Beware of the Illegal Contract!

Is your contract void or unenforceable because it is illegal?

beware of illegal contracts

Illegal Contracts

When parties enter into contracts, they believe that they have a binding agreement and can enforce the contract no matter what. However, one defense that defendants often use to avoid liability is the defense of illegality or “void as against public policy.” Parties seeking to enforce contracts must be wary and careful in drafting and entering into agreements as the illegality defense has been broadly applied and the consequences can be very severe. When advising clients at the pleading stage, attorneys must carefully consider whether illegality will be an issue in litigation.

General Law
California Civil Code § 1608 codifies the doctrine of illegality and provides that “[i]f any part of a single consideration for one or more objects, or of several considerations for a single object, is unlawful, the entire contract is void.” Under Civil Code § 1667 , “unlawful” is broadly defined as that which is contrary to an express provision of law; contrary to the policy of express law, though not expressly prohibited; or, otherwise contrary to good morals. In determining illegality, the extent of enforceability and the remedy granted depends upon a variety of factors, including the policy of the transgressed law, the kind of illegality and the particular facts. ( Asdourian v. Araj (1985) 38 Cal.3d 276, 282).

Consequences of Illegal Contract
The consequences of an illegal contract can be harsh. Once a contract is deemed illegal and void, the court will refuse to enforce the contract and leave the parties as it finds them. ( Yoo v. Jho(2007) 147 Cal.App.4th 1249, 1251. Illegality of contract also precludes the enforcement of attorney fee provisions in contracts. ( Id. at 1256).

Court Can Bring Up Any Time
Illegality can be raised by any party or the Court even if it is not plead in the answer. As stated by the California Court of Appeals in Fellom v. Adams (1969) 274 Cal.App.2d 855, 863, “the court has both the power and duty to ascertain the true facts in order that it may not unwittingly lend its assistance to the consummation or encouragement of what public policy forbids. It is immaterial that the parties, whether by inadvertence or consent, even at the trial do not raise the issue. The court may do so of its own motion when the testimony produces evidence of illegality. It is not too late to raise the issue … even on appeal. [Citations omitted]

When Enforceable Even if Illegal
Because of the severe consequences and the overarching reach of the doctrine, California courts have, depending on the facts, carved out exceptions to the illegality doctrine. For example, so long as the party seeking its enforcement is less morally blameworthy than the party against whom the contract is being asserted, and there is no overriding public interest to be served by voiding the agreement, and the parties are not in pari delicto, the illegal contract may be enforced. ( McIntosh v. Mills, 121 Cal.App.4th 333, 347 (2004) . A contract may also be enforced if (1) the violation of law did not involve serious moral turpitude; (2) the adverse party would be unjustly enriched if enforcement were denied; and (3) the forfeiture would be disproportionately harsh in proportion to the extent of illegality. (See Lewis & Queen v. N.M. Ball Sons 48 Cal.2d 141, 153 (1957), Tri-Q v. Sta-Hi Corp. 63 C.2d 199, 219 (1965); Asdourian v. Ajar 38 C.3d 276, 292, 293 (1985)). Courts have also found that illegality is not a defense for parties who are not members of the group in which the particular law was designed to protect. ( Henry v. General Forming Ltd. (1948) 33 Cal.2d 223; R.M. Sherman Co. v. W.R. Thomason (1987) 191 C.A.3d 559).

Quantum Meruit
In certain circumstances, a party may recover under quantum meruit for the reasonable value of the goods or services performed even if a contract is later found to be illegal or void. “The law does not imply a promise to pay for services illegally rendered under a contract expressly prohibited by statute. But if the services rendered under a void contract by one party thereto were not intrinsically illegal and the other party fails voluntarily to perform on his part, the former may recover as upon a quantum meruit for what the latter actually received in value, though no recovery can be had upon the contract.” ( Trumbo v. Bank of Berkeley (1947) 77 Cal.App.2d 704, 710).

Whenever a breach of contract cause of action based on failure to pay for services provided is being asserted, the plaintiff should almost always plead a cause of action for quantum meruit in order to preserve his or her right to recover.

Case Discussions

Public Works
Illegality has been used in the public works arena to strike down contracts between school districts and contractors that have failed to meet competitive bidding requirements. (SeeReams v. Cooley (1915) 171 Cal. 150) There are also several exceptions to illegality as applied to competitive bidding requirements. One court has found that the competitive bidding statutes apply to the procedure upon which contracts are bid, and not to damage awards for breach of contract. ( Shea-Kaiser-Lockheed-Healy v. Dept. of Water & Power (1977) 73 Cal.App.3d 679). Second, under Public Contract Code § 5110 and Paul G. Marshall Jr. v. Pasadena Unified School District (2004) 119 Cal.App.4th 1241, a contractor may also recover based on a good faith belief that the contract was valid and if the failure to competitively bid was due to the public agency’s actions. If competitive proposals would be unavailing or would not produce an advantage, and the advertisement of competitive bid would thus be undesirable, impractical, or impossible, courts have enforced contracts between the public entity and the contractor ( Graydon v. Pasadena Redevelopment Agency 104 Cal.App.3d 631, 635-46 (1980) and Los Angeles Dredging Co. v. Long Beach 210 Cal. 348, 354 (1930)).

Family Law
The illegality defense has been also been applied in the family law arena with respect to post-marital agreements. For example in In re Marriage of Mehren & Dargan (2004) 118 Cal.App.4th 1167, the husband and wife entered into a post-marital agreement whereby the husband granted the wife all of his interest of the parties’ community property should he use illicit and illegal drugs. The Court of Appeal found that the agreement was illegal as the sole consideration by the husband was refraining or promising to refrain from committing a crime or tort, or from deceiving or wrongfully injuring the promisee or a third person. ( Id. at 1173).

When analyzing breach of contract matters (or for drafting contracts), always thoroughly analyze whether there is any issue regarding illegality. A party can have a slam dunk breach of contract case in which the existence of the contract, breach and damages are clearly established. However, if illegality is an issue, there is a possibility that the client will be left with nothing.

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