3. Contracts Rendered Illegal by Statute

3. CONTRACTS RENDERED ILLEGAL BY STATUTE

What if a contract infringes legislation? Again Kirby J in Fitzgerald suggests that a contract might infringe both public policy and legislation. In that case he recommends that the question of statutory infringement be considered first.

Some contracts are expressly prohibited by statute. If so, the courts will not uphold the contract in any way.

In Re Mahmoud and Ispahani [1921] 2 KB 716 - here an Order made under the Defence of the Realm Regulations prevented the sale of linseed oil without a licence. Briefly the relevant part of the legislation provided as follows:

"Until further notice a person shall not buy or sell or otherwise deal in ... any [linseed oil] except under and in accordance with the terms of a licence issued by or under the authority of the Food Controller.

The plaintiff seller sold linseed oil to the defendant who did not have the necessary authority from the Food Controller. The defendant refused to accept the goods and argued that the statute prohibited the contract and that therefore the court could not enforce it.

The court held that the contract was illegal because the statute expressly prohibited it. You can tell that by the words “shall not sell” shall not buy”. The vendor plaintiff could not enforce the contract even though it was innocent and the defendant was able to rely on its own illegal act to defend the action. But at least the goods had not been delivered .If the purchaser had accepted delivery and then refused to pay the plaintiff vendor could not have recovered the price and the defendant would have been enriched at the plaintiff’s expense.

An example is Australia is section 45 (2) of the Trade Practices Act that says:

“A corporation shall not ... make a contract ... if the provision of the proposed contract arrangement or understanding ... would have or be likely to have the effect of substantially lessening competition”.

Can statutes impliedly prohibit contracts? 2

Difficulties can arise when the statute, on the one hand, imposes a penalty or a fine on persons who act in contravention of its provisions but, on the other hand, remains silent about the status of contracts which may have been created in the course of those acts. So when does a statute impliedly prohibit a contract?

The fundamental principle in assessing the effect of statute law upon contracts is whether the statute intended to affect contracts and make them void. Was Parliament intending to penalize the specific conduct mentioned in the statute or was it also intending to go further to deprive the contracting party the benefits under the contract? Further, did Parliament intend by its statute that both parties be deprived of their contractual rights or only the party committing the wrongful act? Justice Mason said in Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd (1978) 139 CLR 410

“Where as here, as statute imposes a penalty for contravention of an express prohibition against carrying on a business without a license or an authority and the business is carried on by entry into contracts, the question is whether the statute merely intends to penalize the person who contravenes the prohibition or whether it intends to go further and prohibit contracts the making of which constitute the carrying on of the business” (at 426)

So how do you know whether the statute intended such a result? The court will use the rules of statutory interpretation to ascertain the intention of the legislation. Consider the words of then Acting Chief Justice Gibbs in Yango Pastoral case,

“The question whether a statute, on its proper construction, intends to vitiate a contract made in breach of its provisions, is one which must be determined in accordance with the ordinary principles that govern the construction of statutes”.

The following cases illustrate the approach taken by the courts when the relevant statute is silent about the fate of contracts formed or performed in contravention of its provisions. There is a slow change beginning with Yango in the philosophy of the judges in declaring a contract illegal impliedly by statute, especially since Fitzgerald v FJ Leonhardt Pty Ltd (1997) 189 CLR 215 at 243. 3

In the case of Yango Pastoral Co Pty Ltd v First Chicago Australia Ltd in the casebook at 1110, First Chicago lent to Yango the sum of $132, 600 secured by a mortgage and a guarantee. After Yango defaulted on the repayment of the loan, First Chicago sought to recover on the guarantee. In defence, the appellants argued that the mortgage and guarantee were illegal and void because they contravened s 8 of the Banking Act 1959 (C'th). That provision prohibits the carrying on of banking business without being authorised to do so and at the time provided for a penalty of $10,000 for each day during which the contravention continues. As the parties agreed that First Chicago was in breach of s 8, the real question concerned the status of the mortgage and guarantees.

