Illegality Lecture

The last of the vitiating factors of contracts we will cover is illegality. This chapter will first explore the two different types of illegality; statutory illegality and common law illegality. The consequence of either of these types of illegality can be varied, therefore the final section will examine the consequences for a contract that is found to be illegal.

Statutory prohibition of contracts

A contract may be prohibited by a statute either expressly or impliedly. Whether either party may enforce the contract is dependent on the wording and purpose of the statute.

Express Prohibitions

Where the statute expressly says that a contract or term is void or unenforceable, the court must give effect to that provision. Check whether it applies to the whole contract, to a particular term or only to enforcement by one party.

The case of Re Mahmoud and Ispahani [1921] 2 KB 716 involved the example of a statute prohibited unlicenced dealing in linseed oil. The purchaser of the oil claimed he had a licence to purchase the oil, but in fact did not. When the sellers delivered the oil, the purchaser refused delivery, explaining he did not actually have a licence. Despite the fact the seller of the oil was completely innocent, the contract could not be enforced due to the statutory provision.

Implied prohibitions

An implied prohibition is more difficult to identify. The question is whether Parliament intended a breach of the statute to prevent enforcement of the contract (Okedina v Chikale [2019] EWCA Civ 1393).

In order to determine whether an implied prohibition is operable, the court must ascertain whether the objective of the legislation is to forbid the contract. One relevant consideration is:

1. Is the object of the penalty simply to raise revenue?

A requirement for a trader to have a licence may serve a revenue purpose without prohibiting the contracts made by an unlicensed trader.

Case in focus: Smith v Mawhood (1845) 14 M & W 452

In this case, Smith, a tobacconist, sold an amount of tobacco to Mawhood. It was subsequently found that Smith did not have the required licence to sell the tobacco, and therefore statute required he paid a penalty for £200. Smith then attempted to recover the price of the tobacco he had delivered to Mawhood.

It was held that the contract was not illegal, and he could claim the price of the tobacco back. This was because the statute’s primary purpose was revenue. Parke B stated ‘Looking at the act of Parliament, I think its object was not to vitiate the contract itself, but only to impose a penalty upon the party offending, for the purpose of revenue’.

A licensing scheme may also protect the public. That purpose must be considered when deciding whether the legislature intended to prevent enforcement. An example of this would be individuals requiring a licence to trade with certain dangerous types of animal. The requirement of the licence may be to raise revenue, but it is also for the public benefit as the licence can ensure dangerous animals are not introduced into the country in the incorrect way.

2. Does the statute contemplate that the prohibited act will be done in the performance of a contract?

This is a confused concept best examined with an example. Take a fictitious act which has these provisions:

Section 1 - It is a criminal offence to…

1. Sell chickens
2. Keep chickens as pets

Option (a) prohibits the very sale that the parties wish to make. That is strong evidence that Parliament intended to prevent enforcement of the sale.

Option (b) prohibits keeping a pet. A sale does not necessarily involve keeping the chicken as a pet, so the prohibition does not by itself imply that every sale of a chicken is unenforceable.

Contracts which are not illegal, but have been performed in an illegal manner

A contract may well be legal, but the way in which one party has undertaken their obligations amounts to illegality.

Case in Focus: Archbolds (Freightage) Ltd v Spanglett Ltd [1961] 1 QB 374

In this case, a contract was formed for the shipping of a consignment of whisky to London. Unknown to the claimants, the shippers did not have the required licence to use the transportation vehicle. The consignment of whiskey was then stolen. In order to avoid liability, the shippers attempted to argue that the contract was illegal in the first place, and therefore damages could not be claimed.

The courts held that the contract itself was not illegal (to ship a consignment of whiskey), the method used was illegal (using that particular vehicle). Therefore, because the claimants were not aware of the illegal method of transport being used, they were able to enforce the contract.

The claimant’s participation in the illegal performance may matter even where the contract could have been performed lawfully. In Ashmore, Benson, Pease & Co Ltd v A V Dawson Ltd [1973] 1 WLR 828 one party carried goods which exceeded the statutory maximum weight for lorry transportation. The owners of the goods knowingly participated in the overloaded carriage and could not recover for damage to the goods on that journey. Mere knowledge is not a universal bar to enforcing the contract.

