Illigality of Contract CIMA

TYPES OF VOID OR ILLEGAL CONTRACT

Illigality of Contract CIMA: Some types of contract cannot be enforced in a court of law because they are unlawful in themselves or disapproved as contrary to public policy. The following categories may be distinguished.

(a) Void by statute

1. Wagering contractsA
2. Restrictive trading agreements
3. Resale price maintenance agreements

(b) Void at common law on the grounds of public policy .

1. Restraints of trade contracts
2. Contracts prejudicial to marriage or parental obligations
3. Contracts to oust the jurisdiction of the courts in relation to private matters – such as an agreement not to prove in bankruptcy

(c)Illegal, void and prohibited by statute

1. Cartel agreements
2. Contracts made in breach of license requirements

(d)Illegal and void at common law as contrary to public morals or the interests of the state

1. Agreements to commit a crime or tort, such as assault or defrauding the Revenue
2. Contracts to promote sexual immorality
3. Contracts to promote corruption in public life_­
4. Contracts to oust the court’s jurisdiction in relation to a matter of concern to the public – such as a contract not to prosecute a person for a crime.

All such contracts are void and neither party can enforce them by legal action. In general, money paid or property transferred under a contract which merely void may be recovered. If the void part can be _separated from the other terms without rendering the agreement meaningless,then the remainder may be valid. But if the contract is also illegal the courts will not (subject to some exceptions) assist a Party to recover his money or property. The rules on the . consequences of illegal contracts are very involved and what follows is an outline only.

EFFECTS OF AN ILLEGAL CONTRACT

If the contract is obviously illegal in its inception or if the contract appears to be legal but both parties intend to accomplish an illegal purpose by it, neither has an enforceable right at law against the other.

Case: Pearce v Brooks 1866

The plaintiffs, who were coach builders, let a carriage described as `of a somewhat intriguing nature’ to a prostitute. They knew that she was a prostitute and the jury found (although they denied it) that they also knew that she intended to parade along the streets in the carriage as a means of soliciting clients and would pay for the carriage out of her immoral earnings. She failed to pay the agreed amount and they sued to recover it.

Held: although the letting of a carriage is not obviously unlawful, to do so to facilitate known immoral purposes is an illegal contract which will not be enforced.

2.If one party in performing a contract does an act prohibited by statute, the act only may be illegal or the whole contract may be illegal. It depends on whether or not the statute was_. ~ intended to prohibit the whole contract.

Case: Archbolds v Spangletu 1961

S contracted to carry whisky belonging to A in a van which was not licensed to carry goods which did not belong to him. In carrying the whisky S therefore committed a criminal offence. The whisky was stolen on the journey and A sued for damages. S pleaded the illegality as his defence.

Held: the defence failed because:

(a)the statute in question did not prohibit the contract expressly or by implication; and

(b)A did not know that S did not have the correct licence.

3Although money paid or property transferred under a contract which was illegal from its inception cannot generally be recovered, there are two exceptions.

(a)If one party is less at fault than the other then the less blameworthy (for example, a party who was less aware of the rules or under pressure from the other) may be permitted to recover.

Case: Hughes v Liverpool Victoria Legal Friendly Society 1916

A grocer insured the lives of customers who owed him money. This was legal since he had an insurable interest. The policies lapsed and an insurance agent persuaded the grocer’s wife to take them up, assuring her that this was lawful. It was illegal since she was not their creditor and had no insurable interest. On discovering that the policies were void she sued to recover premiums paid.

Held: she might recover her money since she had been persuaded by fraud to enter into an illegal contract.

(b)A party to an illegal contract who repents of it and withdraws without performing the illegal acts under it may be permitted to recover money or property.

4 A related transaction, even if legal in itself, is usually void and illegal because of its connection with an illegal contract. However, if the contract is illegal under statute in its formation, any legal ‘severable’ (separately identifiable) parts may be enforced if:

(a)           the illegal promise is not the main or only consideration given; and

(b)           the illegal promise is independent of the others; and

(c)            it is not illegal on grounds of public policy to enforce the rest.

