Illegal & Void Contracts

Contracts can be called into question because their object is one, which the law does not wish to enforce. Such contracts can be declared to be either illegal or void

A contract may be illegal because it is prohibited by statute, or because it infringes a rule public policy.

Illegal Contracts

Contract can be declared illegal either pursuant to statute or common law principles.

     * Statutory Illegality

A contract can be prohibited by a statute depending on the intention of the legislature as expressed in the statute and principles governing the interpretation of statues must be applied - Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd (1978)

Two types of contract can be declared illegal by statute:

In St John Shipping Corp v Joseph Rank Ltd, Devlin J stated, as a general principle, that a court “will not enforce a contract, which is expressly or impliedly prohibited by statute”.

   1. Expressly illegality.

A statute explicitly states that contract entered into, in violation of the statute are illegal.

Re Mahmoud and Ispahani, in this case the defendant didn’t have a license although he said that he had it. The contract was express illegality.

   2. Implied illegality.           

Implied illegality occurs when legislation prescribes certain conduct and imposes certain penalties for violating that legislation. This was seen in,

Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd (1978)

Whereby, s8 of the Banking Act 1950 was contravened by the plaintiff, in which a penalty was imposed.

This was also seen in, St John Shipping Corp v Joseph Rank Ltd,

Whereby a freight company had contravened the Merchant Shipping Act by overloading the vessel. They were penalised but the main theme of this case on statutory illegality is that the court should not find an implied prohibition if this would lead to an unreasonable or inconvenient result, or to an absurd conclusion.

     * Common law Illegality

1. Any contract that has as its purpose the commission of a crime. Tort or fraud on a third person is illegal. Such as unlawfully trading, which is seen in Neal v Ayers.

2. A contract that is sexually immoral is illegal. What is “sexually immoral”?

In Seidler v Schallhofer, Hope JA held that the “agreement did not involve meretricious sexual services, but a sexual relationship as part of a wider relationship”. It would be wrong to hold the present agreement contrary to public policy.

3. Contracts which prejudice public safety or good relations with other states (ie contracts with countries at war with Australia)

4.Contracts that are prejudicial to the administration of justice.

In the cases of Callaghan v O’Sullivan and Clegg v Wilson the contracts made were contrary to public policy, which in this case was the payment of money to not prosecute the plaintiff, and money could not be recovered.

5. Contracts tending to promote corruption in public life.

This is seen in, Wilkinson v Osbourne whereby the contract was contrary to public policy because of the clear conflict of interest and duty of a member from the legislative assembly.

6. Contracts to defraud the revenue.

This concept was seen in Alexander v Rayson, whereby the Court held that because the plaintiff had prepared the documents in order to commit a legal wrong he could not enforce the lease.

He wasn’t entitled to enforce the contract, since the foundation was a device for the achieving of a purpose that was illegal, immoral or contrary to public policy.

Effects of Illegality

If both parties intend to commit an illegal act or act in a manner contrary to public policy neither party can bring an action pursuant to the illegal contract.

If only one party is guilty of performance of an otherwise legal contract in an illegal manner or for an illegal purpose, the other can sue on the contract. This notion is seen in Archibolds (Freightage) Ltd v S Spanglett Ltd.

However, even if contract is illegal as to its formation, an innocent party may have alternative remedies, not based upon the contract. Possible alternatives include:

1.Tort of deceit (Fraud)

This is seen in Hatcher v White, whereby the contract was based on a fraudulent misrepresentation by the builder. The plaintiff was awarded damages based on the performance of the contract and not the formation of the contract.

2. Collateral Contracts

Where a person may require a licence that licence does not exist (they have said they are licensed when in fact they are not) and there is an implied illegality rendering that contract unenforceable.

However, if there was a promise that a party was licensed, that assurance may be a separate and distinct contract and the consideration for that contract is the entry into the main contract. This is seen in,

Strongman v Sincock

Although the illegality made the contract unenforceable, Strongman could recover for breach of the collateral promise, since there was no culpable negligence on its part relying upon it.

