A contract to do something that is prohibited by statutory law is void from the outset

An illegal contract can affect any type of agreement or transaction.

Not all illegality associated with contracts is equal.

Serious illegality typically renders a contract void or unenforceable. Legal remedies may well be out of reach of one or more the contracting parties.

But then just because there is illegality involved with contract does not necessarily mean that a court will deprive a party or all parties of any legal remedy.

Types of Illegality in Contract Law

Broadly speaking, courts will not enforce a contract which is:

• expressly or impliedly forbidden by statute 
• entered into with the intention of committing an illegal act
• entered with no unlawful intention, but then is performed with an unlawful purpose or object.

What is an Illegal Contract?

An illegal contract prevents claims based on a contract when a party seeks to enforce an agreement which the law prohibits. The illegality operates primarily as a defence to legal claims.

Courts will not assist a claimant to recover a benefit from their own wrongdoing.

Whether illegally taints a contract case is decided by applying series of factors against the turn of events which gave rise to the dispute, and apply to assess the seriousness illegality.

Is a Breach of Contract Illegal?

Although a breach of contract could be said to be illegal, it’s not illegal in the relevant legal sense.

Unlawful or Illegal?

Breach of contract gives rise to a civil claim: a right to damages and a series of other remedies in appropriate cases. The unlawful conduct – unlawful because it is contrary to the terms of the contract - gives rise to the breach of contract. That breach in turn gives rise to the right of the innocent party to be compensated with damages for the breach (and other remedies, depending on the nature and seriousness of the breach).

When illegality exists, the situation is different.

One or more of the parties to the contract is deprived of legal remedies if it would mean that they would benefit or profit from the illegality.

The part of the contract – one or more clauses, or the entire contract - may be found to be void or unenforceable altogether.

A breach of contract does not deprive a party to a remedy for the breach.

Serious illegality by the party claiming breach will.

How Illegality Arises

Illegality in contracts arises in a number of ways.

Illegal Contracting

The types of illegality can overlap with one another.

What renders a contract illegal includes:

• illegality at formation:
  An intention to make a contract with:

• • knowledge of its illegality at the time it was made.
  • an intention to perform in an illegal way from the outset.

Even when a contract is capable of lawful performance, if the agreed purpose is to do something unlawful, ignorance of the illegality does not excuse it from the illegality.

• Illegal purpose or object

The purpose or object of the contract is to achieve some unlawful end.
The illegal purpose may be known to one or both of the parties. 

The illegality does not need to appear in the wording of the contract.

• illegality during performance A perfectly valid contract which doesn’t require an illegal act and wasn’t made for an unlawful purpose becomes illegal when it is performed in an illegal way. The illegality can arise by the conduct of one or both of the parties, and whether they knew about the illegality or not. So there’s no reason why a perfectly valid contract can’t become illegal due to an illegal purpose developing between the parties mid-stream, after the contract was made.

  Even then, when there is some illegality involved doesn’t always mean all parties are deprived of all remedies.

It depends on a range of factors, such as the seriousness of the illegality and how the illegality relates to the main purpose of the contract.

Illegality Defences

Whether a defence of illegality is available depends on a whole series of factors.

One factor - amongst many - is whether the illegality can be removed from the contract altogether.

Illegality in one clause in a contract may be enough to taint an entire contract, if it cannot be severed from the contract to remove the illegality. The process of evaluating whether part of a contract can be removed to save the contract from illegality is known as severance. 

It depends in large part on:

• the type of illegality claimed which is being defended
• whether the illegality is ex turpi causa
• whether the defendant knew and/or participated in the illegality

The main factor is whether public policy supports making the defence available.

Illegal Contracts Act

While some countries may have an Illegal Contracts Act, that's not the case in the UK.

The law of illegality in respect of business contracts are governed by the common law. The common law takes account all statutes when assessing illegality.