.5 If the contract is legal at its inception and one party later performs his side of it for illegal purposes, the other innocent party may recover money paid or property transferred or payment for services rendered (while in ignorance of the illegality).

Case: Clay v Yates 1856

A printer agreed with an author to print copies of the author’s book. The printer was unaware that the book contained libelous material. He discovered the libel after he had printed part of the book and refused to do any more. He claimed the value (quantum meruit, explained in Chapter IS on remedies for breach of contract) of work done, but the author refused to pay for incomplete performance.

Held: the printer was justified in ceasing work on the book and might recover payment for work done.

6 A contract of insurance is distinguished from a wagering contract by the existence of an `insurable interest’. If there is no insurable interest the contract is illegal and void. In outline the rules on insurable interest are as follows:

(a)Properly. the person who insures must have legal ownership of the property insured or a legal interest in it. One can only insure someone else’s property if one has an interest in it. A bailee who has possession of another person’s property with liability for its safekeeping has an insurable le interest.

(b) Events: one may insure against an event, for example rain which spoils an open air happening such as a garden fete, if one has a financial interest in its success. For the same reason one may insure against the death of one’s debtor (Hughe;’ Case above).

(c)Lives-. one may only insure the life of oneself, one’s spouse or any other person, e.g. a debtor or employee, if the latter’s death will cause !loss to the insured.

CONTRACTS VOID AT COMMON LAW

1.As stated above, contracts in restraint of trade are by far the most important examples of this type of void agreement. However, the other two categories should not be forgotten.

2 Contracts prejudicial to the state of marriage include any agreement which restricts a person’s freedom w marry. Hence an agreement not to marry someone, or to marry only one person or one from a set of persons, is void. Similarly, a `brokage’ contract is void, whereby one person agrees for a money payment to procure a marriage.

3.It used to be the case that a promise from A to marry B (a woman) was enforceable in the courts. Although this is no longer the law, it is still public policy to protect freedom of marriage.

4Contracts to oust the court’s jurisdiction are those whereby the parties agree not to apply to the courts no matter what may happen. For example, a separated husband and wife may draw up a contract whereby one agrees to pay maintenance to the other. Any clause in it that the recipient should not seek to enforce the contract in court is void as it seeks to oust the court’s role.

5Note that it is perfectly allowable for parties to agree in a contract that disputes should be referred to arbitration rather than to the courts, because arbitration is an effective and independent alternative to the court. What is avoided by the common law is an attempt to agree that a path of recourse to the law which is there as of right should be closed off.

CONTRACT’S IN RESTRAINT OF TRADE

1.If a contract includes a restraint of trade clause, the restraint may be void and unenforceable but the rest of the contract is usually valid. As explained below the general policy of the law is against upholding any restrictions on a person’s freedom to work or carry on a trade. But there are some exceptions.

2Any restriction on a person’s normal freedom to carry on a trade business or profession in such _a way and with such persons as he chooses is a restraint of trade.A restraint of trade is treated as contrary to public policy and therefore void unless it can be justified under the principles explained below. IF a restraint is void the remainder of the contract by which the restraint is imposed is usually valid and binding – it is merely the restraint which is struck out as invalid.

3.The objection to a restraint of trade is that it denies to a community useful services which would otherwise be available. On the other hand, it is recognized that a restraint may be needed to protect legitimate interests.

A restraint of trade may therefore be justified and be enforceable if.

(a)the person who imposes it has a legitimate interest to protect;

(b) the restraint is reasonable between the parties as a protection of that interest; and

(c)it is also reasonable from the standpoint of the community: NordenJelt v Maxim

Norder:Jelt Guns and Ammunition Co 1894.

