Illegal Contracts Are Enforceable. Sometimes.

Posted on March 21, 2014 by cebca

The following is a guest blog by Alan M. Goldberg of the Law Office of Alan Goldberg. Alan’s practice includes Appeals, Civil Trials, and Family Law. You can follow Alan on Twitter @AlanMGoldberg.

We learn in law school that illegal contracts aren’t enforceable. But that’s not precisely true. Some illegal contracts may be enforced, depending on the “realities of the situation.”

The court in Johnson v Johnson (1987) 192 CA 551 took some colorful facts and laid out for us the factors that govern judicial enforcement of illegal agreements.

In that case of family drama, the apple didn’t fall far from the tree. The parents had asked their son to submit false information on a US Government GI loan application so the parents could buy a house. Of course the house had to be in the son’s name, so the son lied and wrote that he would be living in the house. With the house in his name, can you guess what the son did next? Yep, he tried to sell it out from under his parents; after all, the house was in his name. The parents then sued to quiet title. The son audaciously argued that the contract couldn’t be enforced because his actions with regard to the loan application were illegal.

Although the general rule is that illegal contracts are unenforceable, this isn’t always true. Here are the factors that make even illegal agreements enforceable:

1. Contract has been performed. If the contract has been performed, the public can’t be protected by the rule except by example. In Johnson, the parties had already changed positions and the parents had moved into the house and had given up their old house, so there was no possibility of protecting them by finding the agreement to be illegal.
2. No moral turpitude by the party seeking enforcement. Courts will consider the absence of serious moral turpitude (bad acts) on the part of the party against whom the defense is asserted, and will look at who has the greatest moral fault. In Johnson, the parents weren’t as guilty of wrongdoing as the son: they didn’t falsify the documents even though they participated in the transaction.
3. Unjust enrichment by party claiming illegality. The likelihood that enforcement of the rule will permit the party asserting the illegality to be unjustly enriched at the expense of the other party is an important factor. In Johnson, the son would make out like a bandit by getting the house and the sales proceeds when it’s really the parents’ home.
4. Impact of forfeiture outweighs illegality. Disproportionality of the impact of forfeiture is weighed against the nature of the illegality. That is, will enforcement cause a forfeiture that is more severe than the illegality. In Johnson, the question is whether throwing the parents out of their house is disproportionate to the son’s fraud in obtaining the loan.

The Johnson court gave us sound advice in approaching any case involving an illegal contract:

“courts should not be so enamored with the Latin phrase ‘in pari delicto’ that they blindly extend the rule to every case where illegality appears somewhere in the transaction.”

Courts temper general rules with practical considerations. But even though courts will sometimes grant relief for illegal contracts, don’t rely on obtaining this relief, because it may not come. In fact, your reliance on illegal terms may invite a lawsuit against your client and a resulting malpractice claim against you.

All aspects of contract formation, including issues around illegality, are covered in CEB’s California Law of Contracts, chapter 3.