Contracts Seminar 13 Illegality & Remedies Dr William Higgs Adjunct Fellow, School of Law, Western Sydney University Barrister-at-law Elizabeth Street Chambers, Sydney, Australia
Vitiating factors A quick reminder about vitiating factors. These are extraneous influences that impact upon the formation and/or the terms of the contract and include: Undue influence Duress Mistake Misrepresentation (misleading & deceptive conduct) Unconscionability Illegality Legislation Today we deal with illegality
Illegality - Introduction Illegality is a complex area of contract law. It deals with: 1. Contracts made illegal by statute 2. Contracts illegal at common law 3. Contracts contrary to public policy (what is that?) In some cases it will be simple to determine whether or not an illegal contract exists and will be rendered void; for example, a contract with a bikie gang to steel your ex-partners car and give it to you is clearly be considered illegal. You can t go to the courts and ask for it to be enforced. In other cases it will be more difficult. For example, you hire a chauffeur driven limo for a night out and you refuse to settle the bill because the driver broke the speed limit driving you into town. Can the driver make you pay as agreed?
Effect of illegality Where a contract is banned by statute the contract will be void. Where conduct is classified as illegal at common law or contrary to public policy it is generally held to be unenforceable. This is purely a technical difference. There are, however, some exceptions to these rules and, in some cases, it may be possible to sever the offending terms and enforce the remainder of the contract. Knowledge of the unlawfulness by one or both of the parties to the contract is not essential for the prohibition for illegality to take effect - JM Allan (Merchandising) Ltd v Cloke [1963].
Statutory Illegality Statutory illegality comes in four flavours all of which involve a breach of a statute as follows : 1. Contracts directly prohibited by statute (e.g. cartel contracts); 2. Contracts entered into for an illegal purpose (e.g. to kill, supply drugs etc.); 3. Contracts performed illegally (e.g. speeding whilst driving in the course of performing a contract); and 4. Contracts otherwise made void by statute (e.g. certain unfair terms in consumer contracts). Different rules and consequences attach to each.
Statutory illegality direct illegality Some contracts are expressly prohibited by statute. If so, the contract is invalid at formation and the courts will not uphold the contract in any way. The cases of Re Mahmoud and Ispahani [1921] and Bradshaw v Gilbert s (Australasian) Agency) are classic examples of where the court held that the contract was illegal because the statute expressly prohibited it. Case Analyses: Re Mahmoud and Ispahani [1921] Bradshaw v Gilbert s (Australasian) Agency)
Re Mahmoud and Ispahani [1921] 2 KB 716 FACTS An Order made under the Defence of the Realm Regulations prevented the sale of linseed oil without a licence. The relevant part of the legislation provided as follows: "Until further notice a person shall not buy or sell or otherwise deal in... any [linseed oil] except under and in accordance with the terms of a licence issued by or under the authority of the Food Controller. The plaintiff seller sold linseed oil to the defendant who did not have the necessary authority from the Food Controller. The defendant refused to accept the goods and argued that the statute prohibited the contract and that therefore the court could not enforce it.
Re Mahmoud and Ispahani [1921] 2 KB 716 HELD The vendor plaintiff could not enforce the contract even though it was innocent and the defendant was able to rely on its own illegal act to defend the action. Luckily (for the vendor)the goods had not been delivered. If the purchaser had accepted delivery and then refused to pay the plaintiff vendor could not have recovered the price (at common law) and the defendant would have been enriched at the plaintiff s expense.
Bradshaw v Gilbert s (Australasian) Agency (Vic) Pty Ltd (1952) FACTS In January 1949 Gilbert s Agency (R) agreed to sell Bradshaw (A) 127 tons of battery scrap lead, together with export licence at the price of 98 per ton. At this time battery scrap was a declared commodity within the Prices Regulation Act 1948 (Vic). The Act provided that battery scrap couldn t be sold in Victoria for more than 22 per ton. Within days of contracting, A realised the overseas market was deteriorating. A cancelled the contract stating it breached s 25 (1) of the Act and was illegal. R sold the lead to another purchaser and sued A for the difference, claiming breach of contract.
