ABE Principles of Business Law 2008

Contract Law 2: Contract Regulations 155

G. VOID AND ILLEGAL CONTRACTS

For one reason or another, the state may either refuse to assist a person in enforcing certain contractual rights or it will declare a contract to be null and void. Contracts falling into these categories are, in some way, tainted. However, the reasons why they are tainted, and why the state takes or denies the actions it does, cover a very wide range of situations.

A contract to commit murder may have all the ingredients of a perfectly valid contract. However, quite obviously, the state is not going to enforce it. Can you imagine the furore there would be if a judge made an order of "specific performance", compelling a man to carry out his contract to strangle someone's mother-in-law, according to its terms?

At the other end of the scale, a contract may either be only mildly naughty or it may have no moral taint whatsoever but merely be contrary to some state regulation. A contract to fiddle your income tax might fall into the former category, and one to sell goods without having obtained a statutory licence into the latter.

However, all these wide varieties of contracts are contrary to public policy. They are all illegal contracts, which may be void ab initio, or they may be merely unenforceable.

Objects Illegal by Statute

Statute may declare certain types of contract void ab initio – that is, the contract itself is illegal and incapable of creating any rights. Certain gaming and wagering contracts fall into this category.

The Gaming Act 1845 (as amended by the Gambling Act 2005), Section 18, states as follows:

"All contracts or agreements ... by way of gaming or wagering shall be null and void ... no suit shall be brought or maintained in any court of law or equity for recovering any sum of money or valuable thing alleged to be won upon any wager."

On the other hand, a contract may be void without being itself illegal, and all that happens is that no rights are created which can be enforced by the courts. There is no other penalty. An example of this occurred in Re Makmoud and Ishahani.

Re Makmoud and Ishahani (1921)

A wartime statutory order forbade the sale or purchase of linseed oil without a licence from the appropriate government department. A contract was made between P and D to sell linseed oil. Before making it, D falsely assured P that he possessed a licence. However, he later refused to take delivery, because he had no licence.

HELD: The court would not entertain the action, as the statute clearly said that that kind of contract must not, in the public interest, be entered into.

Yet again, a contract may in itself be perfectly lawful but its performance may be illegal, or the particular method of performance may be forbidden.

St John Shipping Corporation v. Joseph Rank Ltd (1957)

A shipping company so overloaded its vessel that she was submerged below her statutory load line. The cargo owners refused to pay the freight.

HELD: The legality of the contract was not affected but it amounted to a statutory offence. So, the cargo owners had to pay.

On the other hand, in Ashmore, Benson, Pease & Co. Ltd v. A V Dawson Ltd (1973), D, a haulage company, was engaged by P to carry two 25-ton loads. These loads were loaded on

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to two 20-ton lorries under the eyes of P's manager. One of the lorries had an accident, and the load was damaged.

HELD: P's claim for the loss suffered failed, as the manager must have realised that the lorries were overladen, and, hence, he participated in an illegal performance.

The distinction between these two results is that, in the first case, the illegal performance was unknown to the cargo owners at the time, and, hence, there could be no justification for their refusing to pay the agreed freight. The statute merely provided a penalty for contravention, without making the contract itself void or illegal. In the second case, both parties knew of the illegal performance – and, so, damage directly resulting from the method of performance was irrecoverable.

The important thing to remember about statutory illegality is that, because of the wide variety of reasons for which the legislature may interfere in private contracts or transactions, it is essential to read and construe the words of the statute properly. Some may merely provide a penalty for transgression, leaving the contract unaffected; others may make the contract itself void or unenforceable, while some provide for both a penalty and unenforceability.

Gaming and Wagering

The subject of gaming and wagering is extremely complex. However, a short summary is called for. A wagering contract is one where there must be two parties or sides who both stand to win or lose on an uncertain event. Buying a sweepstake ticket, entering a coupon for the pools, or betting on the "tote" at a racecourse, are not wagering contracts. In all of these, only one of the parties stands to win or lose. Another essential of a wagering contract is that the parties have no interest in the contract, other than that created by the bet. This lets out of the category such transactions as insurance contracts and Stock Exchange bargains, both of which bear a superficial resemblance to wagering.

The common law long discouraged betting, until the Gaming Act 1845 made such contracts null and void. It not only did this but it also affected collateral contracts in the same way.

Hill v. William Hill (Park Lane) Ltd (1949)

A racehorse owner failed to honour debts with a bookmaker. The bookmaker reported the matter to Tattersalls (a form of "court of honour" for horse-racing bets), which ordered the debt to be paid by instalments. The owner failed to comply.