3.Equitable Estoppel

Where a person has made an assurance that they are licensed when in fact they are not you may have a ground under promissory estoppel. (Refer to estoppel notes)

Severance

In some circumstances the illegality can be severed from the contract.

There are two main forms of severance:

1. A term of a contract which is itself invalid may be severable form the rest of the contract.

2. If a term is partially invalid and the invalid part can be severed so as to permit enforcement of the remainder of the term.

It is, however, clear from the High Court’s decision in Thomas Brown & Sons Ltd v Fazal Deen that severance of an illegal contract is sometimes possible.

Facts: The plaintiff had deposited a quantity of gold with the defendants in contravention of the National Security Regulations. In addition, the plaintiff also deposited a quantity of gems, which did not contravene the legislation.
Held: The Courts severed the bailment contract and permitted the enforcement of the contractual obligations in regards to the gems. This suggest that the plaintiff could demand the return of other part of the property bailed, the bailment of the gems was in effect distinct form the bailment of gold.

Recovery of money or property transferred under an illegal contract.

Generally, courts will not assist either party to an illegal contract to recover property that has passed pursuant to it. Exceptions here include:

1. The principle of Locus Poenitentiae

Principle – Locus Poenitentiae – means literally is “place or chance of repentance”

If the person withdraws or repents from their illegality then you can recover property that may have passed pursuant to that contract. The illegal act(s) must not have been carried out or at least in substance not carried out at the time the person withdraws from the illegality of the contract.

Only relevant to common law illegality – not statute illegality.

The relevant case that establishes this notion is seen in Clegg v Wilson.The repentance or withdrawal does not have to be genuine or sincere – it must be voluntary.

Facts: Mrs Clegg agreed to transfer her house ‘fairlawn’ at Turramurra to Wilson, in return for his refraining from giving evidence in a prosecution against her son, a solicitor. However, the charge was withdrawn for other reasons, and Mrs Clegg sought to have the agreement set aside.
Held: The sup court of NSW held that she was entitled to relief. An agreement to stifle a prosecution was against public policy and was illegal, but equity would undo the transaction while the illegal purpose remained wholly executory notwithstanding that there was an element of turpitude in the contract and both parties were in pari delicto.

*Turpitude: Everything done contrary to justice, honesty, modesty or good morals

2. If the parties are NOT in pari delicto

If the parties are NOT in pari delicto, they are not both guilty or equally guilty of an illegality or illegal intent OR the absence of knowledge of the illegality. Then they can recover property.

Thus, in Archbolds (Freightage) Ltd v S Spanglett Ltd the plaintiff recovered damages even though the defendants had contravened an Act but not knowing this fact the plaintiff was not in pari delicto.

3.A party has alternative grounds for recovery such as in the law of torts.

Plaintiff may be able to recover property based on some independent cause of action that has nothing to do with the contract. Mainly tort principles such as tort of conversion.

*conversion is a tort that deals with the wrongful interference with goods

The Bowmakers principle concerning recovery of property is derived from the decision of the English Court of Appeal in, Bowmakers Ltd v Barnet Instruments Ltd.

Facts: Barnet obtained possession of machine tools under hire-purchase agreements with Bowmakers, who purchase them from Smith. Unknown to all the parties, the
transactions were prohibited by orders under Defence regulations. Barnet did not pay all the monthly payments of hire and sold the tools or refused to deliver them up. Bowmakers sued for damages for conversion. Judgement for Bowmakers, Barnet appealed.
Issue: Whether Bowmakers was entitled to sue for conversion of the goods?
Held: Appeal dismissed. Bowmakers succeeded.

A man’s right to possess his own chattels (personal property) will as a general rule be enforced against one who, without any claim of right, is detaining them or has converted them to his own use, even though it may appear either from the pleadings or in the course of the trial that the chattels in question came into the defendant’s possession by reason of an illegal contract between himself and the plaintiff, provided that the plaintiff does not seek, and is not forced, either to found his claim on the illegal contract or to plead its illegality in order to support the claim.