Bradshaw v Gilbert s (Australasian) Agency (Vic) HELD The trial judge, Barry J, found that the Act did not cover goods set for export. Because the contract was valid, he gave judgment for R (i.e. A had breached) A appealed to the High Court. Appeal allowed. Dixon CJ and Taylor J held that the Act did apply to the sale of goods intended for export so the question then was did the Act operate to void contracts made in breach of its provisions? The prohibition imposed by s 25 is in express terms and the purpose of the prohibition is quite clear a sale or contract of sale made in breach of s 25 must be regarded as void and as being incapable as giving rise to an action for damages in the present form. It is beyond doubt that that the terms of the section preclude a party to an agreement for the sale of declared goods at a price in excess of the maximum price from seeking in a court of law to enforce hid contract.
Statutory illegality illegal as performed There is another category of contracts which, whilst not directly prohibited by statute, are tainted by illegality because one or both parties breaks a statutory provision. Traditionally the courts would refuse to enforce such a contract and this led to some unfair outcomes e.g. if goods had changed hands but no money paid. In Australia the High Court has ameliorated this approach over time. Two examples are Yango Pastoral Co. Pty Ltd v. First Chicago Australia Ltd in 1978 and Nelson v Nelson in 1995.
Yango Pastoral Co. Pty Ltd v. First Chicago Australia Ltd (1978) FACTS First Chicago lent Yango $132,600 secured by a mortgage and guarantees by the appellants. The appellants defaulted and the respondents sued. The appellants pleaded illegality based upon section 8 of the Banking Act 1959 (Cth) that stated a body corporate shall not carry on any banking business in Australia unless the body corporate is in possession of an authority under the next succeeding section to carry on banking business. Penalty $10,000 each day during which the contravention continues.
Yango Pastoral v. First Chicago Australia Ltd HELD The court found in favour of First Chicago on the basis that section 8 did not prohibit the lending of money secured by mortgage and guarantee. It prohibited only those contracts central to 'banking business'. A contract to lend money was only one of many types of contracts found in the business of banking. The court considered the protection of the public and stated (at 413-415) that if this contract was found to be illegal, that depositors could lose their money, causing great inconvenience to the public. In this respect, the legislation had been passed to protect the public - it did that by forbidding unlicensed banking. The interests of depositors would be jeopardised if the statute prohibited contracts of loan and deposit. The court also remarked on the fact that the statute provided a daily penalty on conducting business not on each contract, therefore, it was not transactions that were prohibited, rather, the physical act of carrying on an unauthorised business.
Nelson v Nelson (1995) 184 CLR 538 FACTS A mother purchased a property with her own funds and the property was transferred to her son and daughter. The purpose of the arrangement was to enable the mother to purchase another property with the benefit of a subsidy under the Defence Service Homes Act 1918 (Cth). She would not be entitled to such subsidy if she owned another property. She then purchased another property and received the subsidy, after making a false declaration that she did not own or have any financial interest in another property. The first property was subsequently sold and the mother and son sought a declaration that the proceeds of sale were held in trust for the mother, while the daughter sought a declaration that she had a beneficial interest in the sale proceeds.
Nelson v Nelson (1995) 184 CLR 538 HELD - The majority in the High Court rejected the 'all or nothing approach' exemplified in previous cases. Instead of considering that the illegality made the trust void, the Court considered whether the policy or importance of the public interest to be protected was of an overriding nature before which considerations of hardship must yield. McHugh J. stated that the courts should not refuse to grant legal or equitable rights merely because they were associated with or arose out of an unlawful purpose, unless the statute explicitly provided that such rights should be unenforceable or the imposition of the statute was not disproportionate in the circumstances. The policy contravened was not of such overriding nature and the mother's claim was therefore allowed on the condition she repaid the subsidy she had received.
Modern approach to statutory illegality As can be seen from the decision in Nelson v Nelson, the courts are likely to take a less hard line approach to statutory illegality in the future. Instead the determination will likely be influenced by the following considerations: 1. Whether the statute shows an intention that rights will not be enforceable (e.g. is there a specific penalty in the statute for a breach?); 2. Whether the sanction of refusing rights is proportional to the seriousness of the unlawful conduct; 3. Whether the refusal of rights is required to achieve the policy or object of the statute.
