Imagine that person X signed a contract with Person Y, whereby X agrees to pay Y 10,000 dollars and Y agrees to shoot person Z. If the parties fail to carry out their promises, you probably feel that as an intuitive matter, no court would enforce the party's agreement and order damages for breach of contract. That intuition is correct. But why? One important reason is because of the negative externalities of the agreement with regard to person Z. I've said in the past that the formation defenses, can be seen as policing the revealed preference inference to make sure that the contract is value enhancing. Formation defenses, tend to render contracts voidable, when courts aren't confident that the agreement really is in the party's joint interest. But illegality doctrine sets aside contracts, when the agreement may not be welfare enhancing because of net negative effects on people outside the contract. The illegality defense can thus, set aside contracts even when there is no defect in the bargaining process. Even if the parties manifest sufficient assent, courts can set aside the agreement if one of the promises exchanged is illegal or violates public policy. As we will see the circumstances in which questions of illegality or public policy arise are often much less clear cut than the hired shooting example above. Determining when an agreement is illegal shouldn't prove too difficult. But how should a court determine if an agreement violates public policy? To take one example, consider a class of agreements known as Aleatory contracts. Aleatory comes from the Latin word for Die. An aleatory promise, is a promise, the performance of which depends on the occurrence of some fortuitous event occurring. Perhaps, the most common example of aleatory promises are found in insurance contracts. If you have fire insurance, your insurer does not have to pay unless you, unless and until your property burns. Generally these agreements are enforceable. But common law is long viewed gambling as against public policy. The line between enforceable aleatory agreements and unenforceable wagers, can become blurry indeed. Why does public policy prohibit, the latter but not the former. One possible explanation at least for these examples is that, buying insurance is usually a responsible risk mitigating decision. Gambling by contracts, creates artificial risk. Problem gambling often hurts gamblers loved ones. While we don't even have the category of problem insuring.historically courts typically, took a hard line against enforcing illegal contracts. According to the first restatement of contracts, in Section 512," A bargain is illegal within the meaning of the restatement if either its formation or its performance is criminal, tortious, or otherwise opposed to public policy". As the comments to this section make clear an agreement could be illegal either because the statute specifically prescribed the conduct which was the agreement subject or because courts had determined, that such agreements were opposed to public policy. A common example of the latter, comes with contracts in restraint of marriage. If John Doe agrees to pay Richard Rowe a thousand dollars in return for Richard agreeing not to marry Jane, courts will not enforce that agreement even if the prohibition against contractual restraints on marriage had has not been codified. Though it has in many jurisdictions. Traditionally, courts will not order either party to an illegal agreement to make any payment to another. If a bargain was illegal under 512 and both parties were in Perry Dileto that is equally blameworthy. Section 598 provided that," a party to that agreement could quote neither recover damages for breach thereof nor, by rescinding the bargain, to recover the performance that he has rendered there under or its value". If you pay a scalper, for a ticket, when the sale is prohibited by law, courts under the first restatement standard, would normally not force the scalper to give you your money back. It seems unfair that people like the scalper would come away with a windfall. But the comment provided justification for this effect is further deterrence. According to the comment, denied the plaintiffs in such cases recovery, court tends to diminish the number of illegal agreements. Ticket purchasers may be less likely to pay for tickets. If the law says the scalper can take the money and run. The no restitution rule, help support the maxim of there being no honor among thieves. In fact, while most of the formation defenses try to police certain types of sharp dealing. Illegality is a circumstance where the law is trying to facilitate and foster opportunism in order to drive out illegal contracting. There are limited exceptions to this no restitution rule. Section 600, provided an exception for when there was slight illegality, where no law prohibited the agreement and there was no court serious moral turpitude involved. These are circumstances where the equities seem to trump the strategic impulse to deter illegal contracting. The second restatement however, has introduced a more flexible balancing test on enforceability of illegal agreements. According to Section 178 of the second restatement, subsection 1," a promise or other terms of agreement is unenforceable on grounds