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Breach of an illegal contract: enforcable or not?

Will the civil courts enforce an illegal transaction?

An interesting case came before the UK Supreme Court this year whereby the court was effectively asked to consider whether it had the power to apply the remedy of restitution for a breach of contract when the subject matter of the contract was illegal.

One may have assumed that if two parties agreed to do something illegally, they would have no recourse to the Courts of Justice when one party decided to renege on the deal. However, in this case the Supreme Court decided the person who had breached the contract had been unjustly enriched and should therefore make restitution to the other party.

The facts of the case

Patel v Mizra [2016] UKSC 42, had first come before the UK Courts in 2013. Mr Patel and Mr Mirza had entered into a contract whereby Mr Patel had paid £620,000 to Mr Mizra to buy shares in the Royal Bank of Scotland. He had agreed to do this on the basis that Mr Mizra, who was a foreign exchange broker, had insider knowledge whereby Mr Mizra knew when the Chancellor of Exchequer would make a statement about the Government’s investment in the bank which would affect the bank’s share prices. Insider dealing is a criminal offence and therefore the contract was clearly founded on a criminal act.

As it transpired, the statement was never issued and it appears that the money was either kept or paid to the wrong person. Mr Patel sued for the return of his money.

At first instance, the Court rejected Mr Patel’s claim, but in 2014 he appealed and was successful. Mr Mizra then appealed to the Supreme Court. The Supreme Court upheld the Court of Appeal’s decision and determined Mr Mizra had been unjustly enriched and should provide restitution for that enrichment in the sum of the money paid to him. The court made it clear that a claimant who had satisfied the ordinary requirement of a claim for unjust enrichment should not be debarred from enforcing his claim simply because he was seeking to recover money paid pursuant to a contract to carry out an illegal activity.

Has Patel opened the flood gates?

In the writer’s opinion, this case does not mean we will see an influx of criminals trying to enforce contracts. Delivering the lead judgment, Lord Toulson started by confirming the following:

“No court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act” (as stated by Lord Mansfield in Holman v Johnson (1775) 1 Cowp 341, 343.

However, it was further stated that whilst illegality has the potential to provide a defence to civil claims of all sorts, case law has already established that this is not a definitive defence. For example in Holman, the plaintiff was entitled to recover the sale of the goods because although he knew the defendant had planned to smuggle the goods into England, he was not himself involved in the smuggling.

Whilst acknowledging there were strong public policy grounds for the common law doctrine of illegality as a defence to a civil claim – “A person should not be allowed to profit from his own wrongdoing, and the law should be coherent, not self-defeating and should not condone illegality”, the Supreme Court decided courts should apply a discretion so as to avoid complexity, uncertainty, arbitrariness and a lack of transparency.

It was therefore established that on-going the general rule was that a person who satisfied the ordinary requirements of a claim in unjust enrichment should be entitled to the return of his money or property and such a person should not prima facie be debarred from recovering money paid for property transferred by reason of the fact that the consideration which had failed in whole or in part was an unlawful consideration. It was helpfully clarified that since an order for restitution of the money paid by the plaintiff to the defendant would merely return the parties to their previous position before the conclusion of the illegal contract and prevent the defendant gaining by unjust enrichment, such an order should be made.

To assist courts further, the Supreme Court decided to set principles for judges to consider when deciding whether to provide restitution for a breach of a contract which had an illegal element to it. A court will therefore, inter alia, consider whether denying the claim would be a proportionate response to the illegality, and in assessing this the court would consider factors such as:

  • the seriousness of the conduct;
  • its centrality to the contract;
  • whether it was intentional; and
  • whether there was disparity in the parties’ respective culpability.

The Supreme Court made it clear that punishment for wrong doing was the responsibility of the criminal court and not the civil court. Whilst there may be circumstances where it would undermine the integrity of the justice system to allow a person who contracted on an illegal basis to rely on the normal principles of unjust enrichment, such cases would be rare.

Commentary

Fundamentally readers should not view this case as anything other than confirming that civil courts will not enforce an illegal transaction or a benefit derived from an illegal transaction. It distinguishes from when an illegal contract is not completed and therefore the illegal act does not occur. Restitution is a remedy which places the two contracting parties back into the position they were before entering into the contract. As such, the court is not enforcing an illegal transaction, rather it is undoing the potential contract. However, parties need to be aware that even though a civil court may find a solution for them, this does not mean they will avoid possible criminal consequences for entering into such a contract!

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