So in illegality cases:

• there may be a term of the contract, an act or series of acts which are illegal
• under a statute and/or under the common law
• even if a statutory authority such as the Competition and Markets Authority or Competition Appeals Tribunal is empowered to decide a case and impose a fine, it takes a court to finally and conclusively decide whether a contract is illegal

Types of Illegality in Contracts

The sort of illegality (see above) which makes a contract illegal can arise through:

• statutory illegality: Contracts illegal by statute include primary legislation and those that offend delegated legislation, by doing something outlawed by the statute
• common law / public policy: It’s in the interests of society as a whole that certain types of contracts aren’t enforced. They include for example, contracts which involve:
  • criminal conduct: such as to conceal a crime, criminal conspiracies, misbehaviour in public office and receiving compensation for a crime over and above the loss or injury suffered as a result of it
  • moral turpitude: That’s serious immorality.
    For example, contracts to commit a fraud are illegal, such as:
    • fraud over shareholders of a company or a business
    • bribery in all of its forms
    • intention to commit a tort
    • use of land or other property for an unlawful purpose
  • restraints of trade, which are restrictive covenants which go too far.
    For example attempts to:

• • • restrict on free movement of employees, workforces and sellers of businesses
    • prevent or obstruct competition in industries, including offences which attract a fine or penalty

• • penalty clauses, which seek to impose an obligation to pay a level of damages in excess any commercial justification
  • interference with the administration of justice: including restraints and interference with evidence witnesses may give to a court

Contracts that contravene:

1. a statute is illegal for a simple reason: the legislature said that the type of contract is not permitted
2. public policy are illegal because the public interest overrides private contractual rights.

That is described in 3 main cases.

Illegal Contract Cases

The law relating to illegality follows from pre-eminent decision of Lord Mansfield  in Holman v Johnson (1775) which encapsulates the maxim (in italics):

The principle of public policy is this; ex dolo malo non oritur actio. No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act.
If, from the plaintiff's own standing or otherwise, the cause of action appears to arise ex turpi causa, or the transgression of a positive law of this country, there the court says he has no right to be assisted.
It is upon that ground the court goes; not for the sake of the defendant, but because they will not lend their aid to such a [claimant]. So if the [claimant] and defendant were to change sides, and the defendant was to bring his action against the [claimant], the latter would then have the advantage of it; for where both were equally in fault, potior est conditio defendentis [where both parties are in the wrong and the claimant can only succeed upon reliance of an illegal act, the position of the defendant is better]

The reference to ex turpi causa  by Lord Mansfield describes the standard of illegality which must be met for a claim for public policy illegality to be sustained.

Another frequently cited case is Weld-Blundell v Stephens (1920) where Lord Wrenbury said:

It has, I think, long been settled law that if an act is manifestly unlawful, or the doer of it knows it to be unlawful, as constituting either a civil wrong or a criminal offence, he cannot maintain an action for contribution or for an indemnity against the liability which results to him therefrom.

And not any old illegal activity will do to render an agreement illegal.

In Saunders v Edwards (1987) Lord Justice Bingham said:

[…] it is unacceptable that the Court should, on the first indication of unlawfulness affecting any aspect of a transaction, draw up its skirts and refuse all assistance to the plaintiff, no matter how serious his loss or how disproportionate his loss to the unlawfulness of his conduct.

Consequences of Illegal Contracts

Whether the illegality is sufficient to trigger legal consequences of illegality depends on the facts of the case: ie what happened and the law that made the contract illegal.

The seriousness of the illegality plays a part, along with the knowledge of the parties when the contract was made.

There are at least 3 possible outcomes from illegal agreements.

The overall effect of illegality is that courts will not lend assistance to a party to litigation by granting a remedy to a party to allow a benefit from illegal conduct. The outcome is usually that the contract is illegal and:

• void: At law, the contract never existed.
• unenforceable: The court will not – depending on how the illegality arose - assist one or more of the parties obtain legal relief under the contract; or
• a form of restitution is ordered: In many cases, transactions can be unravelled where property is transferred back to its original owner, before the contract was made. It’s not necessarily (depending on the facts of the case) the same as a contract being void ab initio at law.

Void Agreements

When a contract is void, it is deemed to have never existed, just like in cases where rescission is ordered.

