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Chapter 15
LEGALITY AND PUBLIC POLICY
RESTATEMENT
When a contract is illegal, it is void and generally not enforceable by the courts. There are certain exceptions to
this principle which are allowed to avoid hardship as in permitting recovery of funds by the party intended to be
protected. Another exception is when a contract is only partially legal. The legal portions can be enforced.
Illegality takes many forms. One issue in illegality is whether a contract is unconscionable. A contract is
unconscionable when it is too harsh or oppressive to one of the parties who was left with no opportunity for
negotiation at the time the contract was agreed to. A contract or clause is determined to be unconscionable on
the basis of the circumstances existing at the time the contract is made. If a contract or portions of a contract is
unconscionable, it will be set aside as void.
Another form of illegal contract is one that affects the public welfare or is contrary to public policy. An agreement
is contrary to public policy when it is so offensive to society that judicial intervention is needed to preserve the
public good.
Gambling contracts are generally illegal, but states have been carving out exceptions for lotteries and games of
chance. Prizes and give-aways are also permitted in some states.
Licensing is an important part of business regulation. A contract for a sale or service that requires a license by an
unlicensed entity or person is void if the license requirement is one of qualification. If the license requirement is
a revenue-raising statute, the courts may declare the contract valid.
Courts scrutinize contracts in restraint of trade carefully. Covenants not to compete, with an ex-employee or as
part of the sale of a business, are enforceable if necessary and reasonable in duration and geographic scope.
Credit contracts have numerous parameters in the law including restrictions on interest rates (usury) and various
credit regulations on price and disclosures.
STUDENT LEARNING OUTCOMES
LO.1: Explain the general contract principles on "illegality".
LO.2: Explain the implied obligation on all parties of good faith and fair dealing.
LO.3: Understand that it is only in unusual situations that a contract provision will be unenforceable because it
is unconscionable.
LO.4: Explain the rationale for requiring licenses to carry on as a business, trade, or profession.
LO.5: Distinguish between noncompete clauses after the sale of a business and noncompete clauses in
employment contracts.
INSTRUCTOR’S INSIGHTS
Break the chapter down into three components – related Learning Outcomes are indicated in ( ):
1. What are the general contract principles on illegality?
Discuss the effect of illegality on a contract (LO.1)
Explain what happens when a contract is partially illegal
2. What agreements protecting public welfare are void?
Explain the importance of public policy constraints on contracts (LO.3)
3. What is the effect of contracts that violate regulatory statutes?
Discuss the issues surrounding licensing requirements and the contracts with the unlicensed party (LO.4)
Explain when contracts in restraint of trade are void
CHAPTER OUTLINE
I. What are the General Contract Principles on Illegality?
A. Effect of illegality
1. The agreement is void, and no court relief exists
2. Promissory notes given for illegal contracts cannot be enforced
CASE BRIEF: Neiman v. Provident Life & Accident Insurance Co.
217 F.Supp.2d 1281 (S.D. Fla. 2002)
FACTS: Brian Neiman was involved in the illegal practice of law for over seven years. Having
been found guilty of illegally practicing law, he sought to collect disability benefits under his
disability insurance policy with Provident Life due to an alleged bipolar disorder, the onset of
which occurred during the pendency of criminal and bar proceedings against him. Neiman
contends that his bipolar disorder prevents him from working as a paralegal. Provident
contends that Neiman should not be indemnified for the loss of income generated from his
illegal practice of law.
ISSUE: Can Neiman collect on a policy to compensate him for loss of income derived entirely
from an illegal activity?
HOLDING: No. Because all of Neiman’s income was derived from the unlawful practice of law in the seven
years preceding his claim, as a matter of public policy, a court will not enforce a disability
REASONING: Contracts that are contrary to public policy are void because they have no legal sanction and
establish no legal bond between the parties. To determine whether a contract violates public
policy, courts look to established law, primarily to statutes and secondarily to decisions of the
courts. The rationale of the rule is that the judiciary will not provide aid to enforce an obligation
that arises from an illegal conduct.
B. Exceptions to effect of illegality
1. Protection of one party – e.g., illegal shares sold – buyer can get money back
2. Unequal guilt
a. Parties are not in pari delicto
C. Partial illegality
1. Legal parts are enforced if possible
D. Crimes and civil wrongs
1. Agreements to do either are illegal
E. Good faith and fairness
1. The trend is in this direction
F. Unconscionable and oppressive contracts
1. Provision in a contract that gives one party too much advantage over the other party to the contract
2. Determination of unconscionability
a. Procedural unconscionability: focuses on assent; bargaining power; fine print
DISCUSSION POINTS: Thinking Things Through
Legality and Public Policy
Have students discuss the UCC position on unconscionability.