of public policy if legislation provides that it is unenforceable or the interest in its enforcement is clearly outweighed in the circumstances by a public policy against the enforcement of its terms". Subsection two offers factors, in the interest of enforcing an agreement terms that which include, the parties justified expectations, any forfeiture that would result if the enforcement were denied, and any specific public interest in enforcement. Subsection three, list factors weighing against enforcement, which include the strength of the public policy in question, as manifested by legislation or judicial decisions, the likelihood that failing to enforce that term would further the public policy in question, the seriousness and deliberateness of any misconduct involved, and the nature of the connection between the misconduct and the terms in question. Under the second restatement, courts have significantly more discretion to determine whether to enforce an agreement, even if it may violate public policy. Let's look now, at a case that raises some of these questions. Sinnar versus Le Roy which was decided by the Supreme Court of Washington in 1954. Sinnar a grocery store owner, applied to the Washington State Liquor Control Board for a license to sell beer. But his application was denied. He and Le Roy a friend of his agreed that he would pay Le Roy 450 dollars, so that Le Roy could get a city official. Le Roy new to secure Sinnar a license. If this was unsuccessful, Le Roy would return the 450 dollars back to Sinnar. Sinnar did not get his license, and Le Roy did not return the bribe money. Sinnar sued to recover the funds, in the trial Le Roy did not raise an illegality defense. And the trial court found for Sinnar. An appeal to the state Supreme Court. Le Roy raised the defense of illegality. And the first question before the court was whether, illegality as a procedural matter, could be raised for the first time on appeal. Usually parties are procedurally barred from raising defenses on appeal that were not pledged at the trial stage. But the court held not only that Le Roy could raise it, but also that the court could bring up illegality on its own, sua sponte. Quote, "Illegality if of a serious nature, need not be pleaded. If it appears in the evidence, the court of its own motion will deny relief to the plaintiff. The defendant cannot waive the defense, if he wishes to do so. Indeed, if the court suspects illegality, it may examine witnesses and develop facts not brought out by the parties and thereby establish illegality that precludes recovery by the plaintiff." Why do you think that the court resolved this issue where the court of its own motion, can raise the question and decide the question of illegality? Well probably it's because, illegality implicates the public interest to a far greater extent than other defenses that a defendant might raise in a contractual dispute. The negative externalities of illegality, mean the court shouldn't rely on private incentives of the parties to raise the defense. It was clear that there was in fact illegality in this case. So the next question became whether, that fact would bar the plaintiff from recovery. Not every instance of illegality, the court suggested would necessarily have the result of barring restitution. If however, the legality is not serious and neither public policy nor statute clearly requires denial relief, courts refuse to give effect to facts showing illegality, unless those facts are essential to establish a prima facie right of recovery or pleaded by the defendant. This however, was not such a case. According to the court, the illegality at issue was of a serious nature and concerned a matter which is exclusively within the realm of public policy. Further, the evidence suggested that the parties planned on using only illegal means presumably, bribery of a city official, to accomplish their aims. Therefore, the court asserted it would not knowingly aid in the furtherance of an illegal transaction. But will leave the parties where it finds them. Think about this result. Le Roy ends up 450 dollar richer, than he was before signing onto this illegal agreement. Given what, we have discussed from the restatements, what do you think of the court's reasoning is? By not furthering an illegal transaction, the court hopes to deter such transactions from being made in the first place. This deterrence focused policy, reflects an Ex Ante efficiency concern, or at least it's consistent with such Ex Ante concern. At the expense of Ex Post concerns about fairness. This is a common tension in the law. Think about which you find more compelling in this case. But by the way, even from Ex Ante perspective, will this no restitution result, really reduce the number of illegal contracts? If the rule is known, it should reduce the willingness of bribers to bribe. But it should also increase the willingness of bribees to take bribes. Imagine instead that we wanted to deter employers from hiring undocumented workers. The no restitution rule would mean that employers could hire and then refuse to pay undocumented workers. That might lead to more employment of workers. We might deter undocumented hiring more by requiring employers to pay employees three times what they promised.
