Illegailty and enforceability of contracts

In Patel v Mirza [2016] UKSC 42 the Supreme Court was afforded the opportunity to review and revise the doctrine of illegality.

The Facts

Mr Patel had paid the sum of £620,000 to Mr Mirza for the purpose of acquiring shares in RBS on the basis that Mirza had acquired some inside information about an impending government announcement likely to inflate the share price. It transpired that the information was mistaken and Mr Mirza never used the money for the purpose of acquiring the shares. He also failed to repay the money. Mr Patel sued for breach of contract to recover his money, but his claim failed on the grounds that the contract was founded on his illegal intentions (insider trading). He successfully appealed to the Court of Appeal and Mr Mirza then sought the opinion of the Supreme Court.

 The Question

The question for the Supreme Court was whether the contract between them was affected by the principle ex turpi causa non oritur actio (from a dishonourable cause an action does not arise) commonly known as the 'illegality principle'. The leading judgment was given by Lord Toulson who reviewed the authorities and the application of the doctrine to the law of contract and equity dating back to the 18th century. In fact, his judgment opens with the quotation of Lord Mansfield's famous maxim "no court will lend its aid to a man who founds his cause of action upon an immoral or illegal act" Holman v Johnson (1775).

The Court of Appeal Decision

The Court of Appeal had been predominantly concerned with a much more recent authority and specifically the "reliance principle" upon which the House of Lords had decided the case of Tinsley v Milligan [1994] 1 AC 340.  It was Lady Justice Gloster's rejection of the application of the "reliance principle" which was central to Mr Patel's successful appeal of the first instance decision that his contract was unenforceable because of the intended illegal act upon which it was founded. The so called "reliance principle" dictates that title to property can pass under an unlawful transaction but an owner cannot recover property if he was reliant upon his own illegality to prove title (per Lord Browne-Wilkinson). Gloster LJ rejected the notion of this being a rule of universal application.  Rather, she thought it necessary to look at underlying public policy behind the rule and if it was so engaged then the claim ought to be disallowed. In this case, as the passing of inside information never took place (and hence the policy of preventing market abuse was not affected), she found Patel's claim should have been allowed.

The Leading Judgement

Lord Toulson was supportive of Lady Justice Gloster's rejection of the creation in Tinsley v Milligan of a rule of universal application in dismissing Mr Mirza's appeal. He quoted Lord Esher in Yarnouth v France (1887): "I detest the attempt to fetter the law by maxims. They are almost invariably misleading: they are for the most part so large and general in their language that they always include something which really is not intended to be included in them".

At paragraph 108 he said: "the integrity and harmony of the law permit - and I would say require- [the flexibility to consider various factors]. Part of the harmony of the law is its division of responsibility between the criminal and civil courts and tribunals. Punishment for wrongdoing is the responsibility of the criminal courts and, in some instances, statutory regulators. It should also be noted that under the Proceeds of Crime Act 2002 the state has wide powers to confiscate proceeds of crime, whether on conviction or without a conviction. Punishment is not generally the function of the civil courts, which are concerned with determining private rights and obligations. The broad principle is not in doubt that the public interest requires that the civil courts should not undermine the effectiveness of the criminal law; but nor should they impose what would amount in substance to an additional penalty disproportionate to the nature and seriousness of any wrongdoing".

Conclusion/comment

What does this mean? In effect, Lord Toulson is drawing an important distinction between the functions of the civil and criminal courts, or perhaps between the concepts of lawfulness and legality. Save for a few notable exceptions (a non-exhaustive list) a defendant should not be able to defeat an otherwise perfectly good claim in law or equity by pleading reliance upon an illegal act. The notable exceptions (always allowing for flexibility in application) averred to by Lord Toulson are perhaps not surprising. The contract for hire of a person to murder another perhaps or the claimant in a drug trafficking operation. In a general sense  ”cases where the contract may be of a nature too grossly immoral for the court to enter into any discussion of it" (per Heath J in Tappenden v Randall 1801). He described such cases as "rare" as well they may be given the unlikelihood of the proponent of serious criminality exposing himself as a claimant in the civil courts.

It will be fascinating to see this decision applied in both the civil and criminal courts. One can think of numerous examples of its applicability. The question, for example, of whether a fraudulent mortgage application should defeat the otherwise equitable claim to a beneficial interest in property. It is also interesting to compare the ratio of this judgment with the objective in the Financial Services and Markets Act 2000 to render prohibited activity (such as unauthorised regulated activity) as illegal giving rise to criminal penalty and unlawful such as to render contractual rights created by such activity as unenforceable (albeit not for insider trading).

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