The effect of an illegal contract will depend on whether it is illegal due to a statute or due to the common law. Where a contract is illegal because of a statute, in some cases the statute provides for the consequences of any illegality. Where the statute does not expressly or impliedly state the effect of the illegal contract, the common law principles will apply.
Under common law an illegal contract is void and courts will not order it to be performed. A court will never enforce an illegal contract, in the sense of ordering a party actually to do something that is unlawful or contrary to public policy. Illegal contracts are not devoid of legal effect but no action on the contract can be maintained. Illegality, where operative, acts as a defence to the general right that a party would otherwise have to enforce a contract (that is, it acts as a defence to what would otherwise be a valid claim for damages for breach of contract, or to an action for the agreed price).
Contracts illegal at time of formation
In this case the contract is treated as if it was never made, so the illegal contract is unenforceable by either party.
Because the contract is unenforceable, property handed over under an illegal contract cannot be recovered. This position was illustrated in the case of Parkinson v College of Ambulance Ltd and Harrison.
There are two main exceptions to the general principle that the contract is unenforceable.
- The first is that a person will be able to recover their property if they can rely on some other cause of action which does not involve the illegal contract.
- The second exception to the general rule applies where one party is more at fault than the other (they are described as not being in pari delicto). In such a situation the courts may be prepared to view the less guilty party as the victim of the transaction and allow them to recover property transferred to the more guilty party.
Contracts illegal as performed
A contract perfectly lawful when made, may be carried out in an illegal manner. It will be possible to enforce the illegal contract if the illegal act was merely incidental to the performance of the contract.
Where the contract is merely illegal because of the way it has been performed, it is possible for either both or only one of the parties to intend illegal performance. It is customary to distinguish between the situation where the legally objectionable features were known to both parties and where they were known to only one of them.
- Both parties aware of illegal performance
If both parties are aware that its performance is illegal, the consequences for this type of contract are the same as for a contract that is illegal at the time of its formation: neither party can enforce it. This was the position in the case of Ashmore, Benson, Pease & Co Ltd v AV Dawson Ltd (1973).
- Only one party aware of illegal performance
When one party did not know of the illegal performance of the contract by the other party, the innocent party can enforce it. Where the innocent party has provided any performance of the contract, they may sue on a quantum meruit for its value.
Where one party is completely innocent, the guilty party in these circumstances cannot sue on the contract for damages, or recover any property handed over, unless this can be done without relying on the illegal contract.
In some cases, it is possible to divide the illegal part of a contract from the rest, and enforce the provisions which are not affected by the illegality – this is called severance. It appears that the illegal parts of a contract can be severed if they are relatively unimportant to the contract and if the severance leaves the nature of the contract unaltered, because the words simply lifted out of the contract with no rewording required. If the unlawful part of a contract cannot be severed, the whole contract will be void.