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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 in 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. 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.

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.

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. 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 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.
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.

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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 partys superior bargaining power. Contract of Adhesion -- Offered by a party who is in superior bargaining position on a take-itor-leave-it basis, 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
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 employees 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 the 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 wouldnt 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 Blairs agreement to marry him. At the time, he was married to Serena. After Nates 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 in 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, 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 employees conduct can include: Confidentiality/nondisclosure agreements
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.

These agreements constrain the employee from using certain information gained during his employment. Non-solicitation agreements

These agreements forbid an employee from soliciting the employers 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 others 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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