978-0077733711 Chapter 15 Lecture Note

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Chapter 15 – Illegality

CHAPTER 15

ILLEGALITY

I. OBJECTIVES:

This chapter is designed to teach students about the circumstances under which a contract cannot

be enforced because it violates public policy. After reading the chapter and attending class, a

student should be able to:

A. Explain the concept of illegality as it is used in contract law.

B. Determine when a contract that violates the language or policy of a statute is likely to be

illegal.

C. Analyze whether a given noncompete clause is likely to be enforceable.

D. Analyze whether a given exculpatory clause is likely to be enforceable.

E. Explain the concept of unconscionability and identify the circumstances that make a contract

unconscionable.

F. Determine the effect of illegality in a given scenario.

II. ANSWER TO INTRODUCTORY PROBLEM

A. Yes. This problem is based on an actual case, Wilson v. Kealakekua Ranch, Ltd., 551 P.2d 525

(Hawaii 1976). The court there ruled for Wilson on the ground that the fee aspect of the

statute was a revenue raising rather than a regulatory measure. The court therefore concluded

that the annual fee provision of the statute was not intended to protect the public and that it is

unlikely that the legislature intended unenforceability of contracts.

B. Yes. The licensing requirements are designed for the protection of the public. A contract in

violation of a regulatory statute will not be enforced.

C. Yes. It must pay him the sum agreed upon because the contract was valid. However, if Wilson

had never been a licensed architect, the court could refuse to give Wilson any remedy.

D. No. The Ranch received the value that it was seeking from Wilson and Wilson did not

commit any act that was unethical in order to do the work. Under a rights theory, Wilson’s

right to receive payment for his work outweighs any rights the Ranch might have to escape its

legal obligations based on a technical violation of the licensing requirements.

III. SUGGESTIONS FOR LECTURE PREPARATION:

A. Introduction

1. Discuss the meaning of “illegality” in contract law and explain that “illegal” often means

that the contract is against public policy rather than that the contract is a violation of the

criminal law.

2. Explain that when a contract is held to be illegal, courts generally refuse to enforce it

even if it was a clear, voluntary agreement between individuals who had capacity to

contract and was supported by consideration.

3. Explain that this area of contract law involves the weighing of competing public policies

(the public policies that favor allowing people to order their own relationships through

contracts vs. other public policies that may be adversely affected by the contract).

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Chapter 15 – Illegality

Coma Corporation v. Kansas Department of Labor (p. 435): In this case, an

undocumented worker sued his former employer for earned but unpaid wages under the

Kansas Wage Payment Act. The employer claimed that the Kansas act was preempted by

the federal Immigration Reform and Control Act and that the employee’s employment

contract was illegal and void. The court decided that the IRCA did not preempt Kansas

law regarding payment of wages and that the employment contract was not illegal.

Points for Discussion: What conflicting public policies are involved in this case? How

would enforcing this contract actually further the policy underlying the IRCA? Does this

argument support extending other employment rights to undocumented workers, such as

worker’s compensation?

4. Note the different functions courts engage in when they determine whether a contract was

illegal (interpreting statutes, weighing the strength of various policies, declaring policies

of their own creation).

a. Convey that the decision to hold a contract illegal is not a “knee jerk” reaction every

time a contract interferes with a public policy. Courts will consider the extent of

interference with the public interest, even when one of the parties has violated a

statute. The case about the fertilizer supplier cited as a text example, Amoco Oil Co.

v. Toppert, 56 Ill. App. 3d 595, 371 N.E.2d 1294 (1978), is a good example. Note that

in that case the seller had already supplied the fertilizer and the buyers allegedly

owed the sellers $55,000 plus interest. In such a case, would public policy really be

served by permitting the buyers such a windfall because the seller had failed to

comply with a technical statutory requirement?

