If the Formation Or the Performance of an Agreement Is Illegal, the Contract Is Void

CHAPTER 15

ILLEGALITY

Outline

I. Introduction

A.Illegality

If the formation or the performance of an agreement is illegal, the contract is void.

B.Types of Illegality

An agreement is illegal if it calls for behavior that violates a statute or rule of common law.

C.The Presumption of Legality

Unless the parties clearly intended an illegal bargain, the courts presume the parties intended a legal result.

II.The Effect of Illegality

A.General Rule

Courts generally will not enforce illegal agreements but leaves the parties as it finds them. Illegality is behavior that violates a statute or a rule of common law.

B.Ignorance of Fact or Special Regulation

Sometimes a court will permit recovery if the parties are ignorant of the facts.

C.Rights of Protected Parties

Parties protected by regulatory statutes may be entitled to enforce the agreement if public policy is served.

D.Rescission Before Performance of Illegal Act

To encourage people to cancel illegal agreements, the courts allow one who rescinds the contract before any illegal act has been performed to recover any consideration given.

E.Illegality and Divisible Contracts

If the legal parts of the contract can be separated from the illegal parts, the courts will enforce the legal parts of the contract.

III. Contracts to Commit Illegal Acts

A.Agreements to Commit Crimes

Any agreement that calls for the commission of a crime is illegal.

B.Agreements to Commit Torts

Any agreement that calls for the commission of a tort is illegal.

IV.Contracts Made Illegal by Statute

A.Wagering Statutes

Agreements in violation of a state statute to prohibit or regulate gambling are illegal.

Example: Grigsby v. Russell: The court found that the assignment of a life insurance policy in exchange for medical aid did not make the agreement unenforceable.

B.Statutes Declaring Bargains Void or Voidable

1.Usury laws prohibit charging more that a stated amount of interest for the use of money.

Example: Perez v. Rent-A-Center Inc.: The court found that rent-to-own contracts fall within the state usury laws.

2.Sunday laws (Blue Laws) prohibit the performance of certain work and business transactions on Sunday.

C.Regulatory Statutes

Agreements in violation of regulatory licensing statutes are generally unenforceable; however, agreements in violation of a revenue-raising statute are often enforceable.

Example: Alatriste v. Ceasar’s Exterior Designs, Inc.: CEDI cannot recover for the work done while the license was in effect.

V. Contracts Contrary to Public Policy

A.The Idea of Public Policy

Public policy is determined by a court and reflects acceptable social or economic behavior.

B.Contracts Injurious to Public Service

Agreements that induce public servants to deviate from their duties are illegal.

C.Contracts to Influence Fiduciaries

An agreement that tends to induce a fiduciary (person in a position of trust or confidence) to breach his fiduciary duties are illegal.

D.Exculpatory Clauses

A provision in a contract that attempts to relieve one party of liability due to his own negligence is illegal.

Example: Johnson v. New River Scenic Whitewater Tours, Inc.: New River is unable to enforce an exculpatory clause against a child who was killed on a whitewater rafting trip.

E. Contracts in Restraint of Trade

Agreements whose sole purpose is to restrain trade are illegal. However, a restraint that is ancillary to a contract may be legal if it is designed to protect interests created in the contract.

Example: Home Paramount Pest Control Companies, Inc. v. Shaffer: The court found the non-compete clause of the contract unreasonable due to its restriction of activity.

F. Unequal Bargains

Under this doctrine, a court may refuse to enforce a contract or contract clause it finds to be "unconscionable."

1.Generally requires finding that parties lacked equal bargaining power and contract contains substantively unfair provision.

Example: Lhotka v. Geographic Expeditions, Inc.: The court found the arbitration clause was unconscionable because there was an absence of meaningful choice on the part of one of the parties, along with contract terms that are unreasonably favorable to the other party.

G. The Code and Unconscionable Contracts

UCC 2-302 is the UCC provision on unconscionability; the Restatement has adopted a similar approach.

Learning Objectives

1.You should understand the concept of public policy, which may be determined by a court.

2. You should understand that a court will generally refuse to enforce an agreement it finds to violate public policy; further, the general rule is "hands off" illegal contracts, so that the court will leave the parties as it finds them.

3.You should know when “ignorance of the facts” making a contract illegal will enable a party to recover damages or consideration.

4.You should know the situations in which a party is permitted to rescind an illegal contract and obtain relief.

5.You should know when a court will enforce the legal portions of a contract that also contains an illegal term.

6.You should know and understand the difference between an illegal wager and a legal risk-shifting contract or speculative bargain.

7.You should know and understand the difference between licensing statutes that are intended to raise revenue and those which are intended to protect the public, and you should know the significance of this distinction in situations where the party violating the licensing statute is seeking relief under a contract.

