Business Law (part 16)

Illegal Agreements (part A)

 by

 Charles Lamson 

A contract must be for a lawful purpose, and this purpose must be achieved in a lawful manner. Otherwise the contract is void. If this were not true, the court might force one party to a contract to commit a crime. If the act itself is legal, but the manner of committing the act that is called for in the contract is illegal, the contract is void.

If the parties are not equally guilty, courts may assist the less guilty party. However, courts will not allow a wrongdoer to enforce a contract against an innocent party.

If the contract is indivisible, that is, it cannot be performed except as an entity, then illegality in one part renders the whole contract invalid. If the contract is divisible, so that the legal parts can be performed separately, the legal parts of the contract are enforceable. For example, when one purchases several articles, each priced separately, and the sale of one article is illegal because the price was illegally set by price-fixing, the whole contract will not fall because of the one article. 

A contract that is void because of illegality does not necessarily involve the commission of a crime. It may constitute merely of a private wrong---such as an agreement by two persons to slander a third. A contract contrary to public policy is also illegal.

Contracts Prohibited by Statute

There are many types of contracts declared illegal by statute. Some common ones include:

1. Gambling contracts
2. Sunday contracts
3. Usurious contracts
4. Contracts of an unlicensed operator
5. Contracts for the sale of prohibited articles
6. Contracts in unreasonable restraint of trade

Gambling Contracts

A gambling contract is a transaction wherein the parties stand to win or to lose based on pure chance. What one gains, the other must lose. Under the early common law, private wagering contracts were enforceable, but they are now generally prohibited in all states by statute. In recent years certain classes of gambling contracts regulated by the state, such as state lotteries and pari-mutuel systems of betting on horse races and dog races, have been legalized in many states.

In general the courts will leave the parties to a private gambling contract where it finds them and will not allow one party to sue the other for the breach of a gambling debt. If two parties to a gambling contract give money to a stakeholder with instructions to pay the money for to the winner, the parties can demand the return of their money. If the stakeholder pays the money to the winner, then the loser may sue either the winner or the stakeholder for reimbursement. No state will permit the stakeholder, who is considered merely a trustee of the funds, to keep the money. The court in this event requires the stakeholder to return each wagerer's deposit. 

Closely akin to gambling debts are loans made to enable one to gamble. If A loans B $100 and then wins it back in a poker game, is this a gambling debt? Most courts hold that it is not. If A and B bet $100 on a football game and B wins, and if A pays B by giving a promissory note for the $100, such a note may be declared void.

Trading on the stock exchange or the grain market represents legitimate business transactions. But the distinction between such trading and gambling contracts is sometimes very fine.

Alewine and Goodnoe could form a contract whereby Alewine agrees to sell Goodnoe 10,000 shares of stock one month from the date at $42 a share. If they do not actually intend to buy and sell the stock, but agree to settle for the difference between $42 a share and the closing price on the date fixed in the contract, this is a gambling contract.

However, Ripetto could agree to sell Bolde 10,000 bushels of wheat to be delivered six months later at $1.70 a bushel. Ripetto does not own any wheat, but intends to buy it for delivery in six months. They agree that at the end of the six-month period the seller does not actually have to deliver the wheat. If the price of wheat has gone up, the seller may pay the buyer the difference between the current price and the contract price. If the price of wheat has gone down, the buyer may pay the seller the difference. Such a contract is legal because the intention was to deliver. The primary difference between the Alewine case and the Ripetto case is the intention to deliver. In the case of trading, the seller Ripetto intended at the time of the contract to deliver the wheat and the buyer to accept it. In the gambling case, the seller Alewine did not intend to deliver. 

Sunday Contracts

The laws pertaining to Sunday contracts resulted from statutes and judicial interpretation. They vary considerably from state-to-state. Most states have repealed their statutes that had made Sunday contracts illegal. The violators of Sunday acts are seldom prosecuted. For this reason the types of transactions one observes being carried on Sunday do not necessarily indicate restrictions imposed by these laws.

Usurious Contracts

State laws that limit the rate of interest that may be charged for the use of money are called usury laws. Frequently there are two rates: the maximum contract rate and the legal rate. The maximum contract rate is the highest rate that may be charged; any rate above that is usurious. In some states this rate fluctuates depending on the prime rate. The legal rate, which is a rate somewhat lower than the contract rate, applies to all situations in which interest may be charged but in which the parties were silent as to the rate. If merchandise is sold on 30 days credit, the seller may collect interest from the time the 30 days expire until the debt is paid. If no rate is agreed upon in a situation of this kind, the legal rate may be charged.

The courts will treat transactions as usurious when there is in fact a lending of money at a usurious rate even though disguised. Such activities as requiring the borrower to execute a note for an amount in excess of the actual loan and requiring the borrower to antedate the note so as to charge interest for a longer period than that agreed on could make a loan usurious.

The penalty for usury varies from state-to-state. In most states the only penalty might prohibit the lender from collecting the excess interest. In other states the entire contract is void, and in still others the borrower need not pay any interest but must repay the principal. If the borrower has already paid the usurious interest, the court will require the lender to refund to the borrower any money collected in excess of the contract rate.

In all states special statutes govern consumer loans by pawnbrokers, small loan companies, and finance companies. In some states these firms may charge much higher rates of Interest. 

*SOURCE: LAW FOR BUSINESS, 15TH ED., 2005, JANET E. ASHCROFT, J.D., PGS. 102-105*

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