5.4.2 Illegality Lecture

Statutory prohibition of contracts

A contract may be prohibited by a statute either expressly or impliedly. This is an important distinction to make as whether or not a party may enforce the contract is dependent on this.

Express Prohibitions

If a statutory prohibition expressly prohibits a type of contract or term, there is no question as to the illegality of the contract. Neither party will be able to enforce the contract, irrespective of the innocence of either or both parties - Re MahMoud and Ispahani [1921] 2 KB 716.

Implied prohibitions

Implied prohibitions are much more difficult to identify, and there are two tests the courts may apply to determine whether the contract made is impliedly prohibited. The tests applied and the decisions made are very fact dependent.

In order to determine whether an implied prohibition is operable, the court must ascertain whether the objective of the legislation is to forbid the contract. Here is the first rule:

  1. If the sole object of the statute is to increase national revenue, the contract itself is not illegal

This rule covers examples such as statutes which requires individuals to have a licence to trade in a particular area or with particular goods.

It should be noted that the above must relate to the sole object of the statute. If there are other objectives, such as public policy, this rule will not operate.

  1. Does the statute contemplate that the prohibited act will be done in the performance of a contract?

This is a confused concept best examined with an example. Take a fictitious act which has these provisions:

Section 1 – It is a criminal offence to…

  1. Sell chickens
  2. Keep chickens as pets

Option (a) will always involve a contract, therefore it is clear that the statute would contemplate this prohibited act would take place in the performance of a contract, and would therefore be an implied illegal contract.

Option (b) may involve a contract, but more often than not, will not. You may purchase a chicken for the purpose of keeping it as a pet, but you would not contract with somebody to keep a chicken as a pet. Therefore, the statute does not contemplate this prohibited act to take place in the performance of a contract, and would not be an implied illegal contract.

Contracts which are not illegal, but have been performed in an illegal manner

A contract may well be legal, but the way in which one party has undertaken their obligations amounts to illegality.

Whether the contract is legal or not is dependent on whether the ‘innocent’ party is aware of the illegal performance of the contract or is involved in it - Ashmore, Benson, Pease & Co Ltd v A V Dawson Ltd [1973] 1 WLR 828

The general rule above may be restricted where the purpose of the legislation is not undermined by the illegal performance - Anderson Ltd v Daniel [1924] 1 KB 138

Recent case law has added more complexity to this area of law - ParkingEye Ltd v Somerfield Stores Ltd [2012] EWCA Civ 1338.

The court held that when deciding whether the illegal performance would render the contract unenforceable they would consider these things:

  1. The object and intent of the party attempting to enforce the contract;
  2. The gravity of the illegality in the context of the claim; and
  3. The nature of the illegality.

Each situation will be fact-dependant. Just remember to apply these factors and come to a well-reasoned conclusion.

The effect of statutory penalties

In some cases, the performance of an illegal contract will be subject to a statutory penalty. The courts have held that where the penalty is proportionate and sufficient to the breach, the contract is enforceable by either party - St Johns Shipping Corporation v Joseph Rank [1957] 1 QB 267.

Common law prohibition of contracts – Public Policy

Contracts may be prohibited via the common law, on grounds of public policy or morality. There is a lot of uncertainty in this area, and the when the court can prevent a contract from operating is often unclear. The courts approach this area of law with a consideration of the common values of society – if the contract breaches common values of society it will be void for common law illegality.

Contracts to commit crimes

The case of Bigos v Boustead [1951] 1 All ER 92 confirms a contract which includes an obligation to commit a crime will be illegal. Furthermore, a criminal or criminal’s estate may not benefit from the crime (Beresford v Royal Insurance Co Ltd [1938] 586).

Contracts which prevent the administration of justice

Despite the law of contract mostly being self-regulatory, in the event of a dispute, the courts will intervene. Contracts which preclude parties to the contract accessing justice, or prevent the courts interfering with a contract, may be illegal on the ground that they prevent the administration of justice. See Hyman v Hyman [1929] AC 601 and Scott v Avery (1855) 5 HL Cas 811.

Contracts which are sexually immoral

Sexually immoral contracts refer to those relating to contracts for sexual acts or services - Pearce v Brooks(1865) LR 1 Ex 213.

However, this approach has evolved along with societies views - Sutton v Mishon de Reya [2003] EWHC 3166 (Ch).

Contracts which involve public corruption

Some contracts are invalid because they involve corruption - Parkinson v College of Ambulance Ltd [1925] 2 KB 1.

Common law prohibition of contracts – restraint of trade

To ensure there is a continuing freedom of contract, contracts that restrain trade can be void for illegality - Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535.

In assessing whether the restraint on trade is enforceable, the courts will focus on whether the contract between the two parties is reasonable, and if the limitation would not be in the public’s interest.

Is the contract reasonable?

In Herbert Morris Ltd v Saxelby [1916] AC 688, the courts identified general presumptions for deciding whether or not a contract may be illegal due to a disproportionate restraint on trade.