Du Parcq: “Prima facie a man is entitled to his own property, and it is not a general principle of our law (as was suggested) that when one man’s goods have got into another’s possession in consequence of some unlawful dealings between them, the true owner can never be allowed to recover those goods by an action. The necessity of such a principle to the interest and advancement of public policy is certainly not obvious. The suggestion that it exists is not, in our opinion, supported by authority”

In Singh v Ali, the plaintiff relied upon the cause of action that a person in possession of goods, or entitled to their immediate possession, has the right to recover damages for trespass against a person who unlawfully interferes with the goods by taking them out of the possession of the person legally in possession of the goods.

Void Contracts

The three major areas in which common law principles will declare a contract as being void are dealt with below. Generally, property that may have passed under a void contract can be recovered.

1. Contracts to Oust the Jurisdiction of the Court are Void

Although a contract, which purports to oust the jurisdiction of the courts, is probably not illegal, it is contrary to public policy and therefore void or unenforceable.

A contract or provision ousting the jurisdiction of the courts to hear disputes is void. Nevertheless in, Scott v Avery (1856) the House of Lords decided that an arbitration clause of this type does not infringe public policy even if it enables the arbitrator to determine whether any liability has been incurred under the contract.

2. Contracts Prejudicial to the status of Marriage are void

A contract that unduly restrains the freedom of a person to marry is void.

3. Contracts in Restraint of Trade

A contract, or term in a contract, in restraint of trade is one, which restricts the right of a person to freely carry on his or her trade, business or profession. The purpose of such restraints is stated in Lindner v Murdock's Garage (1950):

It is common to use the expression covenants in restraint of trade, with the covenantor being the person burdened by the covenant and the covenantee being the person for whose benefit the provision applies.

At common law such restraints are prima facie void and unenforceable. The fact that a restraint clause has been freely bargained for and entered into by the parties does not mean that the restraint is enforceable. This point was made in Maggbury P/L v Hafele Australia P/L, whereby restraints of trade are likely to reduce competition.

“ The importance of competition for the economy…That this is so should be taken into account in formulating and apply any contemporary doctrine eof restraint of trade”
However if the restraint is reasonable then the prima facie rule will not apply.

A restraint of trade contained in a deed in which the covenantee has not provided consideration, is not enforceable by the covenantee. Even in a deed form the consideration exception does not apply in restraint of trade. The authority is stated in, Davis v Mason (1793).

Restraint of Trade

The basic propositions for common law principles on restraints of trade are found in,

Nordenfelt v Maxim Nordenfelt Buns and Ammunition Co

Facts: Nordenfelt developed a business in connection with the manufacture of quick-firing guns, and later sold it to a company (Sale of business Contract). With his concurrence the business was transferred to the respondent company and, as part of the arrangement, he entered a covenant not to engage in a competing business for 25 years.
Held: The covenant could be considered on the footing of a direct transfer of goodwill by Nordenfelt to the respondent, and was not void as an unjustifiable restraint of trade. Although it was unlimited in space, the covenant was reasonable and, having regard to the worldwide nature of the business, not wider than was necessary for the protection of the respondent. It could therefore be enforced by an injunction against Nordernfelt.

Lord Macnaghten: “The public have an interest in every person’s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void….. if the restriction is reasonable- reasonable, that is, in reference of the interests of the parties concerned and reasonable in reference to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time it is in no way injurious to the public.”

If a restraint is unreasonable it is unenforceable even if the covenantor has acted in a way, which would have been within the boundaries of a reasonable restraint. This is seen in, Papastravou v Gavan [1968] 2 NSWR 286 where the restraint went beyond what was reasonable, and the plaintiffs were unable to obtain relief even though, had the restraint been limited to a more reasonable radius, it would undoubtedly have been enforceable.