The protective purpose of the legislation can be decisive. The case of Anderson Ltd v Daniel [1924] 1 KB 138 provides a clear example of this. The seller supplied material for use as fertiliser without the statutory invoice stating its composition. The seller could not recover the price. Enforcing the sale would have defeated the protection the statute gave the buyer.

A different issue arose in ParkingEye Ltd v Somerfield Stores Ltd [2012] EWCA Civ 1338. This case concerned the installation of a monitoring system of a car park that would charge customers for overstaying. The defendants ended the 15-month contract early and the claimants who were making revenue from the charges claimed damages from the defendants for loss of revenue. The defendants claimed the contract was illegal due to the illegality of the letters the claimants sent to customers to induce them to pay.

The court held that when deciding whether the illegal performance would render the contract unenforceable they would consider these things:

1. The object and intent of the party attempting to enforce the contract;
2. The gravity of the illegality in the context of the claim; and
3. The nature of the illegality.

The third demand letter was deceptive, but the system could be operated with a corrected letter. Refusing ParkingEye damages for Somerfield’s early termination would have been disproportionate. The Supreme Court subsequently set out the general common law approach in Patel v Mirza [2016] UKSC 42, discussed below.

The effect of statutory penalties

A statute may impose a penalty for unlawful performance without preventing either party from enforcing a lawful contract. Whether it does so depends on what Parliament intended the penalty to achieve.

In St John Shipping Corporation v Joseph Rank [1957] 1 QB 267 the statutory breach in question was the overloading of a ship. The shipowner was fined. The cargo owners withheld part of the freight, but the statutory prohibition on overloading did not invalidate the contracts of carriage. The unpaid freight was recoverable.

Common law prohibition of contracts - Public Policy

Contracts may be prohibited via the common law, on grounds of public policy or morality. There is a lot of uncertainty in this area, and the when the court can prevent a contract from operating is often unclear. At common law, the court considers whether allowing the particular claim would damage the integrity of the legal system. Under Patel v Mirza, it considers the purpose of the prohibition and whether refusing the claim would advance it, other public policies affected by refusal, and whether refusal would be proportionate. The seriousness of the conduct, its connection to the claim, the parties’ intentions and their relative responsibility may all matter.

Contracts to commit crimes

The case of Bigos v Bousted [1951] 1 All ER 92 concerned an agreement to evade exchange controls. A court will not order a party to perform an unlawful act. Beresford v Royal Insurance Co Ltd [1938] AC 586 concerned an insurance claim after suicide at a time when suicide was a crime. Section 1 of the Suicide Act 1961 abolished that rule in England and Wales.

Examples of illegality arising in contract and in other civil claims include:

• Tax fraud contracts (Alexander v Rayson [1936] 1 KB 169)
• An offender claiming damages from a negligent third party for the consequences of the offender’s own manslaughter (Gray v Thames Trains Ltd [2009] UKHL 33). In Lewis-Ranwell v G4S Health Services (UK) Ltd [2026] UKSC 2 the claimant had been found not guilty of murder by reason of insanity. The Supreme Court held that his unlawful killings engaged the public interest and that the illegality defence barred his negligence claim for their consequences.

Contracts which prevent the administration of justice

Despite the law of contract mostly being self-regulatory, in the event of a dispute, the courts will intervene. Contracts which preclude parties to the contract accessing justice, or prevent the courts interfering with a contract, may be illegal on the ground that they prevent the administration of justice. Here are some of the main examples:

• Agreements between husband and wife where one agrees not to apply to the court for maintenance (Hyman v Hyman [1929] AC 601). Note that this does not invalidate the whole agreement, only the term that prevents the court application (Section 34 of the Matrimonial Causes Act 1973)
• An agreement to arbitrate can validly make an award a condition of bringing a court claim (Scott v Avery (1856) 5 HL Cas 811). Under section 9 of the Arbitration Act 1996, the court must, on a proper application, stay proceedings on a matter covered by the arbitration agreement unless the agreement is null and void, inoperative or incapable of being performed.

Agreements concerning sexual relationships

An early decision concerning prostitution was Pearce v Brooks (1866) LR 1 Ex 213, where a contract for the hire of a carriage used for prostitution was held to be illegal due to public policy.

A property agreement between adults who are in a sexual relationship must be distinguished from an agreement to perform sexual acts. Consent to sexual activity must be freely given at the time and can be withdrawn.