II. What Agreements Protecting Public Welfare are Void?
A. Agreements contrary to public policy
1. A contract may be held not binding on the ground that it is contrary to public policy, even though no
statue or decision declares the contract to be illegal. A contract in itself lawful may be condemned
2. The concept of public policy – contract is offensive to society
DISCUSSION POINTS: Ethics & the Law
Public Policy Issues Regarding Surrogacy Contracts
In the Matter of Baby M, the public policy issues surrounded contracts for the sale-adoption of a baby. The New
Jersey court felt that the public interest in protecting the child required that such contracts be void. The case was
then turned into a custody case and Mr. Stern was awarded custody because Mrs. Whitehead had proven herself
to be unstable. The Rosecky case approves the validity of surrogacy contracts in Wisconsin to the extent that
enforcement is not contrary to the child’s best interests. The Chief Justice raises public policy issues that need to
be addressed.
B. Gambling, wagers, and lotteries
1. Have your students discuss whether the lottery should be illegal on the basis of pure chance only or
whether there can be a combination of chance and skill, and what the appropriate percentages
might be. Address the problem of a golfer who puts a dollar in a pool at the beginning of a round of
2. Have the students discuss whether wagers and lotteries should be illegal. Many activities involve a
degree of speculation and risk that are perfectly legal, such as insurance contracts, the purchasing
3. Skill contests are permitted
4. Some states permit prizes as part of product promotion
III. What is the Effect of Contracts that Violate Regulatory Statutes?
A. Effect of violation of regulatory statute
B. Statutory regulation of contracts
1. Consumer protection statute
C. Licensed callings or dealings
1. Protective license
a. Licensing exists to provide public protection
2. Revenue-raising license
a. Not qualification based
CASE BRIEF: Meteor Motors v. Thompson Halbach & Associates
914 So.2d 479 (Fla. App. 2005)
FACTS: Thompson Halbach & Associates, Inc., an Arizona corporation, entered into an agreement with
Meteor Motors, Inc., the owner of Palm Beach Acura, to find a buyer for the dealership, and it
agreed to pay a 5 percent commission based on the closing price of the sale. Among those
contacted by Thompson Halbach was Craig Zinn Automotive Group, which ultimately purchased
ISSUE: Was the contract for a sales commission invalid due to Thompson Halbach’s status as an
unlicensed out-of-state real estate broker?
REASONING: The Florida statute clearly applies to a foreign broker who provides brokerage activities in
Florida. Thompson solicited potential Florida purchasers for the Florida business and that
purchaser was a Florida corporation.
D. Contracts in restraint of trade – agreement to fix prices or not compete are void
E. Agreements not to compete
1. Sale of business
a. Permissible to protect goodwill
2. Employment contract
a. With regard to covenants not to compete, this is an important area because it may arise in the
future employment of your students.
b. Again, must be necessary and reasonable
CASE BRIEF: Genex Cooperative, Inc. v. Contreras
39 IER Cases 294 (E.D. Wash 2014)
FACTS: On December 12, 2012, defendants Contreras, Senn, Verduzco, and VanderWeerd,
inseminated cows at several dairy farms in Sunnyside, Washington on behalf of their employer,
Genex Cooperative, Inc. (“Genex”). The very next day, they inseminated cows at the same dairy
farms − but this time on behalf of CRV USA (“CRV”), a Genex rival. Jilted by its former
employees and spurned by its customers, Genex filed suit in this court to enforce
non-competition agreements against three of the defendants. Although the individual contracts
varied in terms, Contreras, Senn, and Verduzco contended the agreements were
unenforceable. Mr. VanderWeerd had not signed an agreement.
ISSUE: Did Genex meet its burden to establish the reasonableness of its covenants not to
compete against Verduzco, Senn, and Contreras?
REASONING: The individual contracts varied in terms, but the court found all were unenforceable. Verduzco’s
and Senn’s restrictive covenants were found to be unreasonable in scope because they were
not limited to soliciting or servicing Genex’s customers. Contreras’ restrictive covenant was not
enforceable because it applied to an at-will, low-level employee without unique skills. At one
point the court pointed out: Thus, it appears Genex actually used restrictive covenants as either
a method to eliminate legitimate competition or to strong-arm its employees to accept
ever-dwindling wages and restrict their freedom to work. Genex has failed to demonstrate that
the equities are in its favor and has failed to show how any reformation of the covenant would
be reasonable.
3. Effect of invalidity
F. Usurious agreements
1. Contracts with interest rate in excess of maximum
2. Penalties vary from void to loss of interest
DISCUSSION POINTS: Thinking Things Through
Noncompete Clauses, Cause for Concern?
Discuss the balancing courts do in handling non-compete clauses and their effects on innovation, right to earn a
living, and protection of property rights.
CASE BRIEF: Pinchuck v. Canzoneri
920 So.2d 713 (Fla. App. 2006)
FACTS: Karen Canzoneri entered into two agreements with Howard Pinchuck. Under the first
agreement, Canzoneri advanced $50,000 to be repaid at 12 percent per month for 12
consecutive months “as an investment profit.” The second agreement required “$36,000 to
be repaid on or before 6/1/01 with an investment profit of $36,000, total being $72,000.”