4.In principle any restraint of trade may be subject to scrutiny by reference 😮 the tests set out in the previous paragraph. But where the parties have agreed upon it in the normal course of business and on the basis of equal bargaining strength, it is accepted that the restraint is justifiable and valid without detailed examination. In practice the doctrine of restraint of trade is applicable only to the following:

(a)           restrictions on employees;

(b)           restrictions on vendors of businesses;

(c)            petrol solus agreements; and

(d)           one-sided agreements. Restrictions on employees

5An employer may (in consideration of the payment of wages) insist that the employee’s services shall be given only to him while the employment continues. But any restraint imposed on the employee’s freedom to take up other employment (or to carry on business on his own account)after leaving the employer’s service is void unless it can be justified. Such a restraint, if reasonable in its extent, may be valid if it is imposed to prevent the employee from making use of the trade secrets or trade connections (business goodwill) of the employer, since these are interests which the employer is entitled to protect.

6An employee who has access to trade secrets such as manufacturing processes or even financial and commercial information which is confidential, may be restricted to prevent his using it after leaving his present job.

Case: Forster & Sons v Suggett 1918

As works manager S had access to technical know-how of his employer’s business of making glass bottles. His contract of employment provided that for five years after leaving his employer’s service he would not carry on or be interested in the manufacture of glass bottles in the UK or other glass-making similar to that of his employer’s business.

Held: it must be shown (and in this case it had been) that the employee had access to secret manufacturing processes. The restraint was valid.

7.In contrast to trade secrets the employer has no right 😮 restrain an employee from exercising a personal skill acquired in the employer’s service.

Case: Morris v Saxelby 1916

On leaving school S entered the drawing office of M (a manufacturer of cranes and lifting gear) as an apprentice and rose to become head of a department. He had some limited knowledge of the employer’s technical secrets but essentially he became a skilled  draftsman in engineering design work. He undertook that for seven years after leaving his employment he would not engage in any similar business in the UK.

Held: this was a restraint on the use by S of technical skill and knowledge acquired in the service of M. He should not be prevented from earning his  living by the use of it and M had no right to be protected from the competition of a former employee using his own skills. The restriction was also unreasonably wide and was void.

8.If the employer imposes the restraint to protect his connection with his customers or clients he must show that the employee had something more than a routine contact with the .The restraint is only valid if the nature of the employees duties gives_. him an intimate knowledge of the affairs or requirements of customers such that, if he leaves to take up other work, they might follow him because of his knowledge (as distinct from his personal skill).

Case: Filch v Dewes 1921

D was successively an articled clerk and a managing clerk in the employment of F, a solicitor practising at Tamworth. D undertook never to practice as a solicitor (after leaving F) within seven miles of Tamworth.

Held: the restraint was valid since D’s knowledge of the affairs of Fs clients should not be used to the detriment of F. (In modern practice a restriction unlimited in time will probably be treated as excessive.)

Case: S W Strange v Mann 1965

A bookmaker employed M to conduct business, mainly by telephone, with his clients. M’s contract of service restricted his freedom to take similar employment.

Held. the contact between M and his employer’s clients was too remote to give him the required influence over them. The restraint was void.

9.If the employer can show that the restraint is imposed to protect his legitimate interest he must next show that it is reasonable between parties – no more than is necessary to protect his interest. Many restraints have been held void because they prohibited the employee from working in a wider area than the catchments area of the employer’s business (Mason Provident Clothing & Supply Co Ltd 1973), or restricted him for an excessively long time, more than was necessary to eliminate his influence etc.

But note that in Dewes Case above a lifelong restraint was held valid – it depends on the nature of the employer’s interest to be protected. The modern practice is generally to restrain an employee only for a short time (a year or two) within an area related to the employer’s business or to prohibit him only from soliciting or doing business with customers etc. known to him.

Case: Attwood v Lamont 1920

A employed L as cutter and head of the tailoring department in A’s business of a general outfitter (clothing shop) at Kidderminster. L’s contract of service imposed a lifelong prohibition against engaging (within ten miles of Kidderminster) in a specified list of activities which corresponded with the entire range of A’s business – the sale of clothing of any kind. A refused to take L into partnership and L set up on his own account at Worcester. This was outside the ten mile radius of Kidderminster but L came over to Kidderminster and took orders from customers of A who valued L’s personal skill as a tailor and cutter. A did not attempt to enforce the entire restriction but sued to restrain L from engaging in the trade of a tailor only within ten miles of Kidderminster.

