What does “illegality” mean in contracts?
Illegality in contracts refers to the circumstance when an agreement is struck between two or more parties, the contents of which run foul with the provisions of a written law. The penalties attached to the breach of a written law would be visited on the parties to the contract, as the outcome of illegality in the contract itself.
As discussed previously, contracts that are void are unenforceable. Therefore, there cannot be any compensation or reliance on any benefit that would have been derivatively obtained by the parties if the contract was not upheld. Illegality in a contract renders the whole contract void, as opposed to partial illegality, where a part of the contract becomes void and the remaining parts can still be enforced.
The definition of illegality in contract under Nigerian Law is yet to be expressly stated by our courts. Therefore, in practice, the definition of illegality will be best understood from the numerous judicial decisions decided by a splendour of judges on the issue. For example, it was held in the case of Arobieke v. Attorney-General, Lagos State 1972 1 All NLR that , "an agreement is illegal if it is entered into pursuant to, or in support of, an illegal act".
The principles established above is in alignment with the core reasoning behind why incentives are provided to ensure contracts that are entered into do not become void. If a contract is deemed to be illegal, either partially or in its entirety, as discussed above, the burden of establishing the disquieting nature of the illegality will rest on the party that seeks to benefit from the void aspect of an illegal contract.
Further, it has been admitted in several other decisions that an illegal act in of itself is sufficient evidence to oust an enforceable contract. In this regard, Uwaifo JSC in the case of Nigeria Ports Authority v. Afribank N.B. Plc (2004) 16 NWLR (Pt. 904) 1 at 35 – 36 reinforced the definition of illegality by asserting that: "Illegality in a contract means that the transaction is tainted with illegality in the sense of violating the law or public policy whether statutory or common law. A contract may be regarded as illegal because of the object for which it is formed or because of the consideration for which it is formed."
Different types of illegal contracts
Contracts to commit illegal acts
Contracts are not enforceable if the agreement involves an act that is contrary to the criminal law of the state or if the agreement is itself a criminal act. This is especially true if the contract’s purpose is to commit a crime, tort, or other public offense. However, a contract’s unenforceability depends on its purpose. Contracting for goods in itself is not a violation of law, but it may be illegal to buy certain goods. For example, it is not necessarily illegal for two parties to contract for the sale of illegal drugs. In that situation, there is not a violation of law to which the contract is directed, but there is a violation of law to which the subject matter of the contract is directed.
Contracting to commit torts
Contracts that commit civil torts are also unenforceable. As an example, a contract to pay an employee for committing a tort (assault, battery) is not enforceable.
Agreements that restrain trade
One of the most significant groups of illegal contracts is contracts that restrain trade. Some agreements do not have antitrust implications but are nevertheless contrary to public policy. For example, a business cannot sell its business and agree at the same time not to compete in the same area of business. (These are known as "covenants not to compete.") Similarly, employees can’t agree to fix wage levels. Because these agreements are contrary to public policy, they are not enforceable.
Contracts against public policy
Not all contracts to violate a statute are unenforceable. If the purpose of the statute is to enforce a public policy rather than to regulate private relations, the contract will be invalid even though no government prosecutes a violation of the statute. Examples of this type of contract are any agreement to pay a bribe to a public official, a contract not to marry, and any agreement in restraint of marriage.
Outcomes of illegal contracts
The default position as far as the consequences of illegality in contracts is concerned, is one of unenforceability. This means that a party to a contract may not sue a party who has the benefit of the contract to enforce the contract. The Supreme Court of the United Kingdom confirmed that position when it said in Patel v Mirza (Patel) that where the law renders an agreement unlawful or contrary to public policy, the parties cannot in principle rely on it even if the legislation or public policy is designed for their protection.
However, it is not always the case that a party to an illegal contract cannot enforce the contract against the other party to the contract. For example, in Shiell v National Australia Bank Ltd, where the object of the contract was to enable the perpetration of a crime by one of the parties to the contract. The nature of the crime meant that the crime could not be perpetrated without the contract which constituted the crime. In such circumstances, the court held that it would be contrary to public policy to hold that neither party could rely on the contract. A party will be able to rely on the contract if not doing so would adversely impact the administration of public policy.
In circumstances where a claim cannot be made under a contract which is tainted by illegality it does not mean that a party is bereft of a remedy. The illegality principle only bars the recovery of substantive rights which arise from the illegal contract. The bar to the recovery of such rights is based on the fact that the proceedings in which they are claimed would further the performance of the illegal contract and would support its illegality. This principle does not necessarily apply to ancillary claims (for example, claims for the recovery of money paid under an illegal contract).
If a person has acted illegally and a claim cannot be brought in respect of that contract, the party may still be able to claim for restitution in the following circumstances:
What courts do with illegal contracts
Courts take a nuanced approach to the issue of illegality, reflecting a concern that the denial of relief in cases where a contract is only partly illegal will lead a court to act as an "engine of fraud." In Bijan Investments (Group) Inc. v. Koo, for example, the plaintiff claimed breach of contract, breach of fiduciary duty, unjust enrichment and negligence, and the defendants argued that the contracts, which pertained to the brining of illegal goods into Canada, were tainted by illegality such that there could be no recovery under any of the theories advanced.
