What Is an Illegal Contract?
Contracts that are illegal are prohibited under law. Certain elements render an otherwise valid agreement void. Contracts that are illegal might address refined behavior or actions that are barred by common law, equity, state statute or public policy.
Contracts that are illegal will not rise to the level of contract and will be deemed void. Such contracts are often loosely termed "void contracts". Contracts are illegal if the performance of the contract would constitute a crime, a statutory violation or the violation of a federal administrative regulation, or if the contract is opposed to public policy. Given the above elements, contracts that are illegal are void ab initio, meaning that they were never once a legally enforceable agreement.
Many contracts that are illegal operate under the concept that if an act is prohibited under law and both parties are aware of such prohibition than the agreement reached between the two parties engaged in that act is illegal. The outcome of illegal contracts, which are void by law, is that the act is not permitted to be enforced by either party. The agreement cannot be forced by one party over the other. More significantly, with respect to illegal contracts, neither party can collect damages for breach of such contract .
Examples of illegal contracts include:
Contracts to commit a crime (such as blackmail, to obtain illicit drugs, to sell contraband);
Contracts to perform any act contrary to public policy (such as prostitution);
Contracts that restrain someone’s marriage or that infringe on their right to marry;
Contracts that violate a statute or regulation (such as contracts that require a party to pay excessive interest or contracts that require a party to use deceptive means).
Contracts that restrain alienation or transfer of property.
Contracts that are illegal have many different types of practical purposes. Dealers of real estate sometimes pair with no-warranty deeds as a form of "escape clause" in a deed (such as "I don’t know anything about the title, so you are having a deed free of warranty of ownership"). Illegal contracts have very limited elements of recovery. If the all the parties to a contract are engaged in forcing the contract for illegal purposes but one party does not have any knowledge of the illegal element, the contract only is enforceable at the option of the party that is without knowledge of the illegal activity. If the party that had no knowledge of the illegal activity sues for recovery, he or she will be able to reclaim the value of his or her services. However, if the party who was without knowledge goes to some forum to seek voiding of the contract but obtains consideration for his or her services, then the right to rescind that contract is lost when the party seeks the remedy.
What Happens If You Enter Into An Illegal Contract
A contract that is illegal is generally unenforceable from the start. As a general rule, a court will not recognize an illegal contract and provide any outlet for relief. Parties may not take advantage of the fact that they engaged in unlawful behavior—KNIGHT v. N. E. FIRE INS. Co. of Hartford, 49 Conn. 88 (1881). When a contract is void, parties cannot enforce it against each other; if suit is brought on the contract, the suit will be dismissed. Courts do not allow parties to profit from their illegal acts and they allow a party to recover payment when the other has not performed because the price paid for the contract is deemed consideration for the illegal undertaking. Burch v. Hollis, 45 Iowa 296 (1877).
Enforcement of an illegal contract may be viewed as an offense against the public. Therefore, the court may hear a case involving an illegal contract to determine the nature and extent of any penalties to be imposed against a party to the contract. The injured party is permitted to assert a claim for damages in tort. The injured party is governed by the rules of common law negligence and can recover the economic loss suffered and also obtain punitive damages, if willful misconduct is shown on the part of an insured. Wexler v. Harmon, 146 Conn. 275, 150 A. 13 (1942). In addition, a party that has a financial interest in an illegal contract may receive restitution for such an interest (Newell v. Becker, 264 N.W. 165 (Iowa 1936)) or recover damages for breach of a contract that is incidental to the illegal conduct. Naalakkersuisut v. Norsk Hydro Froer A.S.A., 120 Conn. App. 826, 992 A.2d 1180 (2010).
Examples of Common Illegal Contracts
For example, contracts where one party commits fraud (such as falsifying information about a product in the sale of goods or services) are illegal. Contracts that involve selling or attempting to sell a service or good without the necessary licensing are illegal. For example, persons or businesses that operate as real estate agents, financial advisers, and healthcare professionals are required to have specific licenses, and sales performed without those licenses are illegal.
A contract between a consumer and a home repairman where the home repairman agrees to use substandard materials or overcharge for the services is illegal. Contracts that skirt or violate specific consumer protection laws at the state or federal level are illegal. Therefore, if the state prevents charging an interest rate above a certain level, any agreement to do so is certainly illegal.