OR

This case illustrates the fact that at common law a covenant in restraint of trade which is found to be unreasonable in extent is not enforceable even though the covenantor has acted in a way which could have been the subject of a valid restraint

As can be seen from Nordenfeldt, the prima facie proposition that a restraint is unenforceable is subject to the qualification that it will be enforced if reasonable. A number of points relating to reasonableness need to be made:

* Onus of Proof

The onus of proof is establish in Herbert Morris Ltd v Saxelby, in the following terms:

- The covenantor (Burden party by the restraint) has to show that it is unreasonable to the public
-  The convenantee (benefit from the restraint) has to show is unreasonable between the parties

* The Time at which Reasonableness is assessed

The relevant time for examining the reasonableness of a restraint is the time of entry into the contract (Nordenfeldt case)

Qualifying the events after the contract has been entered into can be taken into account only to clarify events prior to and up to the date of entering into the contract

* Reasonableness in the Interest of the Public

The major public interest is the maintenance of competition in business and trade. However, simply because a restraint lessens competition does not necessarily mean it is also unenforceable as seen in Queensland Co-operative Milling Association v Pamag Pty Ltd (1973).

It was thought that reasonable gauge was only determined as to if it was in the interests of the parties to the contract it is also reasonable from the perspective of the public interest (Esso Petroleum v Harper’s Garage).

One feature of the modern cases is to give more prominence to the public interest than was formerly overtly in evidence and in the Esso case, Lord Hodson held one of the restrictive covenants in issue to be unreasonable on the basis that it was injurious to the public.

This was later qualified to include the interests of the public in Baker v Lintott.

* Reasonableness in the Interest of the Parties

The pivotal interest that a covenantee seeks to protect with a restraint is his/her goodwill in a business. In assessing whether the restraint is reasonable it can only go so far as to provide, as stated in Nordenfeldt, ‘adequate protection’ to the covenantee.

EXAMPLE. The purpose of the restraint of trade is to give the purchases time to establish a relationship with the customers etc… and so the purchaser needs to be given time to protect that good will.

Common considerations include with regard to reasonableness – what is reasonable:

a) Scope of the restraint in terms of the geographical area covered by the restraint.
b) Acts or Activities covered by the restraint. What the covenantor is restrained from doing and whether the convenantor must refrain from doing the acts referred to, for the covenantee to be adequately protected.
c) Duration must be taken into account. The longer the restraint the less likely it is that the restraint will be held to be reasonable.

Two further points about duration may be noted:

1) It is sometimes possible to lay down guidelines for parties to particular types of contracts. For example, in Esso Petroleum Co LTd v Harper’s Garage (Stourport) Ltd a period not exceeding 5 years to purchase their petroleum supplies from the one supplier, was said, as a general rule, not to be unreasonable.

2) Also, whether the restraint is to operate after the termination of the contract. Generally, a restraint is more likely yo be regarded as reasonable, where it operates for no longer than the duration of the contract.

d) Benefit derived by the parties.  When reasonableness is an issue, the court will place emphasis on the benefit derived by the parties from the contract.

Thus, the benefit to be taken into account are, as Walsh J said in, Amoco Australia v Rocca Bros “not limited” to what the covenantor “receives in money or other Property”. The effect of having regard to benefits obtained under the contract is to make the “quantum” and perhaps even the “adequacy” of the consideration received by the covenantor relevant to the issue of reasonableness.

e) Bargaining position of the parties. The courts are willing to show more latitude if there is a relatively equal bargaining position between them.

There are some markets and industries where restraints are so well established and widely practised that acceptance of some restraints is in effect part of the price of entry into the industry or market. This is seen in

Amoco Australia v Rocca Bros,

“Amoco and rocca negotiated on an equal footing – rocca was not under pressure to agree to amoco’s suggestions. It was in rocca’s interests to enter into an agreement with some oil company ensuring supplies for the service station. An arrangement effected by means of a lease and an underlease is not an uncommon way for an oil company to obtain a tie over a service station and, generally speaking, the terms of the underlease were not unusual.”

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