8.You should know and understand when an exculpatory clause is unenforceable.

9.You should understand which types of restraint of trade clauses are enforceable.

10.You should understand that the concept of unconscionability is a powerful concept because courts may use this concept to invalidate agreements.

Learning Hints

1.Generally speaking, the courts will not enforce illegal bargains at all, and will leave the parties to such an agreement in the position in which it finds them. This is what is meant by the phrase "hands off illegal agreements" in the textbook. The courts will usually deny even a quasi-contract recovery in the case of an illegal bargain. The reason for this "hands off" policy is to reinforce the public policies making such agreements illegal in the first place, mainly by deterring parties from entering into such agreements.

2.In some situations, however, a party to an illegal agreement is given some relief when this can be done without seriously undermining the public policies making the agreement illegal. In other situations, parties are felt to be deserving of relief despite these public policies.

3. It is not a simple matter to determine public policy, because this concept reflects current social, economic, and political realities. For example, some courts have invalidated "surrogate motherhood" contracts on the theory that such contracts violate general public policy, and also violate public policy that underlies adoption statutes.

4.In addition to being illegal, exculpatory clauses can often be attacked on the grounds that they were not the product of voluntary consent, or that they are unconscionable.

5.The materials you have already studied concerning duress, undue influence, and capacity are relevant to the general issue of shockingly unequal bargains.

6.Today most unconscionability problems arise in the context of contracts for the sale of goods so are usually treated under the Uniform Commercial Code. However, unconscionability also exists as a common law concept and is often applied in the context of contracts that do not involve the sale of goods.

7.Unconscionability is a concept that cannot be defined very specifically. Courts give this concept content by injecting their notions of fairness and sound public policy into the decisions in which unconscionability is an issue. The courts often distinguish between substantive unconscionability, which involves unfairness in the terms of the contract itself, and procedural unconscionability, which involves the way in which the agreement was reached, including things like terms in fine print, contract language which is not understandable by the ordinary person, high-pressure sales tactics, and one party's

ignorance, limited education, or lack of fluency in the language. Some courts hold that both procedural and substantive unconscionability must be present for a contract to be illegal on the grounds of unconscionability.

8. "Covenants not to compete" are agreements in restraint of trade. In other words, a party to an employment contract may agree that he/she will not compete with the other party in the event the employment relationship is terminated. Such agreements are enforceable only if reasonable both to geographic location and to time.

True-False

In the blank provided, put "T" if the statement is True or "F" if the statement is False.

_____1.Illegal contracts are generally unenforceable.

_____2.A person who makes a bad deal with a car dealer for the purchase of a new car could probably argue that the contract is unconscionable.

_____3.An agreement in violation of a revenue-raising licensing statute is almost always unenforceable.

_____4.June forgets to renew her city license for her business. Until she renews her license, all sales made by June’s business are illegal.

_____5.Exculpatory clauses that seek to avoid liability for willful misconduct are unenforceable.

_____6.When a contract is illegal, courts usually will not allow even a quasi-contractual recovery.

_____7.In some cases, a party who rescinds a contract before any illegal act has been performed will be allowed to recover the consideration he has given to the other party pursuant to the contract.

_____8.Employee agreements not to compete are usually judged by a stricter standard than agreements for the sale of a business.

_____9.The legal parts of a divisible contract are enforceable.

_____10.Despite the "hands off" rule, in cases where a person whom a statute seeks to protect enters into an agreement in violation of the statute, the protected person is permitted to enforce the agreement.

Multiple Choice

Circle the best answer.

1.Which of the following situations is not an illegal contract?

a.An agreement between Toni and Al for Al to rough up one of Toni’s skating competitors.

b.An agreement between Friendly Finance and Bill, a collector, for Bill to run a past due debtor of Friendly’s off the road in order to repossess a car.

c.Friendly Finance charges Sue 38% interest on an unsecured loan. The maximum interest rate in that state is 36%.

d.Tina buys property insurance on her new car.

2.A standardized form contract where the parties lack equal bargaining power is called:

a.An adhesion contract.

b.Unconscionable per se.

c.A licensing statute.

d.A Restatement contract.

3.The concept of "unconscionability":

a.Only applies in contracts for the sale of goods under the UCC.

b.Only applies in contracts under common law.

c.Looks to factors like unequal bargaining power and the party with superior bargaining power imposing unfair terms on the other party.

d.Is clearly defined by the UCC.