A unanimous High Court of Australia found that the contracts were both valid and enforceable. The court held that s 8 did not expressly or impliedly prohibit the loan made by the respondent. The court took into account the fact that a finding that s 8 invalidates a contract made with the unauthorised 'bankers' would mean 'that persons who had deposited money with such a body corporate would be unable to seek the assistance of the courts to recover it. Moreover, if a body corporate were unable to recover money that it had lent, it would be disabled from performing its own obligations, including those owed to its depositors' (at page 3 of the report). The court also noted that the penalty imposed by s 8 was calculated on the number of days the contravention continued, and not on the number of transactions made. In the court's view, this was an indication that the legislature was more concerned with preventing unlicensed trading than with prohibiting each contract which resulted from that trading.

Is Yango a case of reasoning backwards? If the contract is illegal neither party could enforce the invalid contract between the bank and its depositors which would have drastic commercial consequences so that contract had better remain valid. In the case Justice Mason said

“In deciding the question the court will take into account the scope and purpose of the statute and the consequences of the suggested implication with a view to ascertaining whether it would conduce to, or frustrate, the object of the statute” (at 426)

By contrast, consider the WA case of Alliance Acceptance Co Ltd v Vella (1985) 2 SR (WA) 355 - the respondent Vella leased several amusement 4 machines from the appellant, a finance company. A term of the lease provided that if the lessee defaulted under the agreement it was liable to pay the lessor a sum equal to the residual value of the machines. Vella defaulted so the appellant claimed the amount so calculated. By way of defence, Vella argued that as the contract was for the lease of goods whose use was prohibited under s 89A of the Police Act 1892 (WA), consequently it was an illegal contract and, as such, the money claimed by the appellant pursuant to the contact was not recoverable. The court agreed, even though s 89A did not expressly prohibit the making of such contracts. In the words of Heenan CJ DC (at page 391 of the report:

'The question that arises is: Did the parties deliberately enter into the contract in order to do a prohibited act? In my opinion, the question must be answered in the affirmative. The prohibited act was the use or possession of the machines and the whole purpose of the contract was to give to the defendant both use and possession. Conscious as I am of the need for a court to be slow in holding that a statute intends to interfere with the rights and remedies given by the ordinary law of contract ... I am satisfied that the contract was illegal at its formation. [Furthermore] it is no answer for the plaintiff to say that it did not know the law on the matter'.

Note the emphasis on the words “at its formation”. So now we look at several cases where the judges said entering into a contract was legal, but then there was an argument about illegality because of the way the contract was performed. Devlin J in St John’s Shipping said:

“There is a distinction … between a contract which has as its object the doing of the very act forbidden by the statute, and a contract whose performance involves an illegality only incidentally.”

The same principles apply where the statute dictates the way in which a contract is to be performed. The statute may expressly indicate the consequences that will flow from a mis-performance of the contract. For eg. under the NSW Credit legislation, if a credit provider fails to give the borrower certain information the credit provider is liable to a penalty but also the legislation impacts upon the contract because it says the borrower does not have to pay the credit charge. 5

Where the statute does not indicate the consequences that will flow from a mis- performance of the contract, the courts will have to decide the matter and, as before, they will have to ascertain the true purpose of the statute.

Consider the English case of Anderson Ltd v Daniel [1924] 1 KB 138 - here the English Court of Appeal had to decide the effect of non-compliance with a statute which provided that every sale of artificial fertiliser had to be accompanied by an invoice which stated the percentages of certain chemicals found in the fertiliser. The statute merely provided for a penalty for breach. The court held that, given the nature of the contracts covered by the statute, the legislature intended that the contracts be invalidated for mis-performance. So given this fact, the court would not allow the party guilty of contravening the statute the right to enforce the contract.

Of course, the mis-performance must be substantial before a court will declare the contract illegal. Consider the English case of St John Shipping Corporation v Joseph Rank Ltd [1957] 1 QB 267. Here the contract was between a cargo owner and shipper. The ship was overloaded in breach of the Merchants Shipping (Safety and Load Limits Convention) Act 1932. The shipper alleged the contract was voided by this statutory illegality. Devlin J held the contract was not voided because the contract was one of a type where the illegality was of collateral or incidental and not a central character and the courts are reluctant to strike down such contracts. The overloading was not intended by the parties as the means of performing the contract.

Hence the contract for freight was enforceable. The overloading of the ship was only an incidental part of the contract of freight. According to the court, Parliament did not intend to make this contract void, so the shipowners, even though they were the guilty party, could enforce the contract.

There are other cases listed in the course outline to illustrate statutory illegality - various "tests" have been applied by the courts to determine legislative intention.