Held: the restraint was void. It was excessive in extent since it prohibited L from engaging in many things besides tailoring and A’s customers had deserted A for L because of L’s personal skill, not because his duties in A’s service had given him any influence or special knowledge of .their requirements. As the restraint was too wide, it was void in its entirety.

10. If the restraint is too wide the entire restriction is usually void and not merely the excess which is unreasonable. The court will not rewrite an excessive restraint by limiting it to that ,     part which might be reasonable In some cases however, the court has concluded that the parties did not intend by the words used to adopt as wide a restraint as e the words might impose and have struck out tF3 words which are too wide. This is the ‘blue ‘ pencil’ rule of simple deletion.

Case: Home Counties Dairies v Skilton 1970

A milk rounds man’s contract of employment prohibited him, for one year after leaving his employment, from selling milk or dairy produce to customers of the employer to whom the rounds man had supplied his employer’s goods during the final six months of his employment. Held: the words ‘or dairy produce’ were excessive since they would prevent the employee from engaging in a different trade, such as a grocery shop. As the object of the restraint was to protect the employer’s connection with customers who purchased their milk, the restraint would be upheld in respect of milk supplied only.

Case: Little woods Organisation v Harris 1977

H was employed by L to prepare their half-yearly mail order catalogues, and had access to much confidential information about the mail order business. His contract prohibited him for one year after leaving L from working for any company of the GUS group, L’s principal UK competitor in the mail order business. But GUS carried on many other business activities in the UK and abroad. H left L and joined GUS in their mail order business. L sued to enforce the restraint on H. Held: as the purpose of the restraint was to protect L’s trade secrets in its mail order business, the restraint would be enforced as a prohibition against working for GUS in its UK mail order business only.

This was, however, a majority decision of the Court of Appeal. In his dissenting judgement, Browne LJ restated the previously accepted view that the blue pencil rule (as the phrase implies) can only be used to delete words which are excessive (see Skelton’s Case above) and not to rewrite the restraint by adding limitations to it or altering its sense. It may well be that the courts, although more sympathetic to the employer than they used to be (the blue pencil principle was not applied in 1920 in the Attwood v Lamont Case even though it could have been), will continue on the lines indicated by Browne LJ.

11. A restraint (in a contract of service) which is reasonable between the parties is not, by definition, prejudicial to the public interest.

12 Attempts by employers to enforce restraints by indirect means, such as the conditions of eligibility for pension benefits or mutual agreements between employers not to engage former employees of the other, have been dealt with under the same principles as restraints directly imposed by the contract of employment. Thus judgement may be given against an association of employers, even though they have no contract with the person concerned.

Case: Greig v Insole 1976

The Test and County Cricket Board sought to ban commercial World Series cricketers from test and county cricket by means of a change of their rules.

Held: the change of rules was ultra vires since it was an unreasonable restraint of trade. Restraints on vendors of businesses

13. A purchaser of the goodwill of a business obviously has a ^–right to protect what he has bought by imposing restrictions to prevent the vendor doing business with his old customers or clients. But the restraint must protect the business sold and it must not be excessive

Case: NordenJelt v Maxim NordenJelt Guns and Ammunition Co Ltd 1894

N had developed a new firing mechanism for guns and carried on, among other things, a business manufacturing these guns and their ammunition. When he sold the assets and goodwill of t business he entered into an agreement, later duplicated when the business merged with another, that he would not engage directly or indirectly in a wide number of gun-related activities any other competing business for 25 years except on its behalf.

Held: the covenant as it related to guns was valid but the term as to competition was void since it went much further than could reasonably be required to protect the business.