The annualized rate of return for the first transaction was 144 percent and for the second
transaction was 608 percent. The civil penalty for violating the state’s maximum interest
rate of 25 percent per annum is forfeiture of the entire principal amount. Canzoneri
contends that the transactions were investments not subject to the usury law.
ISSUE: Was the transaction usurious, even though the language of the contract called the
repayments an “investment profit”?
REASONING: The four elements of a usurious transaction are present: (1) the transaction was a loan, (2)
the money lent required that it be returned, (3) an interest rate higher than allowed by law
was required, and (4) a corrupt intention to take more than the legal rate for the use of the
money loaned exists. Even though the terms called for “profit,” not “interest,” the courts
looked to the substance, not the form of the transaction.
ANSWERS TO QUESTIONS AND CASE PROBLEMS
1. Unconscionability. Parties are in pari delicto when both are equally guilty of a violation of a law.
2. Unconscionability. No, the U.S. West contract was a contract of adhesion. There was lack of mutuality. The
3. Licensed callings or dealing § 11. Judgment for Deafeamkpor setting aside the $90,000 verdict. The licensing
requirement of this city, even when work is satisfactory, is strictly enforced to protect consumers from
4. Noncompete agreements. Even if the covenant not to compete is not void…it is a contract in restraint of
trade that must meet three requirements under Oregon common law to be enforceable: (1) it must be
restricted in its operation in respect either to time or place; (2) it must be on some good consideration; and
5. What constitutes a solicitation prohibited by a restrictive covenant. This letter was a solicitation. Although it did
not expressly seek customers, a person receiving such letter would regard it as a statement that Ewing was
available, licensed, and qualified to do pest control work. The supplying of the address and phone number
that the customers did not previously have was clearly an indication that Ewing was willing to be contacted at
that address and number. Because he was no longer employed by Presto -X, there would be no reason for
customers to use the address or phone number Ewing provided if they were trying to reach Presto -X, only if
they were trying to reach Ewing. Therefore, the letter was a solicitation of pest control work. The ethical
6. Agreement contrary to public policy. Judgment for Crossroads. The Minnesota Adoption Statute made it clear
that the public policy of the state was to place the child with an applicant only if that would be in the best
7. Illegality; public policy; unjust enrichment. The agreement for the sale of fireworks violated state fireworks
law. The equitable principle of unjust enrichment did not permit fireworks supplier’s recovery of fair value of
dangerous fireworks delivered and accepted pursuant to an agreement in violation of state fireworks law
8. Agreements not-to-compete. The provision prohibits Shaffer from working for any other business in the pest
control industry in any capacity. It bars him from engaging even indirectly, or concerning himself in any
manner whatsoever, in the pest control business, even as a passive stockholder of a publicly traded
9. Anticompetitive covenant in employment contracts; effect of excessive restriction. No. Assuming that Smith’s
employment by Lady Baltimore constituted a breach of the anticompetitive covenant with Borden, an
Authors’ Comment: The court refused to follow Iowa and New Jersey, in which the courts had applied the
“blue pencil rule.” Under that rule, a court holding a restrictive covenant inoperable because it is too broad
10. Arbitration requirements; unconscionable clauses. Judgment for Adams. The arbitration provision is
unenforceable. The DRA is procedurally unconscionable because it is a contract of adhesion drafted by the
The DRA is substantively unconscionable because employees must arbitrate “any and all
employment-related claims” while Circuit City was not obligated to arbitrate its claims against employees and
may bring lawsuits against employees, thus depriving the DRA of any modicum of bilaterality. Moreover, the
11. Validity of anticompetitive contract. No. American had a legitimate interest in protecting its goodwill by
preventing Vodra from soliciting its customers. The three -year restraint imposed by the contract was not
12. Knowledge of illegal purpose of other contracting party. No. The plaintiff has not in any way participated in the
commission of a crime. The mere act of leasing the goods did not constitute a crime, and the transaction was
not made illegal because of the lessor’s knowledge of the lessee’s intent to use the property in an unlawful
13. Narrow construction of restrictive covenants. The restrictive covenant only prohibited the New York publisher
from selling the book in England. The customers of the New York publisher were therefore not bound by the
sales contract. The New York publisher sold to its customers without requiring them to agree to comply with
This can be used to illustrate the importance of looking ahead to see whether the contract a party makes will
really cover the future situations that are likely to arise.
14. Unconscionable clauses. The court found the arbitration provision to be procedural and substantively
unconscionable and refused to sever the objectionable clause, because GeoEx sought to create an inferior
15. Good faith and fair dealing. While every contract has an implied obligation of good faith and fair dealing that
neither party shall do anything to destroy the rights of the other party under the contract, the season ticket
holder has no contractual right to renew. As stated on the back of the ticket and in other promotional
LAWFLIX
Midnight Run (1988) (R)
Have the students determine whether the contract Robert DeNiro has for bringing in Charles Grodin, an
embezzler, is legal. Then have them discuss the issues of consideration and ethics as the bail bondsman puts
The Insider (1999) (R)
The movie is the story of former tobacco executive, Jeffrey Wigand, and the issue of his non-disclosure contract
management system for classroom use.