  1. Employment contracts that restrict former employees from being employed by competitors would not normally be valid
  2. Employment contracts that prevent the loss of trade secrets or stealing of custom would normally be valid
  3. Terms in a contract for the sale of a business preventing the seller setting up another business in competition with the purchaser’s business are normally valid

Once one of these presumptions has been identified, the duration and the geographical extent of the limitations made by the contract will be considered. These limitations should not be disproportionate. Some further case examples can be found below:

Mason v Provident Clothing & Supply Co Ltd [1913] AC 724

Home Counties Dairies Ltd v Skilton [1970] 1 WLR 526

Reasonableness as to the public interest is a further important consideration for the courts. The public interest consideration will be invoked where a contract will have an effect on the competitive structure of a certain market - Herbert Morris Ltd v Saxelby [1916] AC 688.

Exclusivity dealing contracts

Exclusivity dealing contracts, also known as ‘tie agreements’, are those between parties at different stages in a commercial chain which force a closer ties between the parties than a mere contract  - Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269.

Exclusive service agreements

An exclusive service agreement is similar to an exclusive dealing contract, but instead it relates to where a person provides services for only one recipient.

These contracts do not usually involve a contract of employment, only a contract of restriction.  Generally, these courts will apply the same rules as those for contracts of employment – that generally these agreements are not valid, dependent on the geographical restraint and duration of the term.

See Creig v Insole [1978] 1WLR 302 and Eastham v Newcastle United Football Club Ltd [1964] Ch 413.

The court will also take into consideration whether the individual subject to the contract has been treated fairly, has undertaken independent legal advice, and whether they have been taken advantage of.  Their age, the fairness of the contract, and the duration of the contract will be helpful in assessing this - Proactive Sports Management Ltd v Rooney [2011] EWCA Civ 1444.

The effect of illegality

The case of Holman v Johnson(1775) 1 Cowp 341 is authority for the general principle of illegality – that the illegal contract will be unenforceable. Dependent on the circumstances, one or none of the parties may enforce the contract, and on occasion only part of the contract will be unenforceable.

Severable illegal contracts

The courts have the power to enforce a contract, but only when the illegal parts of the contract have been removed. There is a three-part test to apply when attempted to sever parts of the contract -  Sadler v Imperial Life Assurance Co of Canada Ltd(1988) IRLR 388:

  1. The ‘blue pencil’ test – can the illegal provision be removed without modifying the words of the remaining terms. If it still makes sense, the illegal provision can be removed.
  1. The remaining terms following the ‘blue pencil’ rule must be supported by consideration
  1. Following the blue pencil rule, the contract must continue to be the same sort of contract that the parties entered into in the first place. It cannot be changed to the extent that it changes the character of the contract.

The final requirement is a question of fact, and can be difficult to assess - Attwood v Lamont [1920] 3 KB 571.

Collateral contracts

Where there is one illegal contract, but there is a collateral contract that allows a recovery of all or part of the contract, this may be enforceable, but only if providing for a remedy under the collateral contract is not equal to enforcing the illegal contract - Fisher v Bridges(1854) 3 El & Bl 642.

A collateral contract must have the effect of protecting an innocent party to whom a promise or misrepresentation has been made.

Claims based on an illegal contract

The general rule is any claim based upon an illegal contract is invalid, unless the claim is related to an unrelated part or transaction of the contract which the illegality does not affect - Euro-Diam Ltd v Bathurst [1990] 1 QB 1.

Recovery under illegal contracts

The final assessment to make when considering an illegal contract is whether or not any money or property may be recovered subject to the contract.

Both parties are guilty

When both parties are guilty in relation to the illegal contract, the general rule from Holman v Johnson (1775) 1 Cowp 341 is that there can be no recovery of any kind of money or property.

This rule has been challenged as being contrary to Article one of the Human Rights Act – ‘no one shall be deprived of his possessions except in the public interest’ - dismissed in Shanshal v Al-Kishtaini [2001] EWCA Civ 264.

One party unfairly induced into the illegal contract

If both parties are guilty of entering an illegal contract, but one party has been forced into the contract as a result of duress or undue influence, the contract will not be enforced, but the victim may successfully recover money or property they have passed subject to the contract - Hughes v Liverpool Victoria Legal Friendly Society [1916] 2 KB 482.

One party withdraws from the contract

If one party withdraws prior to the illegal part of the contract coming into effect, the doctrine of locus poenitentiae comes into effect. The result of this is that the party who withdrew may recover any money or property subject to the contract. The fact one party has withdrew will suffice – Tribe v Tribe [1996] Ch 107.

There has been some debate as to when the withdrawal from the contract must occur - Kearley v Thomson(1890) 24 QBD 742 is the correct approach.

The withdrawal from the contract needs to be voluntary - Bigos v Boustead [1951] 1 All ER 92.

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