B. Agreements in Violation of Statutes

1. Agreements Declared Illegal by Statute

a. Discuss usury statutes, Sunday laws, and wagering statutes. Make it clear that these

statutes vary from jurisdiction to jurisdiction. Note that Sunday laws are not nearly as

prevalent as they once were, and that most states have made substantial in-roads on

their Sunday laws. It is also worthwhile to distinguish wagering agreements from

legal agreements relating to uncertain events, such as stock transactions and

risk-shifting agreements.

Example: Pepsi Cola Bottling Co. of Luverne, Inc. v. Coca-Cola Bottling Co.,

Andalusia, 534 So. 2d 295 (Ala. 1988) (soft drink bottling company’s instant cash

game was not a lottery).

2. Agreements in Violation of Public Policy Manifested in Statute

a. Discuss how public policy may be manifested in a statute, even though the statute

does not expressly address the validity of contracts. A good example would be a

statute providing criminal penalties for acting as a real estate broker without a

license. The statute forbids certain conduct on pain of criminal liability, but may not

tell us what should happen if an unlicensed person contracts to act as a real estate

broker. It is up to the court to determine whether either of the parties should be able

to obtain a remedy if the contract is breached.

Example: Problem Case #6 [unlicensed professional corporation].

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Chapter 15 – Illegality

b. As an example of a contract that was held to be illegal because it violated the public

policy of several state statutes, see In the Matter of Baby M, 109 N.J. 396 (1987).

c. Discuss the status of contracts to commit crimes and torts and contracts that are legal

on their faces but which promote crimes or torts.

d. Discuss the status of contracts involving violations of licensing laws. Discuss how

the nature of the public interest protected by the statute will determine the outcome of

the case to a large extent. Distinguish regulatory statutes from revenue raising

statutes; give examples of each. Make the point that avoiding forfeiture is also

important.

Additional Example: Contrast Problem Case # 3 with the Introductory Problem.

e. Sometimes the degree of forfeiture would be so large in comparison to the relatively

minor public policy at risk that the court will enforce a contract that violates a

regulatory statute. Most regulatory licensing statutes provide for some criminal-type

penalty, such as a fine, for violation of the statute. A court may determine that that

statutory penalty is sufficient to deter and punish violations of the statute, and that the

further sanction of refusal to enforce the contract is superfluous.

Example: Lavine Construction Co. v. Johnson, 101 Ill. App. 3d 817, 428 N.E.2d 1069

(1981). There, a contractor who was obligated to perform building and electrical

services hired a subcontractor to do the electrical work. The subcontractor failed to

obtain a permit for electrical work from the City of Chicago. The electrical work

accounted for $221 of the $5,700 contract price. The homeowner refused to sign a

completion certificate and pay the contract price, challenging the contract on the

ground of illegality. The court construed the ordinance requiring the permit as not

implicitly prohibiting the enforcement of contracts entered into without such permits.

3. Contracts in Violation of Public Policy as Declared by Courts

a. Note that courts have traditionally had broad powers to declare public policy. Before

the “age of codification,” courts often had the primary responsibility of doing so, at

least with respect to determining what contracts would be enforced. (A good example

of this is the policy against restraints on competition, which was originally developed

by courts, but is now reflected in federal and state antitrust legislation).

b. Discuss how public policy changes with changing social, economic, and

technological climates. For example, ask the class how they think courts would have

treated contracts between unmarried cohabitants 100 years ago.

c. Discuss the policy favoring free competition. Illustrate some contracts that might

restrain competition. Give some examples of ancillary covenants not to compete, and

show how they can be valuable business tools as well as very limiting to employees

and others who sign them. Discuss the standards for determining whether a

no-compete will be enforced. Ask why the clauses are scrutinized more thoroughly in

employment contracts than in contracts for the sale of businesses.

Clark’s Sales and Service, Inc. v. Smith, 4 N.E.3d 772 (Ind. Sup. Ct. 2014) (p. 440).