In Sutton v Mishcon de Reya [2003] EWHC 3166 (Ch) the court accepted that cohabiting adults could make a binding agreement about property. It did not uphold the particular deed as an enforceable agreement for sexual services. The claimant’s negligence claim against his solicitors failed.

Contracts which involve public corruption

Some contracts are invalid because they involve corruption. The most common examples of contracts which are corrupt are contracts for public office or honours.

In Parkinson v College of Ambulance Ltd [1925] 2 KB 1, the claimant made a donation to secure a knighthood. The court refused to enforce the bargain or return the money when the honour failed to materialise. In Patel v Mirza the Supreme Court questioned whether refusing repayment would serve the public interest.

Section 1 of the Honours (Prevention of Abuses) Act 1925 makes offering or accepting a reward for procuring an honour an offence.

Common law prohibition of contracts - restraint of trade

As we know, contract law is governed by the principle of contractual freedom, that parties can agree to any contracts and terms they wish. In some circumstances this freedom may be abused. An example of such abuse is where a term in a contract prevents somebody from working for somebody else, or trading with somebody else.  To ensure there is a continuing freedom of contract, terms that restrain trade may be unenforceable.

Lord Macnaghten famously summed up this principle by stating the public has ‘an interest in every person’s carrying on his trade freely’. This statement was made in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535. In this case, a contract prevented a seller from engaging in the business of ammunition and arms for a period of twenty-five years.

Where the restraint of trade doctrine applies, the party relying on the restraint must show that it protects a legitimate interest and goes no further than reasonably necessary to protect it. The restraint must also be consistent with the public interest.

Is the contract reasonable?

The case of Herbert Morris Ltd v Saxelby [1916] AC 688 is the leading authority for the assessment of reasonableness in this area of law. This case involved an employment contract that included a term that restricted the defendant from carrying on any related trade for seven years in the event he left the plaintiff’s employment. The defendant left the job and the plaintiff attempted to enforce this term. The courts held that this term was not enforceable. The House of Lords distinguished protecting an employer’s business interests from preventing an employee using their own skills after leaving.

1. An employer cannot restrain a former employee merely to prevent competition
2. A restraint may protect trade secrets or customer connections if it goes no further than reasonably necessary
3. Terms in a contract for the sale of a business preventing the seller setting up another business in competition with the purchaser’s business may be enforceable to protect the goodwill the purchaser bought

Once the interest to be protected has been identified, the duration and the geographical extent of the limitations made by the contract will be considered. These limitations should not be disproportionate. For example, a contract which prevents the seller of a business setting up a competing business in the same area would likely be valid, but a worldwide restriction would require a business whose interests justified that reach, as in Nordenfelt below. Some further case examples can be found below.

In Mason v Provident Clothing & Supply Co Ltd [1913] AC 724 one term in the defendant’s contract of employment stipulated that he must not enter into a similar business within 25 miles of London. The employment was in Islington, and therefore the restraint was too wide to be proportionate and reasonable.

The case of Home Counties Dairies Ltd v Skilton [1970] 1 WLR 526 a term in an agreement prevented a milkman from selling milk or dairy produce to any former customers he dealt with in the course of his employment. This restraint was reasonable, so long as ‘dairy produce’ was limited to the type of goods he dealt with in his employment.

Case in focus: Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535

This case is the leading authority for the assessment of restrictions in the sales of businesses. In this case, Nordenfelt, an arms manufacturer, sold his business to Maxim. The contract included a term preventing Nordenfelt from selling guns or ammunition anywhere in the world for twenty-five years, and to not compete with Maxim in anyway.

The court held that this clause was partially valid. The part preventing competition ‘in any way’ was not valid due to its complete restriction on trade. However, the rest of the clause was valid due to these reasons:

• A substantial fee had been paid which reflects the fact he could not compete for 25 years
• The amount of customers willing to buy arms and ammunition was limited, therefore the restriction not to sell ammunition anywhere in the world was valid because it was no wider than necessary to protect Maxim.
• The restriction was not damaging to the public interest

Reasonableness as to the public interest is a further important consideration for the courts. An agreement between competitors to fix prices or share markets may also be prohibited by section 2 of the Competition Act 1998. An agreement caught by that prohibition is void unless an exemption applies.

Exclusivity dealing contracts

Exclusivity dealing contracts, also known as ‘tie agreements’, are those between parties at different stages in a commercial chain which force a closer ties between the parties that a mere contract. The best way to understand and identify these agreements is by reference to the leading authority in this area.

In Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269 the parties involved were two garages and a seller of petrol. These are clearly parties involved in different stages of the commercial chain relating to petrol. The company agreed to buy only Esso petrol for one site for the roughly five years remaining on an existing tie. The other site was tied for twenty-one years under an agreement supported by a mortgage.

The courts held that only the contract providing for exclusivity for five years was valid. The shorter tie was reasonable. The Supreme Court later confirmed in Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36 that some restrictions which have become an accepted feature of ordinary trade fall outside the restraint of trade doctrine altogether. The twenty-one year term was seen to be extremely disproportionate due to the sheer amount of time it tied the parties together for.

Exclusive service agreements

An exclusive service agreement is similar to an exclusive dealing contract, but instead it relates to where a person provides services for only one recipient. Here are some common examples of these:

• A singer agreeing only to appear at certain festivals
• A footballer agreeing to only appear in adverts for one company
• A celebrity agreeing to only sell their stories to one news outlet

As you can see, these mostly relate to professional entertainers and sports stars. An exclusive services agreement may fall within the restraint of trade doctrine. Its scope and duration, and the interest it protects, determine whether the restriction is reasonable.

The case of Greig v Insole [1978] 1 WLR 302 involved organizers of international and county cricket attempting to exclude players who played in private games promoted by a certain company. The courts held this ban was not valid as it restricted the freedom of employment of players subject to the ban.

Another similar case is Eastham v Newcastle United Football Club Ltd [1964] Ch 413. The football authorities’ retain-and-transfer rules allowed a club to retain a player’s registration after his employment ended, preventing him signing for another club. The court held that the retention system, used with the transfer system, was an unreasonable restraint of trade.

The court will also take into consideration whether the individual subject to the contract has been treated fairly, has undertaken independent legal advice, and whether they have been taken advantage of.  Their age, the fairness of the contract, and the duration of the contract will be helpful in assessing this.

In Proactive Sports Management Ltd v Rooney [2011] EWCA Civ 1444 a contract that provided for exclusivity of image rights of a sportsman was considered to be invalid. This was in light of the fact Rooney had not undertaken any legal advice, was 17 years-old at the time, the contract was for eight years, and the agency was entitled to 20 per cent of the income from exploiting his image rights.

The effect of illegality

The case of Holman v Johnson (1775) 1 Cowp 341 illustrates why the nature of the claim matters. The seller could recover the price of tea sold abroad even though he knew the buyer meant to smuggle it into England. The seller did not take part in the smuggling. However, as we have seen, dependent on the circumstances, one or none of the parties may enforce the contract, and on occasion only part of the contract will be unenforceable. This section will consider the different effects of illegality, separating them into distinct categories that should be easy for you to remember.

Severable illegal contracts

As we touched on in Nordenfelt v Maxim, the courts may enforce the reasonable part of a restraint if the unreasonable part can be severed. The Supreme Court confirmed the three requirements in Tillman v Egon Zehnder Ltd [2019] UKSC 32:

1. The ‘blue pencil’ test - can the illegal provision be removed without modifying the words of the remaining terms. These remaining terms must be grammatically and verbally separated. It is referred to as the ‘blue pencil’ test as the best way to assess this is simply by crossing out the illegal terms. If it still makes sense without adding to or altering the remaining words, the first requirement is met.

Case in focus: Goldsoll v Goldman [1915] 1 Ch 292

This case involved a defendant who was competing with the plaintiff in the business of imitation jewellery. The defendant’s agreed to no longer compete with the plaintiff in a contract for two years in any capacity. The clause covered ‘London, England, Scotland, Ireland, Wales, or any part of the United Kingdom of Great Britain and Ireland and the Isle of Man or France, the United States of America, Russia, Spain, or within twenty-five miles of Potsdamerstrasse, Berlin, or St Stefans Kirche, Vienna’.

The court severed the excessive geographical restrictions and the words covering real jewellery. The surviving restraint protected the imitation jewellery business in the United Kingdom.

2. The remaining terms following the ‘blue pencil’ rule must be supported by consideration

This part of the test is fairly straightforward. You may need a re-cap on your knowledge of consideration, but here is a simple example of this test in operation:

‘You will be paid £250 per month to not compete with the company in any capacity in the United Kingdom and the United States of America’.