The British Columbia Court of Appeal emphasized that when someone brings a new action to enforce a contract in respect of which unlawful conduct has already occurred, it is appropriate to consider the purposes of the legislation said to have been breached, as well as the public interests at stake, in deciding whether public policy considerations should prevent the enforcement of the contract.
In Bijan Investments, the Court agreed with the trial judge below that the public policy concerns served by the legislation said to have been breached were not of such importance that they outweighed the injustice to the plaintiff that would result from his being denied relief on his claims . This was not a case involving a contract that is "so manifestly injurious to the public" or opposed to the "public good" that it would amount to an affront to the community to grant a remedy to the innocent party.
i) contracts that are unenforceable by one party even where the contract itself does not discriminate between the parties, as in Bijan Investments;
ii) contracts that distribute the burden of infraction in circumstances where it would otherwise be unfair; and
iii) contracts that effect a moral compromise between the parties.
In some cases, the effect of granting a remedy sought by an innocent party to an illegal contract is simply to legalize the illegal act. The effect of the decision in Bijan Investments was to return the parties to the status quo ante and allow them to continue their renegotiation process, where that had not previously occurred by reason of the illegality. This decision turned on the need to balance the public policy objectives of the relevant legislation with the interests of the parties. Of note is the fact that, notwithstanding Bijan Investments, there remains an obligation on the part of innocent parties to illegal contracts to return any benefits derived from the illegality of the contract to the dispossessed party.
Exceptions and defenses
Exceptions to the strict prohibition on contracting in an illegal subject matter may arise in some circumstances. These include:
Defense and Enforceability
Parties may need to plead a defense of illegality to an otherwise legally enforceable contract. However, ignorance of the illegal aspect of the contract may not be a viable defense. In other words, if you enter into a contract with a party you know or reasonably should have known has an illegal aspect to it, this may not be a viable defense to a claim by that party to recover under the contract. (This rule likely is subject to the corporate shield defense discussed below.)
Where the parties have acted fully, or partially, on a contract that is unenforceable due to illegality, the court may, at its discretion, enforce some or all of the contract terms. Moreover, where the illegality is capable of being severed from the contract terms, a court may void some of the terms while allowing others to stand as valid. The principles of severability and partial enforcement are highly fact specific and depend on the intent of the parties as discerned from the agreement.
Capability of severance aside, a court is more likely to enforce the terms of a contract where the public policy proscribing the illegal subject matter is not so strong that it would void the contract of all effects. Moreover, conditions surrounding the formation and execution of the contract may be factors in the court’s determination of whether to enforce all or some of the contract terms.
Avoiding illegality in contracts
When it comes to contractual agreements, the risks of illegality in contracts can be grave and existential: a court is likely to render a contract void as a whole rather than limit the problem to just the offending parts of it. The best way to ensure that its contracts are entirely legal is to be careful while specifying the essential points in the contract so that both parties come to an understanding on the same basis and do not make incorrect assumptions about each other.
The first step is to perform the due diligence for compliance and investigate if the contract is legal under the applicable statutory provisions and case law of the state, province, or territory where it is enforceable. When considering the terms, conditions, and processes included in the agreement, parties to a contract should consider the following: Parties should follow through with their representations made in pre-contract due diligence. For example, if the parties have made warranties and representations as to their integrity and business conduct, those representations should be followed up and verified by conducting the necessary checks, inquiries, and set-off procedures. A new entity may be relatively ignorant of a party’s past corporate history and should take care that its counterpart does not have an undisclosed reputation of non-compliance with laws and regulations (e.g., FCPA, tax, environment, health and safety, etc.) . It is prudent for parties to ensure that they have the requisite effective policies in place and that such policies are being implemented prior to execution of the contract. This area is fraught with regulatory complexities and a party’s mere suggestion of ignorance may not constitute a defence sufficiently to absolve it of liability. In a world of increased information, proper compliance is expected of the corporate world. It is also important that parties, especially consumers, are aware of the regulations and protections provided by local laws. For example, a contract which has the effect — direct or indirect — of eliminating or modifying a consumer’s rights under the applicable local consumer protection legislation may be rendered void. It is important for parties to draft and execute their contracts carefully, using appropriate language and to use clear terms with the intention to be interpreted from a reasonable person’s perspective. The intent of the party should be clear and unambiguous in order to avoid rendering the contract void. Under some jurisdictions, before enforcing a contractual provision, the court will verify that it has been reasonable under the prevailing conditions. Any commission of fraud, fostered or ignored by the parties, may result in a contract being declared illegal and render it void. Therefore, it is important to include a clause in the contract where both parties represent that they are not participating in any fraudulent activities and are free of criminal malpractices.