Clark’s is a family owned business that is involved in high-end, builder-distributor

appliance sales and services. Smith, who worked for HH Gregg for four years before

commencing with Clark’s in 1998, acquired knowledge and expertise of the

appliance-sales business during his 14 years with Clark’s. In 2004, Smith signed a

non-compete agreement, which stated upon his termination or resignation, he shall

not solicit services to any competitor of Clark’s and he will not work for a competitor

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Chapter 15 – Illegality

of Clark’s that resides within a 50 mile radius of Clark’s. The non-compete was to

last for two years upon Smith’s termination or resignation. Prior to his resignation on

April 13, 2012, Smith emailed proprietary information to his personal email. Five

days later, he accepted a job at Ferguson’s, which is a direct competitor of Clark’s

that resides within 50 miles of Clark’s. The court held that although the non-compete

served Clark’s legitimate business interest, the non-compete was far too broad and

indivisible in nature, rending the “blue pencil doctrine” inapplicable and the entire

provision unenforceable.

Additional Examples: Problem Case #1 and Cukjati v. Burkett, 772 S.W.2d 215 (Ct.

App. Tex. 1989) (veterinarian was not engaged in a “common calling”; non-

competition agreement in employment contract was nevertheless unreasonable and

unenforceable). See also, “Log On” (bottom of p. 439) for a further discussion of

NCA’s.

d. Discuss exculpatory clauses, giving examples of the circumstances in which they are

often used. Tell why they are vulnerable to attack on public policy grounds. Explain

the standards that are used to determine whether an exculpatory clause will be

upheld.

DeWolfe v. Hingman Center, Ltd., 85 N.E.2d 1187 (Mass. Sup. Ct. 2013) (p. 443).

Hingman Center, the realty company, was retained by the Tribunas in order to broker

the sale of the property at 461 Washington St. Richards, a real estate agent of

Hingman, was responsible for brokering the deal. The Tribunas either told Richards

that the property was “Residential B” or “Business B,” but instead of assuring,

Richards listed the 461 Washington property as “Business B.” DeWolfe subsequently

entered into a standard purchase and sale agreement with the Tribunas. Within the

standard form, the Sellers made no representations or warranties. Upon closing of the

deal, De Wolfe realized the property was not a “Business B” and, as a result, could

not use the property for his intended purposes. The court held that Richards should

have reasonably inspected the premises to ensure the correct zoning description and

that, although the agreement lacked any substantive representations and warranties

made by the Seller, prior written agreements could have been relied upon.

Additional Example: Problem Case #8.

4. Unfairness in Contracts: Unconscionability and Contracts of Adhesion

a. Note that classical contract law did not normally concern itself with the fairness of a

contract, so long as the contract was not induced by fraud, misrepresentation, duress,

mistake, or undue influence. Discuss how this rule served the purposes of

predictability/stability (one could count on his deal being enforced) and how it

permitted businesses to shift many of the risks that they created.

b. Point out that the doctrine of unconscionability is a significant departure from the

posture taken by classical contract law toward fairness in contracts. Why would

modern courts be more willing to evaluate the fairness of a contract than courts were

100 years ago? (Possible answers: increased use of form contracts, disparity of

bargaining power, less interest in protecting capital of business today than in early

days of industrialization).

c. Discuss the provisions of UCC 2-302. Note how the definition of unconscionability is

left open.

d. Discuss the meaning of unconscionability. Give examples of the procedural and

substantive aspects of unconscionability.

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Chapter 15 – Illegality

Moore v. Woman to Woman Obstetrics & Gynecology (p. 447): Moore went to the

doctor for care for her high risk pregnancy. At her first appointment, she completed

and signed a number of forms, including a lengthy arbitration agreement that

purported to bind her husband and unborn child as well as Moore. The Moores later

sued the doctor and several other parties for malpractice. The trial court granted a

summary judgment against the Moores and entered an order compelling arbitration.

The issue was whether the arbitration agreement was unconscionable. The appellate

court held that summary judgment was not proper in this case because of a variety of

facts that indicated procedural and substantive unconscionability.

Points for Discussion: What facts of this case indicate procedural unconscionability?

What facts indicate substantive unconscionability? Should the doctor’s office have

the responsibility to verbally explain the arbitration clause, or should Monica have

the responsibility to read what she was signing and ask questions if she didn’t

understand?