The parties are put in the position they would have been if they had never entered into the illegal agreement. From a legal perspective that’s the position which they should always have been in due to the illegality.

Illegal contracts are declared void to restore the position the parties to the position they should have been in the first place: they never should have entered into the contract in the first place. To do otherwise undermines the Rule of Law and the civil justice system.

Unenforceable Contracts

Unenforceable contracts on the other hand are agreements where the contract is seen (at law) to have existed, but no remedy will be granted. The contract  remains in force.

It's just that courts will not make any order to enforce what would otherwise be enforceable legal rights.

Difference between Void and Unenforceable Contracts

The difference between a void agreement and an unenforceable contract can be significant.

For example, ownership of property might have passed under the contract.

With a void agreement, the transfer of ownership of property is reversed (such as with rescission).

If a court finds that an agreement is unenforceable and no remedy is to be granted, then the property transferred under the agreement lies where it falls. There is no reversal of ownership rights.

Transfers of property are not reversed. It remains owned by the party that that received it under the contract because the party cannot obtain a remedy.  That could be money, land, moveable property (aka chattels) and/or incorporeal rights, such as intellectual property rights.

Types of Illegality

Back to the types of illegality:

• common law illegality at common law, because the contract offends public policy recognised by courts; and
• statutory illegality, because the type of contract or clause(s) within the contract have been outlawed by either legislation or delegated legislation.

Public Policy Illegality

Contracts which are illegal for public policy reasons – aka common law illegality - can become tainted by illegality in an infinite number of ways.

It’s the harm that would be done to the public interest which is assessed by reference to the facts of the particular case.

It used to be that court used a rule-based approach to assess illegality arising from public policy, and the consequences which should follow from it.

Now, it’s a factors-based approach.

The series of factors are taken into account to assess:

• the seriousness of the illegality, and
• the consequences of the illegality: the orders that a court is likely to make to address the illegality.

Illegal Contracts: Public Interest

In Patel v Mirza (2016) the Supreme Court said that the factors to assess illegality and the consequences of it are:

1. the purpose of the law offended:
   For the illegality to arise in the first place, some law must have been broken.

The underlying purpose of that law - the prohibited conduct – is assessed to identify precisely what it was that was illegal.

The prohibition implemented by statute (say the Competition Act) or recognised at common law (say the common law of bribery) may have come about to:

• • deter fraudulent conduct, and prevent insulation of a fraudster from their own reprehensible conduct
  • protect society as a whole against conduct which would serve to degrade the betters interests of the public, such as:
    • excessive restrictive covenants
    • penalty clauses and
    • rules against forfeiture of property (which are a form of penalty clause).

1. public policy considerations:
   Competing objectives of public policy are balanced against one another. “Public policy” not a single policy.

   It is comprised by a number of different interests of the public, such as:

• • enforcing legally binding contracts
  • disallowing profit from unlawful conduct
  • deterring unlawful behaviour
  • maintaining consistency with the criminal law: if the criminal law imposes a penalty, the civil law should not provide the means to evade or reduce criminal consequences
  • maintaining the integrity of the legal system, such as:
    • prevention of fraudulent legal claims or those based on forged or manufactured documents
    • outlawing contracts to withhold evidence from a court
    • prohibiting contract which would lead to perjury

The assessment of competing public policies is required because an overly simplistic or narrow-minded approach may render important public policy objectives ineffective or less effective by denial of the claim or success of the claim.

1. proportionality:
   The response to illegal conduct from civil courts should be proportionate to the illegality.

The more serious or deliberate the illegality, the more hardened the approach a court is likely to be to deny remedies.
The criminal courts are there to punish criminal conduct on behalf of society: fine and penalties are imposed on behalf of society.

On the other hand, civil courts enforce private rights. Civil court cases result in financial compensation and other remedies to recognise those rights: the private interests of members of the society are recognised. It’s required for society to function. All illegal conduct is serious. Some crimes are more serious than others. Those involving fraud - wilful deception - are at the top of the list.

If a legal claim or defence is to be denied, it should be a proportionate response to the unlawful activity, taking account of factors such as: