Illegality Effect
Consequences of Illegality,
The general principle is that the courts will not enforce an ilegal contract. This principle applies with even greater force where the party who seeks the court’s assistance is implicated in or has participated in the illegality. Where both parties are equally at fault, the contract will not be enforced. No order will be made for return of monies paid or for the payment of unpaid money. The results may be arbitrary. In effect, the gain or loss falls where is lies.
Where the contract is by its very terms unlawful, it is said to be illegal on its face. It is unlawful from its inception. The consideration may be the very thing that is prohibited. In this case, the state of mind and the relative guilt or innocence of the parties is irrelevant. A wholly innocent party may be denied his reasonable expectations.
Where a transaction is prohibited unless a license is held, the transaction may be invalidated, if the license is not held. This is so even if the apparent licence holder has mislead the other party to believe that he had a license.
Illegality in Performance
The position becomes more complex where the contract is not illegal by its terms or “on its face” . Where one person intends to perform the contract in an unlawful way, it may be enforceable by the innocent party.
If there are two methods of performing the contact, one lawful and one unlawful, it will not be readily presumed that the unlawful method of performance was intended by both parties. If one party claims a joint intention to perform unlawfully, he must clearly prove this.
Where both parties to the contract intend to perform an apparently lawful contract, unlawfully, neither may enforce it. Although the contract is lawful on its face, the court itself will not give effect to the contract if it discerns the unlawful context or method of performance.
Restitution
The courts may be prepared to allow restitution in respect of an unlawful contract. The unlawful contact is of no effect so that there may be a total failure of consideration in respect of monies paid.
The Courts will not, however, allow a remedy in restitution to enforce a contract which is unlawful or to be performed illegally, through the backdoor. The restitution in remedy is only available where the parties are not equally at fault.
Where one party is not aware of facts which cause the contract to be unlawful, restitution may be allowed in that party’s favour. If despite the illegality, the court interprets that the law was made for the benefit of a class, including the plaintiff and the parties were not equally at fault, recovery may be allowed. This principle may apply, in particular, where the action is taken by the party for whose benefit, the statute was made.
Relative Fault
If in the circumstances the parties are equally at fault, recovery will not be allowed. Where restitution is sought, the party seeking it must act equitably. If for example a loan is unlawful and the borrower granted security, he may be obliged to repay monies advanced on the basis that a windfall should not be permitted.
Parties who have been subjected to fraud, duress, oppression or undue influence may be allowed to recover notwithstanding the illegality of the transaction. The claimant must not be equally at fault and must have been induced or caused to enter the contract by the fraud or breach of fiduciary duty of another.
Where the illegality arises from duress or attempts to extricate oneself or another, from danger they may be excused and recovery may be permissible.
Where the benefit of the illegality accrues to one person only, this may point to the parties not being equally at fault.
Independent Basis for Recovery
In some cases, one party may be entitled to recover assets or monies which have been paid, on the basis of an independent right. This right may be a property right. Alternatively, he may be entitled to rely on a collateral contract, not affected by the illegality.
Where property or assets are held by another party, it is generally possible to recover them by virtue of title. An action for trespass and recovery is available to the owner of goods against a person detaining them. Such a claim may be allowed, even though it appears that the goods came into the defendant’s possession by reason of an illegal contract, even one to which the clamant was party.
It may be possible in some cases to recover monies paid on the basis of a trust, where a party has contributed towards the purchase price of property put in the name of another for an unlawful purpose. For example, the courts have upheld a resulting trust in respect of a share of the property arising from contributions, for the purpose of qualifying for social security benefits.
Tort & Collateral Contract
Where a contract has been entered on foot of fraudulent misrepresentation, there may be recovery on the basis of the tort / civil wrong of deceit. This claim does not need to rely on the contract. The court may nevertheless considers the conduct and relative culpability of the parties, but to a lesser extent than in a claim based on contract. .
In some cases, it may be possible for the Court to find a separate collateral contract which is not tainted with illegality. Where, for example, a person gives a collateral assurance that he will obtain the necessary licences, thereby misleading an innocent party into entering a prohibited contract, that party may be entitled to recover for fraud, breach of promise or warranty, provided that he is not being guilty of culpable negligence. The approach is controversial as its effect may be to enforce the contract “through the backdoor”.
Where a loan is advanced for the purpose of performance of an unlawful contract, the loan itself may be unlawful if the lender has knowledge of the purpose. Similarly if the loan is made to pay off an illegal loan, it may be unlawful, if this is known to the lender.
Repentance
If the transaction is illegal from the onset, but it has not yet been performed, the innocent party who repents and repudiates the agreement may recover assets transferred. The repentance must be made before performance. Once performance commences of the unlawful promise, it is too late to repent.
A 1995 case has extended the principle to allow repentance up until the point in time when the dishonest intention has been wholly or partly carried into effect. The repentance need not be in the sense of actual remorse.
In some cases, repentance will never be enough. Where a person has entered out a contract to commit a crime, it is unlikely that repentance would be in anyway sufficient to allow restitution.
Severance
Where a contract is illegal or contrary to public policy, the courts may in some cases, sever the offending clauses from the contract, while leaving the rest to stand. Severance is most commonly allowed, in the case of contracts that are void as being against public policy.
A restriction, in a contract which is in restraint of trade, may be capable of severance. Similarly, contracts that affect the jurisdiction of courts may be severed from the remainder of the agreement.
