the Bank to return Hauer's collateral.
- The Union State Bank, as appellant, appealed the judgment to the Wisconsin Court of Appeals.
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Issue:
Does a mentally incompetent person who voids a loan contract have an obligation to return the loan proceeds when the lending bank failed to act in good faith by having reason to know of the person's incompetence?
Opinions:
Majority - Snyder, J.
No. A mentally incompetent person who voids a contract is not obligated to return consideration that has been dissipated if the other party failed to act in good faith. The general rule requiring restoration of the parties to their pre-contract positions does not apply when the competent party knew or had reason to know of the other's incapacity. The court distinguished this situation from the infancy doctrine, noting that contracts with mentally incompetent persons require balancing the protection of the vulnerable with the security of transactions. Here, the jury found Hauer was mentally incompetent and that the Bank failed to act in good faith. This finding of bad faith is inextricably linked to the conclusion that the Bank had reason to know of Hauer's incompetence, based on several 'red flags': Eilbes was in default, the loan would be used to pay his debt, and Hauer's own financial advisor warned against the transaction and may have disclosed her brain injury. Because the Bank proceeded despite these warnings, it bore the risk of loss when the contract was voided, and Hauer was not required to return the dissipated loan proceeds.
Analysis:
This case clarifies the equitable remedies available when a contract is voided due to mental incompetence. It establishes that the duty to restore consideration is contingent on the other party's good faith. By holding that a party with 'reason to know' of incompetence acts in bad faith, the decision places a significant due diligence burden on entities like banks, especially when presented with suspicious circumstances. This precedent shifts the risk of loss onto the party that ignores warning signs of incapacity, thereby strengthening protections for vulnerable individuals in contractual dealings.
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