Incidental illegality If the behaviour is only incidental to the way in which the contract is performed and not an integral part of the intended performance, illegality will not make the contract unenforceable - St John Shipping Corp v. Joseph Rank Ltd [1957)
St John Shipping Corp v. Joseph Rank Ltd [1957) FACTS The plaintiff's ship was chartered by the defendants to carry grain from the USA to England. It was overloaded and its load line was submerged, which was a breach of British shipping laws. The defendants were sued by the plaintiff for non-payment and raised the defence of illegality because of the overloading. HELD The court found in favour of the plaintiff ship owners on the basis that the contract was not illegal. The overloading was not intentional, it was merely incidental to the manner in which the contract had been performed. Lord Devlin stated (at 291) that: there is a distinction between a contract which has as its object the doing of the very act forbidden by the statute, and a contract whose performance involves an illegality only incidentally.
Common Law Illegality Common law illegality and contracts which are contrary to public policy encompasses a broader range of conduct, including contracts: 1. To commit crimes, torts or fraud 2. That are prejudicial to the administration of justice; 3. That promote corruption in public life; 4. To defraud the revenue; 5. Contracts imposing servitude; 6. Promoting sexual immorality; and 7. Contracts in restraint of trade.
Contracts Involving the Commission of a Crime, Tort or Breach of Statute A contract which requires, or contemplates the possibility of, the commission of a crime, tort or breach of statute may be declared void or unenforceable on the basis that it is contrary to public policy. Note the overlap with statutory illegality here. However, the rule against enforcement is not inflexible. Ultimately, whether the contract is declared unenforceable will depend upon the seriousness of the wrong in question and the consequences of declaring the contract unenforceable. Courts will weigh the various considerations of public policy for and against enforcing the contract, including the aims of any relevant legislation - Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd.
Contracts Which Promote Corruption in Public Life A contract which involves a conflict between the public duty and the private interests of the contractor is contrary to public policy - Wilkinson v Osborne (1915). In this case a contract between two members of parliament and a land agent to lobby to have a land development approved was held to be illegal. Do you think that Eddy Obeid could rely on the courts to enforce some of the agreements that his company s have made with corrupt politicians? Does ICAC replace the common law?
Contracts imposing servitude A contract which restrains a person s liberty to the extent that he or she is reduced to a state of servitude is against public policy - Horwood v Millar s Timber and Trading Company Limited [1917]. In this case a worker on a relatively low salary borrowed money and agreed to have his salary paid directly to the money lender. He also agreed not to change jobs, move house or incur any other debts without the approval of the money lender. The court held that the conditions went far beyond what was required to secure the loan and made the borrower practically a slave. It was unenforceable.
Contracts to Defraud the Revenue A person who executes a contractual document with the intention of using it to defraud the revenue authorities (i.e. the Tax Office) cannot rely on that document to enforce contractual rights conferred by it. In Alexander v Rayson [1936] a landlord asked a tenant to sign two documents, one for rent and the other for a service fee. Unbeknown to the tenant the reason was to reduce the amount of council rates that would apply to the premises. The tenant refused to pay the full amount as the services provided by the landlord were inadequate. The court held that the landlord could not recover the short payment as the contract was illegal.
Contracts Promoting Sexual Immorality In JM Allen (Mechandising) v Cloke Lord Denning said: If a landlord lets a flat to a prostitute at a rent beyond any commercial rent it may be fairly inferred that it was their common design that it should be used for an immoral purpose. The letting is unlawful and he cannot recover the rent Although these have traditionally been considered contrary to public policy, it may be that contracts promoting sexual immorality are now outside the purview of illegality if no criminal element is involved. This ground of illegality is especially tenuous as the perceptions of sexual immorality are subject to the evolving notions of community standards which directly alters the force and content of public policy.