Additional Examples: Problem Cases #7, 9, and 10. Many current unconscionability

cases involve arbitration clauses (see Problem Cases #7 and 9). Note that

unconscionability is primarily a consumer doctrine, but it has been used by some

commercial parties, such as those who are in an inherently dependent position (e.g.,

franchisees) and small businesses who were relatively disadvantaged in their

knowledge and bargaining power.

f. Note how the concept of unconscionability has been adopted by courts in many cases

outside the reach of Article 2 of the UCC (e.g., landlord-tenant relationships).

Example: Weaver v. American Oil Co., 276 N.E.2d 144 (Ind. 1971) (exculpatory

clauses in service station lease declared to be unconscionable–great facts for

discussion).

g. Discuss the consequences of a finding of unconscionability.

h. Discuss the meaning and effect of contracts of adhesion. Note that a contract of

adhesion can be conceptualized as a particular type of unconscionable contract.

Contracts of adhesion may be analyzed using the language of unconscionability as

well as, in some situations, the concept that offers include only those terms that the

offeree has reason to know of.

Example: Problem Case #2.

i. Ethics in Action (p. 449): This question is based on Murphy v. McNamara, 416 A.2d

170 (Conn. Super. Ct. 1979). There, the court emphasized the inequality of

bargaining power here and the unconscionably high sales price. It stated that, “[a]n

agreement for the sale of consumer goods entered into with a consumer having

unequal bargaining power and which calls for an unconscionable purchase price,

constitutes an unfair trade practice.” The ethical issues raised by McNamara’s Rent

to Own plan would focus on a stronger party taking advantage of its greater

sophistication and bargaining power to obtain a contract that it could not have

obtained with a party of equal sophistication and bargaining power. It would seem

that McNamara’s disclosure of the total contract price would resolve the problem of

taking advantage of Murphy’s lack of sophistication. On the other hand, it is desirable

for individuals to act responsibly for their own protection, and allowing parties to

avoid doing so does not encourage personal responsibility on the part of contracting

parties.

C. The Effect of Illegality

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Chapter 15 – Illegality

1. Discuss the general rule of “hands-off-illegal bargains.” What purpose does such a rule

serve?

Example: Problem Cases #4 and 6.

2. Discuss the exceptions to the “hands-off” rule.

Gamboa v. Alvarado, 941 N.E.2d 1012 (Ill. Ct. App. 2011) (p. 450). Alvarado engaged in

a fraudulent scheme to obtain U.S. citizenship for the plaintiffs [Gamboa, Nava, and

Lopez] if they paid him $15,000 by the end of June 2006. Alvarado pressured plaintiffs

into paying him on time; however, Nava didn’t pay until October 2006. Alvarado stated

that there would be some delay in obtaining the citizenship documents due to the tardy

payment. In February 2007, Alvarado convinced Gamboa to fly to the U.S. to obtain his

citizenship documents. In doing so, Alvarado told Gamboa to purchase the plane tickets

through Alvarado’s business; however, prior to Gamboa’s departure, Alvarado stated that

Gamboa would be unable to obtain the documents. Alvarado made himself unavailable

until March 2009, where he said there was nothing to be done because they were all

swindled by “Castellanos.” The court held that because the plaintiffs were not in pari

delicto with the defendants that they engaged in the illegal services for. The policy behind

the holding was that the Consumer Fraud Act was designed to protect the types of victims

such as the plaintiffs in the case at bar.

IV. RECOMMENDED REFERENCES:

A. E. ALLAN FARNSWORTH, FARNSWORTH ON CONTRACTS (3rd ed. 2004).

B. Arthur Alan Leff, Unconscionability and the Code––The Emperor’s New Clause, 115 U. PA.

L. REV. 485 (1967).

C. James C. Koslowski, Liability Waivers and Releases Overview: Can You Say “Exculpatory?”

http://classweb.gmu.edu/jkozlows/p&r396.htm

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