Chapter 19: Illegality
Erin Montoia, Lyuben Simeonov
I. Overview of Illegal Contracts
A. Contracts to Commit Crimes, Torts, and Violations of Public Policy:
A contract can be illegal and therefore unenforceable if it is a
crime, tort, or a violation of public policy. A crime would involve
a contract that breaks any federal or state statutory law, making it
illegal and void from the onset. For example, one party cannot
enforce an agreement by which the other party is to commit
murder. A violation of public policy is an activity when the
consequences of the agreement would outweigh the interests that
favor its enforcement. For example, John can promise Joe $500
for his agreement not to marry his daughter, Laura, but if Joe
accepts, the resulting contract is void.
Chuck says to Vanessa: “I will give
you $50 if you will steal an
automobile for me.” If Vanessa
steals an automobile and turns it
over to Chuck, Vanessa may not
recover a judgment against Chuck
for $50.
B. The Effect of Illegality:
As a general rule, an illegal agreement is void or unenforceable. Courts do not aid in resolving
disputes over the breach of illegal contracts. This concept is called the “hands off” approach. If
the agreement has not been performed, neither party can sue the other to obtain performance or
damages. If the agreement has been performed, neither party can sue the other for damages or to
recover money that has been parted with through the performance of
the illegal agreement.
Exceptions:
Exception 1: Ann bought insurance from
IIE Insurance Company, whose issuance
of securities is forbidden by the law. Ann
may recover the money paid.
Exception 3: Max and Nate bet on the
outcome of a ball game and place their
bets in the hands of Julie, a stakeholder. If
Nate decides to withdraw before the
game has been played, he may recover his
money from Julie.
Chapter 19: Illegality
1. Exceptions to the “hands off” approach can sometimes result
when the agreement violates a law which was designed to protect a
certain party. In this case, the court may come to the aid of the party
that the law is assigned to help.
2. If the parties are not in pari delicto, or equally guilty, the
court may come to the aid of the less guilty party. This is likely when
one of the parties was forced into entering an agreement through
misrepresentation, fraud, or duress.
3. If an illegal contract is called off before any illegal act was
performed, the court allows parties to recover their consideration.
This encourages parties to not act on illegal contracts.
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C. Licensing Laws:
If the statute is regulatory, that is, the purpose of the legislation is to protect the public against
dishonest or incompetent practitioners, an agreement by an unlicensed person is generally held to
be unenforceable. In determining the illegality of this kind of agreements, the courts look to the
degree of the violation of public policy. A violation that causes greater harm to society will be
punished more severely. For example, a doctor who practices without being licensed will face
serious charges since licensing is required to protect the general public. People who perform
services without licenses cannot sue to collect for
the services and may also be guilty of a crime.
Contracts made by an unlicensed
If the licensing statute was intended primarily as a
revenue-raising measure, a means of collecting
money rather than a means of protecting the public,
an agreement to pay a person for performing an act
for which she is not licensed will generally be
enforced.
person operating in one of the fields or
businesses covered by such a law are
held valid, but the person may still be
subject to fine or imprisonment for
violating the law.
D. Blue Laws (Sunday Contracts):
Sunday contracts, or Blue Laws, are rare today, but used to be quite common. These laws
prohibit executing or entering into certain contracts on a Sunday. Many of these laws are still on
states’ books, but simply are not enforced.
The sale of alcohol is still prohibited or restricted to certain hours in about half the states.
These laws are still enforced and are the last remains of Blue Laws in the United States. Many
have been found unconstitutional on the grounds of that they violate the freedom of religion.
E. Gambling Contracts: A gambling contract is a transaction in which the parties stand
to win or to lose based on pure chance. What one gains, the other must lose. Wagers and bets are
generally held to be illegal.
In recent years, certain types of gambling contracts, such as state lotteries, bets on horse
and dog races, and riverboat casinos have been legalized in some states. These activities have
been legalized in many cases as a way to increase revenues in addition to normal taxes. If under
state law, a form of gambling contract is legal, the liable party can be legally forced to pay. This
situation is mainly found in Nevada.
Social organizations can hold legal bingo games. However, all other games of chance for
which the patron is required to give consideration in order to participate in such games for which
prizes of monetary value are awarded are prohibited. A contest held by a business is legal if there
is no purchase necessary to enter the contest.
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For example, Baker Company held a running contest which anybody can enter for free.
There was a prize of $10,000 for the winner. Whoever had better running skill would stand a
higher chance of winning. This contest was legal.
F. Contracts Contrary to Public Policy:
Many contracts are illegal and therefore unenforceable because they are contrary to public
policy. These contracts may harm the public welfare and are thus, illegal.
There are a few difficulties for a court to determine illegality based on the grounds of public
policy. First of all, an illegal agreement can violate a statute, but that statute may be of small
importance to the public welfare. Second, public policies change over time. Therefore, when
determining whether an agreement is illegal or not, the court often takes into account: the
importance of the public policy involved; the extent to which the agreement can be enforced; and
the seriousness of the wrongdoing connected with the agreement.
There is not a simple rule for determining when a particular agreement is contrary to public
policy. One court defined it as “Whatever tends to injustice, restraint of liberty, restraint of a
legal right, whatever tends to the obstruction of justice, a violation of a statute, or the obstruction
or perversion of the administration of the law as to executive, legislative, or other official action,
whenever embodied in and made the subject of a contract, the contract is against public policy
and therefore void and not susceptible to enforcement” (Brooks v. Cooper, 50N. J Eq. 761, 26A.
978).
a. Exculpatory Clause:
The exculpatory clause is particularly difficult to determine illegality based public policy
grounds. It is a provision in a contract that excuses a party from liability for his/her own
negligent conduct. Essentially, an exculpatory clause is a waiver of liability which may cause a
party to not use reasonable care in protecting others.
An exculpatory clause cannot protect a party from liability for any wrongdoing other than
negligence. Additionally, excusing intentional or reckless harm is never enforceable. Excusing
negligent harm is subject to close scrutiny. It must be conspicuously placed in contract and
clearly written.
The exculpatory clause may or may not be legal, depending on certain factors such as:

Business or Charity
Parties who owe a duty to the public (such as an airline) cannot use exculpatory clause to sign
away their tort liability because this would present an obvious threat to the public health and
safety.
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
Type of business
Courts hold that common carriers, innkeepers, and public warehousemen may not contract away
their responsibility to the public to exercise due care.

Harm done
Vanessa signed a lease to rent an apartment from James. James is released from any responsibility of
damages or injuries to Vanessa or the property. However James knew that there was a problem with
the staircase but did not fix it. Vanessa was injured when going on the stairs and broke her leg. James
is liable.

Bargaining power
Even if a clause is not against public policy, it still may not be enforced if courts find the clause:
Unconscionable -- Lacks meaningful choice and contains terms unreasonably advantageous to
one of the parties which is usually a product of one party’s superior bargaining power.
Contract of Adhesion -- Offered by a party who is in superior bargaining position on a “take-itor-leave-it” basic, leaving the other party with no opportunity to negotiate the terms of the
contract.
An example of Contract of Adhesion: A rich manufacturer deals with very small parts supplier
who has no choice and must accept all terms of the contract, no matter how restrictive or
burdensome; the supplier has so much of its business with the manufacturer. The supplier
can claim in court that that some parts of the contract are invalid due to adhesion.
II. Illegal Contract Remedies
A. Arbitration:
Arbitration is made when a dispute is submitted, under
agreement of both parties, to a neutral, non-judicial third
party who issues a binding decision resolving the dispute.
The third party is called an arbitrator, and the decision made
by an arbitrator is called an award. Usually, an award is
Chapter 19: Illegality
Arbitration agreements are legal,
unless:
- It does not bind one party
- Only gives the right to
chose the arbitrator to
one party
- Takes away rights to
legal remedies
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binding and arbitration is legal if it is unbiased. You cannot sue unless you are able to prove that
the arbitrator is biased.
The use of arbitration agreements have been on the rise with employment contracts. These
agreements make disputes quicker to resolve and less expensive. However, the issue of whether
these agreements are fair for employees comes into question. The decision is made by a single
person, where a jury would be more sympathetic to the employee’s case. The arbitration decision
is binding and cannot be appealed. Often times you cannot refuse to sign the agreement, but can
try to renegotiate the terms.
B. Choice of Forum:
Choice of forum is the parties’ agreement on a particular court or a particular jurisdiction that
will be used if there is any lawsuit between them arising from the contract. However, the parties
cannot pick a court or jurisdiction with an insubstantial relationship with the performance of the
contract.
C. Choice of Law:
A choice of law provision determines which states’ law will apply to legal controversies under
the contract. Courts usually go along with state that has a substantial relationship with the
performance of the contract. Otherwise, the case will get thrown out.
D. Unconscionable Contract:
A contract is unconscionable if it is grossly unfair or unduly harsh because it can be said to be in
violation to public policy. If a court finds that a contract or a specific provision in a contract is
unconscionable, it has two choices. The court can either refuse to enforce the entire contract, or it
can refuse to enforce the unconscionable portion of the contract while still enforcing the rest of
the contract. Although Courts use the unconscionable contract remedy only on rare occasions, it
is to ensure that the agreement was reached by voluntary consent by both parties and that a fair
agreement was reached. One of the more famous examples concerning unconscionable contracts
involved Puerto Rican immigrants who were coerced into buying encyclopedias at extremely
inflated prices when the sellers told them that buying these books was the only way that their