Tattersalls, therefore, threatened to report this non-compliance to the Jockey Club, which would have warned the owner off the turf. He bowed to the threat, and gave the bookmaker a post-dated cheque, which bounced.

HELD: The debt was irrecoverable. The House of Lords would not countenance the argument that the debt was not a gaming debt at all but, instead, an action on a dishonoured cheque. The cheque was collateral to the main contract of wager, and would not be enforced.

The 1845 Act was further strengthened by the Gaming Act 1892, which extended the provisions to contracts of principal and agent, whereby one man employed another as his agent to make a bet.

Finally, the Gaming Act 1968, while restricting the provision of credit for gaming, did liberalise the law in many respects. Games such as hazard and roulette, as well as games of chance played in a place habitually kept for gaming, were for a long time illegal by statute. The 1968 Act provided that certain games of chance could lawfully be played in such places under strict conditions.

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Objects Illegal at Common Law

Public policy decrees that the courts will not assist parties who have made certain types of contract. The contract is not illegal to make but its object is illegal. Public policy is an imprecise concept, and it changes as time goes by. There are, however, broad categories.

(a)Agreements to Commit a Crime, a Tort, or to Perpetrate a Fraud

Plainly, a contract the object of which is to commit a criminal offence cannot be enforced. However, if an illegal act is committed during the performance of an otherwise perfectly lawful contract, it will not necessarily render the whole contract unlawful.

Archbolds (Freightage) Ltd v. S Spanglett Ltd (1961)

Statute forbade the carrying of goods belonging to another for reward unless an "A" licence was held. D agreed with P to carry 200 crates of whisky belonging to a third party from Leeds to London. P was unaware that D did not hold an "A" licence. The whisky was stolen during the transit.

HELD: The contract was perfectly valid, and it was only the method of performance that was illegal. Hence, the claim by P for the loss of the whisky was enforceable.

In the same way, the courts will not enforce a contract the object of which is a tort – although, if a tort is committed in the course of a contract for other purposes, the contract will not, normally, be invalidated.

W H Smith & Son v. Clinton (1908)

Clinton agreed to indemnify Smith, a firm of publishers, against the consequences of libel which might appear in a certain journal. Smith knowingly published a libel in that journal, and had to pay damages. The firm sought to recover from Clinton under the indemnity.

HELD: The indemnity was unenforceable.

The perpetration of fraud can take many forms but all contracts having fraud as their object are unenforceable. One of the commonest forms is fraud against the Revenue.

Alexander v. Rayson (1936)

Rayson agreed to lease Alexander's flat in Piccadilly for £1,200 a year. In order to reduce the rates payable, the transaction was effected by two documents: in the first place a lease for £450 pa, covering certain landlord's services – and, in the second place, an agreement by the landlord to render substantially the same services for an additional £750 pa.

HELD: The lease and the agreement were both documents intended for a fraudulent purpose; so, neither could be enforced.

(b)Agreements Injuring the State in Relation to other States

These can either be contracts with an enemy in time of war, or they can be contracts which are hostile to a friendly state.

In the first place, any contracts with an alien enemy in wartime are illegal at common law. They are also illegal by statute, by virtue of the Trading with the Enemy Act 1939. It is forbidden to enter into or perform a contract with an alien enemy during a war, and even to perform such a one which was made before war broke out. Apart from any criminal penalties that may be provided by statute, such contracts are unenforceable.

In the second place, agreements which contemplate a hostile act against a friendly country, or even an act to be performed in a friendly state which is illegal by the laws of

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damages awarded to his/her client. English law has always frowned on champerty but it is the common practice in many foreign jurisdictions.

This must be contrasted with a Conditional Fee Agreement, which is a perfectly legitimate arrangement between a potential litigant and his/her legal adviser.

Both maintenance and champerty were, at common law, both torts and crimes. The Criminal Law Act 1967 abolished these, but contracts in respect of both are still contrary to public policy.

Another type of abuse of the legal process is collusion in divorce. Nowadays, however, this is more honoured in the breach!

(f)Agreements Contrary to Good Morals

Contracts which are for immoral purposes will not be enforced.

Pearce v. Brooks (1866)

A firm of coach builders hired to a prostitute a coach with an interesting design. It was known to the firm that it would be used by her in plying her trade. She failed to pay the hire.

HELD: The contract would not be enforced.

(g)Contracts in Restraint of Marriage which Affect the Due Discharge of Parental Duty

It is against public policy to restrain the freedom of marriage or to promote for a fee a marriage between one person and another.

Likewise, agreements for a fee to promote a separation or divorce are unenforceable, or those to transfer rights and duties in respect of a child from its parents.

