11.4: Effect of Illegality and Exceptions

LEARNING OBJECTIVES

1. Recognize that courts will not enforce illegal bargains.
2. Know that there are exceptions to that rule.

Effect of Illegality

The general rule is straightforward: courts will not enforce illegal bargains. The policy is one of nonintervention—the law adopts a hands-off approach, leaving the parties as it finds them. If an agreement is illegal, it is void, and neither party may obtain relief, even if this results in one party receiving a windfall.

This principle is rooted in the maxim ex turpi causa non oritur actio (“no cause of action arises from a base cause”). In other words, the judiciary refuses to lend its authority to agreements that contradict the law or public policy.

Example – Licensing Statutes (California Law):
In Pacific Custom Pools, Inc. v. Turner Construction (2000), a contractor required by statute to hold a license built a waterslide. When the plaintiff discovered the contractor was unlicensed, they refused to pay the remaining $80,000. The court denied recovery to the contractor, emphasizing that California’s Business & Professions Code §7031 bars unlicensed contractors from suing for compensation, even if the work was perfectly completed.

Example – Unlicensed Professionals (Illinois Law):
In Ransburg v. Haase (1992), a man fraudulently represented himself as a licensed architect in Illinois, where licensing is required to protect public safety. He was paid $80,000 for designing a $900,000 house, but the project was late, over budget, and violated zoning laws. The court held that because he lacked the required license, he could not keep his fee.

These examples show how harsh the rule can be: a party may perform significant work but walk away with nothing if the bargain violates statutory requirements.

Exceptions

While the general rule is harsh, courts recognize that rigid application can lead to unjust results. Over time, exceptions have developed where fairness and public policy warrant relief.

1. Party Withdrawing before Performance

If a party repents and withdraws from an illegal contract before it is carried out, they may recover any consideration already paid. The rationale is to encourage abandonment of unlawful arrangements.

• Example – Wager: Samantha and Carlene agree to bet on a soccer game and deposit money with a stakeholder. Before the game concludes, Carlene withdraws. She can recover her money.
• Example – Bribery Attempt: Ralph pays Jacob $5,000 to bribe a juror. Before the bribe is attempted, Ralph changes his mind. He may reclaim his money.

This principle aligns with Restatement (Second) of Contracts §182, which allows restitution when a party withdraws before the illegal purpose is achieved.

2. Party Protected by Statute

When a statute makes an agreement illegal in order to protect a certain class of persons, that class may still recover despite the illegality.

• Example – Employment Law: A federal statute limits airline pilots’ hours. If a pilot works overtime despite the prohibition, she may still recover wages owed.
• Example – Securities Law: Contracts for the sale of unregistered securities are illegal under federal securities law, but buyers are given an explicit right of rescission (return of their money).
• Example – Fee Limits: In one case, an attorney charged a client more than permitted by statute in helping obtain a government pension. The excess was recoverable by the client, even though the contract exceeded statutory limits.

Here, the illegality is meant to shield vulnerable parties, not punish them.

3. Party Not Equally at Fault (Doctrine of In Pari Delicto)

Where the parties are not equally blameworthy, the less guilty party may recover.

• Example – Duress or Fraud: If one party induces another to sign an illegal agreement by fraud, undue influence, or duress, the victim may rescind and recover any consideration already paid.
• Illustration: A company tricks a small vendor into signing a contract requiring them to engage in unlawful price-fixing. The vendor may later recover payments or avoid obligations because they were not equally at fault.

4. Excusable Ignorance

A person who unknowingly enters into an illegal contract, without reason to know of the illegality, may recover.

• Example – Bigamy: A woman marries a man not knowing he is already married. Because bigamy is illegal, the marriage is void. However, she may sue for damages, as she was ignorant of the illegality.
• Example – Innocent Laborer: A worker hired to move sealed crates later discovers they contained marijuana. Since he did not know and had no reason to know the contents, he may still recover payment for his labor.

This exception reflects Restatement (Second) of Contracts §180, which allows recovery where one party is excusably ignorant.

5. Partial Illegality

If only part of a contract is illegal, courts may sever the unlawful provision and enforce the remainder, provided the legal parts can stand independently.

• Example – Employment Contract: A six-page employment agreement includes an overly broad noncompete clause. The court may strike out the invalid noncompete but enforce the remainder of the contract (salary, duties, etc.).
• Example – Loan Agreement: If a loan contract has an illegal usury clause, the court may void the usurious interest term but enforce repayment of the principal with lawful interest.

This doctrine is recognized in Restatement (Second) of Contracts §184.

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KEY TAKEAWAY

The default rule is that illegal contracts are void, and courts will not aid either party. However, strict application may sometimes produce unjust results. Exceptions exist when a party withdraws before performance, when the law was designed to protect one side, when the parties are not equally at fault, when one is excusably ignorant, or when only part of the contract is illegal. These exceptions strike a balance between deterring unlawful agreements and preventing disproportionate forfeitures.

EXERCISES

1. When, in general, will a court allow a party relief from an illegal contract (or bargain)?
2. A and B engage in a game of high-stakes poker under circumstances making the game illegal in the jurisdiction. A owes B $5,000 when A loses. When A does not pay, B sues. Does B get the money? What if A had paid B the $5,000 and then sued to get it back?