It does not clear if severance applies to illegal contracts, as opposed to those which are void, as against public policy. Some courts take the view that severance is not allowed, where the statute prohibits the contract entirely. Severance is not available where the illegal promise is a substantial part of the consideration. Outside of this, it may be permitted.
Scope of Severance
Severance is only allowed in relation to a clause, which will stand alone, having been severed. There must be one or more promises which are legal and the others which are illegal. If there are both lawful and unlawful considerations which are interdependent, then severance will not be possible.
Severance may be allowed in relation to statutory illegality and breach of regulatory rules. It is only allowed, however, if it accords that the principles underlying the legislation.
Severance may take place within the wording of a covenant or clause itself. This is the so called blue-pencil test. Severance is only allowed if the remaining words can stand sensibly and without changing the agreement.
Showing Illegality
If an agreement is illegal on the face, the courts will take cogniscience of it and will not enforce it, notwithstanding that the issue is not raised by either party. If is not illegal on the face, but the court discerns the illegality of the course of the case, it is likely to refuse to enforce the contract.
The burden of proving illegality lies on the person raising it. If there is a regular and apparently valid contract, clear evidence will be required to show that there is some unlawful underlying secondary transaction, for example, for the purpose of defrauding the Revenue.
Statutes Provides
Where a particular course or transaction is unlawful, then contracts which provide for it, will be void. In some (relatively few) cases, legislation specifically prescribes that a contract is not (or less commonly) is valid, where some unlawful element is present.
The Consumer Information Act 1978 / Consumer Protection Act 2007 provides that contracts for the supply of goods and services are not to be void by the reason of contravention of the consumer information requirements of the legislation.
More commonly, statutes do not specify whether contracts concerning the matter concerned, are invalid. If the contract relates to or involves doing the very matter that is prohibited, it will be usually invalid.
Connection to Illgality
In many cases the invalidity will relate to an incidental matter and not to the core contractual obligation itself. It is ultimately a matter of interpretation of the statute as to whether the prohibition invalidates a contract involving incidental illegality.
The courts will look to see whether there is a connection between what is unlawful and the contract. An example sometimes given in this context, is of regulatory legislation which provides for the permissible conditions of carriage of goods. If, for example, there is some minor illegality, such as overloading the vessel or vehicle, it is unlikely that the statute intended to invalidate the contract for the carriage of the goods.
Similarly, the statute may provide that a carrier may not carry on business without a licence. In this case, the court is more likely to interpret the legislation as prohibiting the carrier from recovering monies for services. The legislation is aimed at prohibiting unlicensed hauliers. Correspondingly, it is unlikely to be interpreted so as to deprive the customer of his contractual rights.
Outside Powers
Contracts may be unlawful in the sense that they are outside the powers of a particular public body. Most entities constituted by law, such as public bodies, semi state and other state sponsored institutions are established with powers that are limited to their functions.
Where the legislation limits powers, transactions outside those powers are not inherently illegal. In this case, the court simply limits the capacity of the public body to undertake transactions outside its functions an remit.
An important factor in interpreting legislation in this context, is whether the statute was passed to protect the public or group of public. An example of statute passed to protect the public is that which prohibits pyramid schemes. The Pyramid Selling Act has been re-enacted in the Consumer Protection Act, 2007. Pyramid schemes are entirely prohibited by the legislation.
Modern Approach
In Quinn v IBRC, the Supreme Court, following the broad approach of the UK courts, modernised and restated the law on the effect of illegality on the validity of a contract. Fundamentally, whether a contract, illegal by statute, is void or voidable depends on the public policy purpose of the statute
The Court held that proper approach which provides the greatest level of certainty involves consideration of the public policy purpose of the statute. This determines whether any contract which contravenes the statute must be held to be void or voidable. The proper approach is specific to the statute, not the case.
The Supreme Court Test
Clarke J writing for a unanimous Court (here) set out the issues to be considered:
1. Whether the relevant legislation expressly states that contracts of a particular class or type are to be treated as void or unenforceable.
2. Where, however, the relevant legislation is silent … the court must consider whether the requirements of public policy … and the policy of the legislation concerned, … gleaned from its terms, … require that, in addition to whatever express consequences are provided for in the relevant legislation, an additional sanction or consequence in the form of treating relevant contracts as being void or unenforceable must be imposed.
3. In assessing the criteria … the court should assess at least the following matters: –
3(a) Whether the contract in question is designed to carry out the very act which the relevant legislation is designed to prevent
3(b) Whether the wording of the statute itself might be taken to strongly imply that the remedies or consequences specified in the statute are sufficient to meet the statutory end.
3(c) Whether the policy of the legislation is designed to apply equally or substantially to both parties to a relevant contract or whether that policy is exclusively or principally directed towards one party. Therefore, legislation which is designed to impose burdens on one category of persons for the purposes of protecting another category may be considered differently from legislation which is designed to place a burden of compliance with an appropriate regulatory regime on both participants.
3(d) Whether the imposition of voidness or unenforceability may be counterproductive to the statutory aim as found in the statute itself.
4. The aforementioned criteria or factors are, for reasons which will become apparent, sufficient to resolve this case. However, the following further factors may well be properly taken into account in an appropriate case:-
4(a) Whether, having regard to the purpose of the statute, the range of adverse consequences for which express provision is made might be considered, in the absence of treating relevant contracts as unenforceable, to be adequate to secure those purposes.
(b) Whether the imposition of voidness or unenforceability may be disproportionate to the seriousness of the unlawful conduct in question in the context of the relevant statutory regime in general.
5. Doubtless other factors will come to be defined as the jurisprudence develops.