Contracts that involve ouster or game-fixing by a sports gambler or an agent of the gambler may also be illegal. Contracts creating a monopoly that exclude fair and free competition in any industry or any form of competition are illegal. For example, if an owner of a restaurant asks the other owner of a restaurant to raise their prices in unison, so as to avoid certain price competition, this is a contract formed for an illegal purpose.
Contracts with lenders that cater to low-income customers and target the financially illiterate are illegal and deceptive. Contracts that place consumers and businesses at a competitive disadvantage are illegal under a variety of statutes.
Are Void or Illegal Contracts the Same Thing?
A common question I hear is whether a void contract is the same as an illegal contract, or whether there is a distinction between a void contract and an illegal contract. There are sound legal distinctions between void and illegal contracts.
For example, while both a void contract and an illegal contract are not enforceable by either party, however there are legal distinctions between a void contract and an illegal contract that sometimes surprise people. Further complicating matters, contracts can be declared void ab initio, meaning "it does not exist from the outset" – even if it was not illegal when formed.
The doctrine of illegal bargains has existed for over 300 years, deriving from contract law. For a contract to be unenforceable because it is illegal, the core essence of the contract must be illegal.
Understandably, many people get confused when trying to distinguish between void and illegal contracts. The following sections will clarify the nuances in the legal definitions of a void contract and an illegal contract.
Legal Definitions of an Illegal Contract
An illegal contract is an agreement whose objectives are against the public policy , statutes, or regulations. For example, a person cannot legally offer a person money as a bribe to provide another person certain confidential information. Even if two people agree to provide each other with valuable consideration in exchange for a bribe (even if it is not "considered" money), the contract is illegal.
In contrast, a void contract is one that is automatically void due to the contract terms.
Legal Definitions of a Void Contract
At its most basic legal definition, a void contract is an invalid or nonexistent agreement. The contract is void or voidable at the time the contract is created and does not have any legal effect on the involved parties. For example, a bribe offered in exchange for another person’s decision to give out company secrets will be void if the person giving out the secrets is a government employee of a federal branch of government.
Generally, contracts are void if they: Void at the Time of Formation: A void ab initio contract means "a nullity from the beginning." Courts cite the doctrine of illegality to void every contract that violates statutes or regulations.
How to Prevent an Illegal Contract
To avoid entering into an illegal contract, a contracting party must exercise due diligence. This involves thoroughly reviewing the contract and consulting with legal experts to ensure that all contract terms comply with current laws. Contracting parties should also be careful in reviewing the other party’s business practices to ensure they are not entering into an agreement for an illegal purpose.
What to Do if Your Contract is Illegal
Whether you are a business or an individual, having any kind of business relationship with a company or individual involved in illegal acts can be problematic going forward, on multiple levels. While the following steps are not comprehensive, they provide a general outline of the action you should take—and potentially correct your current legal course—if you find yourself in the unfortunate position of being involved in an illegal agreement.
Step 1: Seek Legal Advice as Soon as Possible
When it is suspected you are involved in an illegal contract or agreement in any fashion, it is important that you seek legal advice from a knowledgeable and experienced contract dispute lawyer. Each situation will be different, but there are often a variety of options to help remedy the situation through proactive legal representation. By seeking counsel, you can get a clearer picture of your legal standing and how best to protect yourself and your rights.
Step 2: Identify All Parties and Scope of the Agreement
The next step when dealing with an illegal contract is to make sure that all parties are identified in the contract, including who has authority to speak on behalf of the company or individual named in the agreement . Once that’s done, a complete scope of the agreement’s intention and nature needs to be understood—and confirmed. The breadth of what your involvement with the illegal contract was could have massive legal ramifications down the road.
Step 3: Evaluate and Verify the Proposed Resolution
Once legal counsel is sought, they will help you determine how to proceed. If the agreement is removable, you may be able to do so. However, if the contract is fundamentally illegal, it likely cannot be enforceable at all and should be completely voided without action.
If the illegal contract involves fraud, or was entered into under duress or coercion, you may have documents that should be submitted to the court as evidence for your defense. Until your attorney reviews all the documents and your case in detail, do not attempt to present anything to the court.
Step 4: Don’t Hide Anything – Be Forthcoming
Finally, if you are involved in a situation where an illegal contract is in play, be able to speak clearly about what involvement you have had with it—and how you’re going to resolve it. Ongoing criminal activity that you were a part of must be addressed, regardless of how unethical and illegal it might have been. Dealing with one issue is better than a continued investigation into your actions.