Contracts on restraint of trade Arguably this is the most common form of common law contractual illegality that you will come across as practising lawyers. At common law, all covenants in restraint of trade are prima facie void and unenforceable. They may, however, be held to be valid if in all the circumstances the covenant is reasonable both in the interests of the parties and the public. In determining this question of reasonability, the Courts have found it useful to distinguish between certain generally recurrent types of covenants in restraint of trade. Contracts where restraints of trade are common include: 1. Contracts of employment - Linder v Murdock s Garage 2. Contracts for the sale of a business - Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co Ltd.
Restraint of trade - employment It is illegal to impose a constraint on an employee that means they cannot work in their chosen profession or trade. However, it may be legal to impose restraints on them using the skills and other knowledge (e.g. customer details) acquired during their employment. In Linder v Murdock s Garage, the restraining covenant was invalid as it exceeded what was reasonably necessary for the protection of the company s business.
Linder v Murdock s Garage (1959) 83 CLR 628 FACTS Lindner was employed as a mechanic by motor engineers, Murdock's Garage. His contract of employment stated that it applied to the sales territory for motor vehicles of the Garage, which covered Crystal Brook and Wirrabara. These two towns were more than 10 miles apart. Lindner worked in the repairs workshop in Crystal Brook for some years. When he left this employment, Murdock's Garage sought to restrain him by injunction from working with a competing business in Crystal Brook. Murdock's Garage relied on a clause in the contract to the effect that Lindner would not within one year of termination of his employment work in the same sort of business within the same area.
Linder v Murdock s Garage HELD The majority of the High Court held that this clause was unenforceable. It went beyond what was reasonable for the protection of Murdock's Garage's business. The Garage needed protection because Linder had personal knowledge of and influence over customers which he had been in contact with during the course of his employment. However, for a geographical limit to be reasonable, it must be formulated with reference to the employer's customers of whom the employee is likely to acquire special knowledge. A person employed in one area was unlikely to come into contact with customers in the other area. Accordingly, the restraint should have been limited to the area in which the employee in fact worked within a reasonable time before termination of employment.
Restraint of trade sale of a business As we have seen, the Courts will balance the public policy perspectives of ensuring freedom of trade by imposing a test of reasonableness against the equal bargaining power of parties to a contract. However, the courts interpret the test of reasonableness more liberally when it comes to the protection of goodwill involved in the sale of a business and impose a stricter test when the purpose of the restraint of trade is to prevent someone from earning a living. Why do you think the courts take a more lenient view when considering the sale of a business? An good example of this occurred in the Nordenfelt case.
Nordenfelt v. Maxim Nordenfelt Guns Ltd [1894] FACTS Mr Thorsten Nordenfelt was a 46-year-old man who sold his munitions manufacturing business and agreed to a 25-year restraint of trade over an unlimited distance which stated: The said Thorsten Nordenfelt shall not, during the term of twenty-five years... engage except on behalf of the company either directly or indirectly in the trade or business of a manufacturer of guns, gun mountings or carriages, gunpowder explosives or ammunition, or in any business competing or liable to compete in any way with that for the time being carried on by the company Later he entered into an agreement with other manufacturers of guns and ammunition. The respondent company brought an action to enforce the restraint covenant in the contract of sale.
Nordenfelt v. Maxim Nordenfelt Guns Ltd [1894] HELD The House of Lords upheld the wide restraint of trade clause because of the nature of the customers Nordenfelt's company dealt with, namely, foreign governments. That is, the company's goodwill could not have been secured by the purchasers without having a wide restraint of trade clause in the contract. The court created an important test that asked: 'Whether the restraint confers greater protection than can be justified?' If it does, then it is enforceable unless contrary to the public interest. As to the public interest, the court found that even if the restraint had been wider than that required to protect the goodwill of the company, it was hardly contrary to the public policy of England for an individual to be restrained from doing munitions business in foreign countries.