children would succeed in school in America. The contract was deemed unconscionable because
it was grossly unfair to the immigrants who hardly spoke English.
III. Contracts Dealing With Marriage
A. Marriage Contract:
Contracts that limit the freedom of marriage are void. The following provisions in contracts have
been held to make the contract illegal:
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



An agreement whereby a party promises never to marry.
An agreement to refrain from marrying for a definite period of time (however,
agreement not to marry during minority is valid).
An agreement not to marry certain named individuals.
An agreement that stipulates that the couple will get married and then subsequently
get divorced after a certain period of time
B. Prenuptial Agreements:
Prenuptial agreements are made prior to marriage by people who have the intention of getting
married. These agreements protect the net worth of one individual from the other, in the case of a
divorce. Prenuptial agreements are legal if:






There is disclosure (both parties are honest with each other about their financial
situations).
The agreement must be entered into voluntarily
The agreement cannot be unconscionable
The agreement must be in writing (Oral prenuptial agreements are not allowed)
The agreement must be executed by both parties in the presence of a notary public
Consideration must be given
Contracts to get married and then get divorced usually get thrown out by courts. The children
and spouse must be provided for in the prenuptial agreement. A lump sum, consideration, is
sometimes given to the spouse in order to secure an agreement.
A well known recent example of a divorce that ended without the protection of a prenuptial
agreement is Paul McCartney having to pay his ex-wife close to $35 million dollars because they
did not have a prenuptial agreement in place prior to the marriage (Mills v. McCartney). Other
celebrities who have gone through divorce recently without the protection of a prenuptial
agreement include athletes Michael Jordan and Greg Norman, who each had to pay their exspouses over $100 million dollars.
These cases highlight how important it is for a couple who wish to enter into a prenuptial
agreement to make sure they follow all the rules to ensure that it is valid. Otherwise, they may
end up like the above celebrities should the marriage fail.
C. Palimony:
In the past, the courts wouldn’t enforce agreements of unmarried couples living together in
regards to property division. However, today, palimony is agreement between people who are not
married but living together and is commonly enforced by the courts. Typically, the contract is in
writing, but some states allow oral palimony agreements. Palimony agreements describe the
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division and sharing of property between a non-married couple. Most courts will throw out the
palimony contract if it involves sex as consideration.
The term ‘palimony’ was invented during the 1976 California case Marvin v. Marvin. The case
involved a former actor Lee Marvin and his long-time live-in girlfriend. In this case, the courts
allowed a very limited recovery for her running the house (non-sexual) (Marvin v. Marvin
(1976) 18 C3d 660).
Before their marriage, Nate executed a prenuptial agreement with Blair, in which he conveyed all
the common stock of Merck Company by bill of sale and agreed to transfer the stock upon the
books of the company and Blair’s agreement to marry him. At the time, he was married to Serena.
After Nate’s death, Blair claimed title to the stock. The agreement to marry another when already
married is contrary to public policy, so it was void.
D. Restraints of Trade:
An agreement that restrains trade unreasonably violates public policy and therefore, it is illegal
and unenforceable.
Covenant Not to Compete:
The policy against restraints on competition is based on the economic judgment that the public
interest is best served by free competition. Agreements whose only goal is to restrict competition
are deemed illegal because they violate public policy, along with federal and state statutes.
Covenant not to compete often arises in contracts for the sales of a business, employment
contracts, partnership agreements, and small business buy-sell agreements. However, they are
enforceable if:




Their purpose is to protect property interest of promise.
The restraint is no more extensive than is reasonably necessary to protect that interest.
The restriction on competition must be reasonable in time, geographic area, and scope.
They do not impose an undue hardship.
It is especially common for people in upper and middle management of a corporation to sign a
covenant not to compete if the case of a terminated employment. A covenant not to compete is
stricter on employment than on sale of businesses.
a. Sale of Business:
In terms of sale of business, agreements resulting in the creation of a monopoly, the obtaining a
corner in the market, or the association of merchants to increase prices, are illegal.
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b. Noncompetition Clause in Employment Contracts:
A contract prohibiting an employee from competing with his employer for a reasonable period
following termination is enforceable if the restriction is
necessary to protect legitimate interests.
Other restrictions on an employee’s conduct can include:

Confidentiality/nondisclosure agreements
These agreements constrain the employee from using
certain information gained during his employment.

Eleanor hired Jenny to work as a designer in
her business. She wants to assure that she
does not disclose trade secrets, confidential
information, or lists of regular customers to
Jenny only to have Jenny quit and enter the
competing business.
Non-solicitation agreements
These agreements forbid an employee from soliciting the employer’s employees, clients, or
customers for use in his new employment.
Dan and Eric, who own competing businesses, enter an agreement whereby they
agrees not to solicit or sell to the other’s customers, such an agreement is
unenforceable.
Many courts refuse to enforce noncompetition clauses if they restrict employees from engaging
in a ‘common calling,’ an occupation that does not require extensive or highly sophisticated
training but involves simple, repetitive tasks.
Works Cited
1. Ashcroft, John D., and Janet E. Ashcroft. College Law for Business. 10th ed. South
Western CO.
2. Clarkson, Kenneth W. West's Business Law: Text, Cases, Legal, Ethical, Regulatory, and
International Environment. 6th ed. Minneapolis/St. Paul: West Pub., 1995.
3. Dawson, and Mounce. Business Law Text and Cases. 2nd ed.
4. Anderson, Fox, and Twomey. Business Law. 12th ed.
5. Marvin v. Marvin (1976) 18 C3d 660
6. Metzger, Michael B., Jane P. Mallor, A. J. Barnes, Thomas Bowers, and Michael J.
Phillips. Business Law and the Regulatory Environment. 7th ed. Boston: Irwin, 1989.
7. Mills v. McCartney (2008) Royal Courts of Justice. Strand, London, WC2A 2LL
8. LegalMatch. "Arbitration Agreements in Employment Contracts."
<http://www.legalmatch.com/law-library/article/arbitration-agreements-in-employmentcontracts.html>.
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