(h)Agreements which Oust the Jurisdiction of the Courts

From a commercial point of view, this category is important. It is the right of every subject of the Queen to have his/her rights determined by the ordinary courts. Hence, any agreement to oust the courts is void.

Arbitration agreements to refer any dispute arising under a contract to arbitration have long been acceptable, provided that the agreement did not preclude the parties from referring any point of law to the courts. In Scott v. Avery (1855), it was held that a clause in a contract providing that it should be a condition precedent to any course of action accruing that an arbitrator should have made an award was not contrary to public policy (even nowadays, such provisions are called "Scott v. Avery clauses").

The principle that parties to an arbitration could refer a point of law to the court was enshrined in the Arbitration Act 1934. The principle has been eroded, but not done away with, by the Arbitration Act 1979 (as amended), which provides that the parties may agree to exclude the right of appeal to the court. If they do not so agree, then the right remains.

(i)Agreements in Undue Restraint of Trade

These also form a most important category of contracts which are contrary to public policy – but also one which contains fine distinctions. The problem is that, prima facie, any agreement is void if the purpose of it is to restrict the liberty of a person in the future to carry on trade with persons who are not parties to the contract – that is to say, to restrain trade. But, at the same time, a person has every right to protect his interests and his business from unfair competition. There is an obvious clash between these two propositions. So, the principle is that a person may restrict the right of another to trade, only so far and to the extent that is necessary and reasonable to protect his legitimate interests.

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Re Motor Vehicle Distribution Scheme Agreement (1961)

UK motor manufacturers agreed among themselves to sell their cars only through specially appointed dealers, who would be required to keep adequate stocks and spares, to purchase a fixed number of vehicles a year, and to purchase at the manufacturer's retail price less a fixed discount. The manufacturers claimed that the agreement was in the public interest, because it kept in existence an efficient distribution network.

HELD: The court ruled that the agreement was in restraint of trade.

In addition, cartels and similar agreements are controlled by statute. We shall outline the law on this subject later in the course.

Exclusive Service Agreements

Under these agreements the employee is, in effect, agreeing to work only for the employer. Here the courts are sometimes conscious of the inequality of the bargaining power of the respective parties. Simply put, if the courts feel that the employee is in a weak position and stands to gain less from the contract than the employer then they will not enforce it.

Schroeder Music Publishing Ltd v. Macaulay (1984)

An unknown songwriter entered into an agreement giving the publishers the full world copyright in all of his songs. The agreement also gave the publishers the right to terminate the contract or assign the benefit of it at any time. There was no corresponding duty to publish or promote any of the songwriter's compositions.

HELD: This was an unreasonable restraint of trade. The court was apparently influenced by the inequality of bargaining power of the parties. However, later cases seem to suggest that the granting of relief on the ground of inequality of bargaining power may be in decline.

You should note that if the court decides that a party is genuinely trying to protect against unfair competition, but the wording of the restraint is too restrictive, it may consider using severance. For severance to be applied, the court must be satisfied on several issues:

That the contract can be split into separate components

That those components are capable of standing alone and being enforceable as separate contracts

That no rewording of the contract is required

That the unenforceable part is a relatively minor part of the contract as a whole.

You can see an example in Goldsoll v. Goldman (1915). The claimant bought the business of the defendant who traded in imitation jewellery in the United Kingdom. One of the terms of the contract was that the defendant would not trade in imitation or real jewellery either in the United Kingdom or in certain foreign countries. It was held that the restraints concerning real jewellery and foreign countries could be severed, and that the contract could be enforced in respect of the sale of imitation jewellery in the United Kingdom only.

In Marshall v. N M Financial Management Ltd (1995), the defendant company, which was operating in the financial services sector, had engaged the claimant as a selfemployed agent selling life assurance and other financial services. He received commission from them for business introduced by him and his contract of engagement stated that entitlement to commission would cease on termination of the contract. It also stated that commission arising prior to, but not paid at, termination would be

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remitted within one year of termination, provided that the claimant was not employed by a competitor during that year.

The claimant terminated his contract of engagement with the defendant company and immediately joined a competitor. He claimed for prior commission due to him on termination, but this was refused by the defendant company.

HELD: The commission claimed was legally due to the claimant. The contractual provision was in restraint of trade, because it could not be justified as reasonably necessary to protect the lawful interest of the defendant company in conserving its existing customer base.

The unlawful restriction could also be severed from the rest of the contract, because the real consideration for the payment of prior commission derived from the claimant’s service under his contract, not an agreement not to compete.

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