If the ‘and the United States of America’ was removed as part of the blue pencil rule, the £250 part would still be included in the contract, and therefore the contract would still include consideration for the remaining promise. However, if the contract was drafted in this manner:

1. You must not compete with the company in any capacity in the United Kingdom
2. You must not compete with the company in any capacity in the USA, and in consideration for not competing in the USA, you will be paid £250 per month.

Now if we attempt to use the blue pencil rule to remove the part of the clause relating to the US, it is evident that the term that includes the payment of £250 would have to be removed. This means only term ‘a’ would remain, and on these facts no consideration is given for that promise.

This is an extremely simple example, and in practice the contract is likely to be much more complex. However, just remember to ensure there remains some form of consideration following the removal of any illegal terms.

3. Removing the words must not make a major change in the overall effect of the restraints in the contract. The party seeking severance must establish this.

The final requirement is a question of fact, and can be difficult to assess. The case of Attwood v Lamont [1920] 3 KB 571 shows the older approach, which must now be read in light of Tillman.

Case in focus: Attwood v Lamont [1920] 3 KB 571

In this case, one party owned a tailoring business, whilst the other party was an employee. The contract of employment prevented the employee from working for any other tailor within ten miles of the store in the context of being a ‘tailor, dressmaker, draper, milliner, hatter, haberdasher, gentlemen’s, ladies’ or children’s outfitter’. The important fact in this case was that the employee was only a cutter in the tailoring department.

The Court of Appeal regarded the covenant as indivisible and declined to sever it. In Tillman the Supreme Court overruled Attwood on severance. It removed words which prohibited even a minor shareholding because doing so made no major change to the overall effect of the post-employment restraints.

Collateral contracts

Where there is one illegal contract, but there is a collateral contract that allows a recovery of all or part of the contract, this may be enforceable, but only if providing for a remedy under the collateral contract is not equal to enforcing the illegal contract.

Fisher v Bridges (1854) 3 El & Bl 642 is one such example of this. In this case, a collateral contract providing for security of an illegal contract was made. This collateral contract is ‘tainted’ by the illegality of the illegal contract, and can therefore not be enforced.

The question is what enforcing the separate promise would achieve. Calling it a collateral contract cannot by itself make an otherwise prohibited payment recoverable.

Claims based on an illegal contract

A separate claim is not automatically barred because an unlawful act forms part of its background. In Euro-Diam Ltd v Bathurst [1990] 1 QB 1, the claimant had issued a false invoice but was allowed to recover under its insurance policy for diamonds stolen in Germany. The modern common law test is that in Patel. In Stoffel & Co v Grondona [2020] UKSC 42, participation in mortgage fraud did not bar a negligence claim against solicitors who had failed to register the transfer of title.

Recovery under illegal contracts

The final assessment to make when considering an illegal contract is whether or not any money or property may be recovered subject to the contract.

Both parties are guilty

Even where both parties intended to break the law, repayment may be available. In Patel v Mirza, Patel paid £620,000 to bet on shares using expected inside information. The information never arrived and no bets were placed. Recovering the sum paid restored the parties to their earlier positions without enforcing the intended bets.

Article 1 of the First Protocol to the European Convention on Human Rights protects possessions. In the case of Al-Kishtaini v Shanshal [2001] EWCA Civ 264 the Court of Appeal rejected a challenge based on that right in the circumstances of a transaction prohibited by sanctions against Iraq.

One party unfairly induced into the illegal contract

If one party was induced to participate by fraud, duress or undue influence, the parties’ relative responsibility may favour recovery. In Hughes v Liverpool Victoria Legal Friendly Society [1916] 2 KB 482, the claimant recovered insurance premiums after the society’s agent fraudulently assured her that the policies were lawful.

One party withdraws from the contract

The older cases describe withdrawal before an illegal purpose was carried out as locus poenitentiae. In Tribe v Tribe [1996] Ch 107, a father recovered shares transferred to his son when the intended deception of creditors had never been put into effect.

Earlier decisions drew distinctions about how far the unlawful purpose had been carried out. Examples are Taylor v Bowers (1876) 1 QBD 291 and Kearley v Thomson (1890) 24 QBD 742. Withdrawal can still matter in assessing the purpose of the prohibition and proportionality. After Patel, an entitlement to restitution does not depend on fitting the claim within one of these older exceptions.

For example, Mr Patel did not have a change of heart. The planned transaction fell through, but that did not prevent him from recovering his money.

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