Case: British Reinforced Concrete Engineering Co v Schel ff 1911

S carried on a small local business of making one type of road reinforcement. He sold business to BC which carried on business throughout the UK in making a range of road reinforcements. S undertook not to compete with BC in the sale or manufacture of road reinforcements.

Held: the restraint was void since it was widely drawn to protect BC from any competition S. In buying the business of S, BC was only entitled to protect what they bought – a lo business making one type of product and not the entire range produced by BC in the U

Case: Allied Dunbar (Frank Weisinger) Ltd v Frank Weisinger 1987

The defendant had sold his business to A, for a sum which included £ 386,000 as consideration F, s financial consultant who had built up his successful business from scratch, not to employed in a similar capacity for 2 years.

Held: the restraint was valid, since it was agreed after equal negotiation, paid for a reasonable in itself.

14 For goodwill to be protected it must actually exist. The courts will not allow `protection goodwill’ to be a smokescreen for barefaced restraint of competition.

Case: Vancouver Malt & Sake Brewing Co Ltd v Vancouver Breweries Ltd 1934

The defendant was licensed to brew beer but in fact only produced sake. It sold its business a agreed to a term restraining it from brewing beer for 15 years. It later began to produce be and the purchaser sought to enforce the restraint.

Held: since the seller did not, at the time of sale, produce beer the purchaser only paid f tangible assets because there was no beer-brewing goodwill to sell. The purchaser had n provided consideration for the promise not to produce beer and so he could not enforce Petrol solus agreements

15 In most cases exclusive distributor or supply agreements are valid since the manufacturer a distributor bargain in a position of equal strength and do not create an oligopoly to 0 detriment of the public. But in the petrol trade the major suppliers are very large international oil companies and the distributors are small-scale petrol filling station Agreements by which the proprietors of petrol “filling stations agree (in consideration of a lump sum payment or other commercial advantage such as long-term finance i to purchase all the petrol etc. requirements from one supplier are valid only if the duration of the agreement not excessive. It is accepted that the supplier is entitled to acquire and enforce monopoly rights of supply. Such arrangements are reasonable between the parties. But the public interest requires that any such restriction should be accepted only for a reasonable period.

Case: Esso Petroleum Co v Harper’s Garage 1969

H had two petrol filling stations and had agreed to purchase all its petrol supplies for both stations from E. In consideration of this undertaking, E agreed to grant a rebate of ld per gallon on the normal price and to make a loan of £ 7,000 to H, secured by a mortgage over one of the filling stations. For one filling station the monopoly rights of E were to last for 4} years and for the other (by the terms of the mortgage) for 21 years. The mortgage could not be paid off in less than 21 years. H broke its undertaking and E sued to enforce it.

Held: in both cases a personal restraint of trade had been imposed on H. It was not merely a restriction on the we of land even though the longer restriction was imposed by a mortgage. Both must be examined under the principles of restraint of trade since arrangements of this kind, unlike some exclusive distributor agreements, were not to be regarded as reasonable by their nature alone. Solus agreements of this type were, however, reasonable if limited to a short period of years. The 4} year restriction was valid but the 21 year restriction on the second filling station was void. The case is Potable for the general review of the principles of restraint of trade in the judgements given in the House of Lords.

16.The owner of a petrol filling station may enter into a solus agreement by means of a mortgage (as in Harper’s Case) or by selling his property to the supplier and taking from him a lease which imposes supply restrictions. In those circumstances he is giving up his previous freedom to buy from any supplier. However, it a petrol company leases a site which it owns to a business tenant (or sells it subject to a mortgage for the unpaid purchase price), the new occupier is not surrendering rights which he previously had. But even in these situations any supply restrictions imposed by the lease or mortgage will be treated as restraint of trade (requiring justification) if commercial monopoly rather than land use appears to be the main consideration.

one-sided agreements

17. Other business agreements of a type which do not usually require justification may nonetheless do so if they are one-sided.