4. Which of the following situations would most likely be enforceable?

a. All businesses in Genoa City are required by city ordinance to pay an annual fee and obtain a license. Hallie buys some goods at Handy Hardware. Handy forgot to renew its license.

b. April buys a life insurance policy from Primer Co. Pete, the agent who sells April her policy is not actually licensed to sell insurance.

c.Doug hires Cathy to represent him in a large civil lawsuit. Cathy has never passed the bar exam.

d.Iowa requires plumbers to be professionally licensed. Steve contracts to provide plumbing services to Howard. Steve has never obtained a plumbing license.

5.Which of the following would the courts most likely not consider to be illegal?

a.An unfair contract between Carl Consumer and Big Corporation.

b.Big Corp., in Denver hires Debbie, an attorney. The employment contract states that if Debbie leaves Big, she cannot practice as an attorney for a year within 1,000 miles of Denver.

c.Kramer moves his grocery store to a new, bigger building. Kramer sells his old building to Hamilton. The contract states that Hamilton or any other owner of the building cannot open a grocery store there for five years.

d.Hair Dye Co. sells hair dye to retail stores and beauty salons. The labels on the containers of hair dye state that if anyone is injured by the product, the damages will be a refund of the purchase price of the hair dye. Sally is severely burned on her scalp by a Hair Dye product.

6.A fiduciary:

a.Is a person in a position of trust or confidence.

b.Is a person who entered into an illegal agreement.

c.Is an employee who signed a covenant not to compete.

d.Is a person who is entitled to enforce an illegal contract.

7.Which of the following is not true?

a.A parking garage states on its receipts that it is not liable for its own negligence. The garage will not be liable for damages to customers’ cars resulting from negligence by the garage.

b.Commodity transactions are an example of legal speculative bargains.

c.Blue Laws may limit or prohibit the sale of some goods on Sunday.

d.Abe represents Indian Tribe A as a lobbyist in its efforts to keep its casino open. Indian Tribe B also hires Abe to represent them and to lobby to keep the casino operated by Tribe A closed. The agreement between Tribe B and Abe may be illegal.

8.Which of the following is an enforceable agreement?

a.A contract with someone who does not have a license as required by a revenue raising statute.

b.A contract with someone who does not have a license as required by a regulatory statute.

c.An agreement in violation of a state gambling statute.

d.An indivisible contract that contains an illegal clause.

9.Cleaver decides to move his successful clothing store in Mayfield to a newer, bigger building. Cleaver does not want the buyer of the building to operate a clothing store there. Jim Bob wants to purchase the Cleaver building and open a strip club that serves meals and liquor. Which of the following is true?

a.Cleaver’s agreement not to compete is illegal because it is in restraint of trade.

b.Cleaver’s agreement not to compete would also apply to a strip club.

c.City ordinance may prevent the sale of the building to someone intending to open a strip club because such a sale may be opposed to public policy.

d.Jim Bob will not be able to open the club because regulatory statutes would require him to have a professional license to own such a club.

10.Rona opens a bank account with Windy City Bank. The fine print in the contract stipulates large monthly service fees, and large fees for overdrafts and stop payment orders. The bank did not disclose this information to Rona at the time she opened her account. Which of the following is most accurate?

a.The court may find this contract to be unconscionable.

b.The court may look unfavorably upon the bank since this appears to be a contract of adhesion.

c.Federal laws may require the bank to disclose important contract terms to customers.

d.All of the above.

Short Essay

1.Many states that at one time enforced Blue Laws have in recent years changed their laws to allow sales on Sunday, including the sale of liquor. Discuss the reasoning for Blue Laws and the reasoning for rescinding these laws.

2.Mary Ann is interested in buying stocks from her broker, Gilligan. Are there regulatory statutes requiring investment brokers to be licensed? Why?

3.Are restrictive covenants in restraint of trade ever enforceable? If so, under what circumstances?

4.Are exculpatory clauses in contracts enforceable?

5. Vanna has been a sports anchor at WWOW in Boston for 10 years. Vanna is popular with the viewers. Her contract with WWOW has a non-compete clause. If she leaves the station, she cannot take a job with another station within 50 miles for one year. Station WHEW in Boston makes Vanna an offer she cannot refuse, so she leaves WWOW in May when her contract terminates. Is the restrictive clause in Vanna’s contract with WWOW enforceable?

6. There is a growing scandal in the financial community that is generally called “predatory lending.” This basically involves taking advantage of poorer people’s economic position by offering them disguised loans at usurious rates through related transactions. One such practice is found in the “rent-to-own” industry. After the rental period is over, the sale of the goods is made at top rates. Is this possibly usurious?

Herman is offered a job with Big Shot law firm in New York. The contract is fair and reasonable except for a restrictive clause that would forbid Herman from practicing law anywhere in the State of New York for 10 years if he would ever leave Big Shot. How might the courts view this contract?

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