3. The contract is merely associated with an illegal statutory purpose and the refusal of retrieval would be disproportionate to the seriousness of the offence - Fitzgerald v F J Leonhardt Pty Ltd. Non-Retrieval Where a particular class of contract is prohibited by statute or is illegal at common law, the general rule is that neither party may recover money or property transferred under it. This is a fairly drastic rule as the plaintiff is trying to reverse the illegal contract rather than enforce it. However, a number of important exceptions to the general rule apply in the following situations: 1. The plaintiff is not in pari delicto (equally guilty) - Callaghan v O Sullivan; 2. The plaintiff repents before the illegal purpose is achieved - George v Greater Adelaide Land Development Co Ltd; and
Fitzgerald v FJ Leonhardt Pty Ltd (1997) 189 CLR 215 FACTS Fitzgerald, a contractor, drilled 5 water bores believing that the owner had obtained the necessary licences under the Water Act. The Act said a person shall not unless authorized under the Act permit a bore to be drilled (fine $5000) The owner had only obtained 2 licences. In an action by the driller to get paid, the owner as defendant argued an illegal contract by legislation. Traditionally, if the court found the contract was illegal at formation due to noncompliance with the legislation (eg, as in Mahmoud v Ispahani) the court would rule the contract void and neither party, including the innocent driller, could enforce it. Hence the owner would make a windfall gain at the expense of the driller.
Fitzgerald v FJ Leonhardt Pty Ltd (1997) 189 CLR 215 HELD The court found that the contract formed or performed was not prohibited by the legislation. The second issue before the court was as a matter of public policy whether the court should decline to enforce the contract on the ground that it was associated with an illegal activity. The court held that the driller s actions were insufficiently associated with the owner s breach of the Act. The drilling contractor enforce the contract as denying a remedy would be disproportionate to the seriousness of the offence. In deciding whether the contractor could recover his expenditure McHugh and Gummow JJ advocated a more flexible approach. The court adopted the approach suggested by McHugh J in Nelson v Nelson.
George v Greater Adelaide Land Development Co Ltd (1929) HIGH COURT OF AUSTRALIA - Illegality - Conditional contract FACTS The Greater Adelaide Land Development Co sold land to George 'subject to the provisions of the Town Planning and Development Act 1920'. The Act required people desiring to sell land to obtain approval for a plan, and expressly made it unlawful to subdivide, offer for sale or sell land except in accordance with the Act. When George was sued for the balance of the purchase money, he claimed that the contract was invalid because no approval had been obtained before it was made.
George v Greater Adelaide Land Development HELD The contract contravened the Act and was therefore illegal and invalid even though it was expressed to be conditional. George could not recover moneys paid by him, since the parties could not be regarded as not in pari delicto. Do you think he was properly advised by his lawyers?
Seminar 13 Part B Remedies
Remedies Cause of action Breach of warranty Minor breach of intermediate term Major breach of intermediate term Breach of condition Undue influence Duress Misrepresentation Mistake Unconscionable conduct Illegality Remedy Damages or specific performance Damages or specific performance Termination and damages or specific performance Termination and damages or specific performance Voidable Voidable (i.e. rescission) and tortious damages Voidable (i.e. rescission) and tortious damages Void or voidable Voidable and tortious damages Void
Common Law remedy of Damages An award for damages is the only common law remedy for breach of contract and is available as a matter of right. Damages for breach of contract are viewed as a 'substitute' for performance - consequently, they are designed to put the plaintiff in the position they would have been in had the contract been performed properly. Punitive damages are not available. The loss claimed must not be too remote from the breach and the non-breaching party must do what is reasonable to reduce (mitigate) the damage they suffer. Often subject to limiting clauses in contract. Damages are available for mental distress in some circumstances: see Baltic Shipping NB: damages might also be available for certain pre-contractual conduct (misleading conduct, duress etc - in other areas, such as tort or pursuant to statute)
Equitable remedies (discretionary) Specific performance This is an order directing the breaching party to perform the contract in the way specified by the court. It will only be ordered if damages will not provide adequate compensation and will not be awarded in relation to contracts of personal service. Estoppel Stops a party enforcing their strict legal rights. Requires representation, reliance and detriment. Rescission Rescission ends all obligations and rights under the contract past and future by placing the parties in the position as if there had been no contract (restitution). This is often referred to as rescission ab initio. Injunctions These are orders directing a party not to do something - eg, not to persist with a contractual breach.