Case: Schroder Music Publishing Co v Macaulay 1974

An unknown song-writer made a five-year agreement with music publishers on their standard terms. The composer had to assign to the publishers (for a royalty) the copyright to any music which he had written before the contract started or which he might write during the five years, but they had no obligation to publish any of his compositions. The agreement was automatically extended from five to ten years if it yielded at least E5,000 in royalties.

The publishers could terminate the agreement at any time by giving one month’s notice; M had no such right. Held: this was restraint of trade which was void unless it could be justified. It was so one-sided – the publishers obtained a monopoly of the composer’s output without any commitment to him to publish his work – that it was unreasonable and void. This is an example of a. ‘void restraint of trade because it is not reasonable between the parties.

CONTRACTS VOID BY STATUTE

1. Since restraints of trade are seen as contrary to public policy, they are void for the most part under common law. However, such a restriction on a clause in restraint of trade is only then enforced if the courts become involved. In order to regulate commercial agreements more effectively, two important statutes exist – the Restrictive Trade Practices Act 1976 and the Resale Prices Act 1976.

Restrictive Trade Practices Act 1976

2 Common law rules against restraint o#’ trade are only effective if the party who is subject to the restraint fails to observe it and this compels the other to abandon it or seek to enforce it by legal action. But manufacturers and traders whQ enter into arrangements to eliminate competition are unlikely to challenge such restrictions in a court of law; it is in their interest-to observe the restriction on themselves so long as the other parties also conform.

To bring these arrangements before the courts, the Restrictive Tr2de Practices Act 1975 (which consolidated previous statutes) requires that arrangements designed to fix prices or to regulate supplies of goods must be registered with the Director General of Fair Trading who in due course brings them before the Restrictive Practices Court. Unless it is then shown that the arrangements are in the public interest they are declared void. There can be heavy fines for infringement of these rules.

3 If a registrable agreement is not registered it is void.

4.A third party who suffers loss by the operation of a void restrictive agreement, for example a customer who has paid higher prices for goods than would have been charged if the suppliers had been competing, may sue them for damages. The Director General may apply to the court for an injunction to restrain arrangements operated in contravention of these rules.

5The Director General has power under the Act to investigate and if necessary bring before the court restrictive agreements relating to services (as distinct from goods to which paragraphs 5.2-5.4 above refer).

6.The Competition Act 1980 extended the ambit of the 1976 Act to anti-competitive practices which do not result from express agreements or arrangements. These must also be registered. Resale Prices Act 1976

7.The Act (which again consolidates earlier legislation) declares void any term of a contract by which a manufacturer or supplier of goods imposes on the buyer a minimum resale price. But the Restrictive Practices Court has power to exempt particular classes of goods if it is considered in the public interest to do so. Books and certain medicines have been exempted on the basis that unrestricted competition between bookshops or chemists shops might produce an inferior service to the public. Applications for exemption by manufacturers of confectionery and of shoes among other things have been refused.

8it is unlawful for a supplier to withhold cr threaten to withhold supplies from buyers who sell at less than his recommended price or to refuse them normal credit or discounts. But there are certain exceptions (e.g.^–supplies may be withheld from buyers whose premises or after-sales service is unsatisfactory).

9.Where exemption is granted or the rules do not apply (eg there is no ban on fixing a maximum resale price) the supplier may enforce his price condition against any person who re-sells his goods even though there is no privity of contract between them. (Privity of contract is discussed in Chapter 6.)

10 Monopoly, semi-monopoly and mergers tending to create monopoly are regulated by a procedure of investigation and review under the Monopolies and Mergers Commission.

EEC competition law

11. Arrangements which restrain or prevent competition within the EEC are prohibited (subject to limited exceptions) by regulations made under Article 85 of the Treaty of Rome. These regulations are self-executing – they have the force of law without need of national legislation and they are enforced by heavy fines for infringement. Article 86 of the Treaty regulates the exploitation of monopoly in the common market.

Summary

The most important type of contract affected by the rules of illegality etc are those containing restraints of trade. This is because public policy requires that people should be free to exercise their rights freely and without impinging on other people.