Consider the NSW case of Dalgety and NZ Loan Co v C Imeson Pty Ltd [1964] NSWR 638 - Here the Plaintiff company auctioned 6 cows but one had tuberculosis (and of course there is legislation which prohibits the sale of diseased cattle). The Defendant meat company argued it did not have to pay for its purchase, as there was an illegal contract. On appeal the court found for 6 the vendor on the basis that the statute was intended only to apply a discretionary penalty and not to render a contract (where both parties did not know of the facts giving rise to the illegality) void for illegality - so the relevant consideration was the innocence of the parties and the fact that voiding the contract would produce commercial uncertainty (could not know of the disease until cow slaughtered).

Of course a different result would ensue if vendor knows of the illegality. For example consider the Queensland case of Buckland v Massey [1985] 1 Qd R 502 - here the vendor sold a car without a roadworthiness certificate as required by law. Purchaser refused to pay over the balance of the purchase price. The court held that the contract was unlawful and unenforceable.

To summarise this first category it appears that the cases we have considered have been of 2 types - they are either

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(1) illegal as formed - ie. the vitiating factor operates at the time of formation - eg. Aliance Acceptance v Vella, or (2) illegal as performed - ie. the contract is legal at formation but while it is "on foot" (ie. being performed), a factor rendering it illegal comes into play - eg. Anderson v Daniel.

The factors stressed by the court in working out legislative intention are -

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1. Wording of the statute – see Mahmoud v Ispahani 2. Primary aim of the legislation - if public safety, then a contravention is likely to make the contract illegal, but if the primary aim is e.g., to raise revenue then the contract will not be illegal. Authority is Smith v Mawhood (1845) 14 M and W 452. A statute prohibited sale of tobacco by vendors who did not have a licence. The sale contract was legal despite the vendor not having a licence. 3. Penalty test –What conduct does the statute penalize? What is the form of the penalty? Obviously the outcome depends upon the severity of the penalty. If the penalty is "light" and / or 7

discretionary, then that might indicate the intention that the penalty be the full extent of the legal sanctions applying - ie. status of contract not effected (eg. Dalgety case). Alternatively a statute might provide a heavy penalty worked out on a continuing basis eg $10,000 per day – The judges said in Yango that because it was a continuing penalty that indicated Parliament intended the penalty to be the main focus - not the contract itself. Kirby J said in Fitzgerald v Leonhardt at 244 that a finding of illegality in Yango would have deprived the parties of contractual rights which “might be enormous, supplementing in a wholly arbitrary way the defined penalties for which the legislature has expressly provided”. 4. Innocence/guilty knowledge of party relying upon defence (Buckland v Massey). 5. Commercial convenience (Dalgety and Yango cases again). 6. Central or collateral conduct to the performance of the contract - (St John Shipping Corporation).

Now let’s move to the last major illegality category.

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4. CONTRACTS RENDERED VOID BY STATUTE For various reasons, the legislature has chosen to deprive particular contracts of their legal efficacy rather than prohibit them outright. In such cases, the contract is rendered void, not illegal.

A current “void” example is section 68 of the Trade Practices Act 1974 which renders void any term in a contract with a consumer which tries to exclude implied warranties.

So, while some statutes render the contract totally void for all purposes, other statutes eg are more limited in their application. Another example, are statutes which render a contract void but only against certain persons. For instance, s 260 of the Income Tax Assessment Act 1936 (C'th) provides as follows:

'Every contract, agreement, or arrangement made or entered into, orally or in writing, whether before or after the commencement of this Act, shall so far as it has or purports to have the purpose or effect of in any way, directly or indirectly - 8

(a) altering the incidence of any income tax; (b) relieving any person from liability to pay any income tax or make any return; (c) defeating, evading, or avoiding any duty or liability imposed on any person by this Act; or (d) preventing the operation of this Act in any respect be absolutely void, as against the Commissioner, or in regard to any proceeding under this Act, but without prejudice to such validity as it may have in any other respect or for any other purpose' (emphasis added).

Consequently, as far as the Commissioner of Taxation is concerned, the contract, agreement or arrangement is void; but vis-a-vis persons other than the Commissioner, the contract, agreement or arrangement remains valid.

Similar provisions apply under the Duties Act 1997 (NSW)

Well, now we have finished covering the 4 major categories of illegality. Remember they were-

contracts illegal by statute contracts void by statute contracts illegal by common law contracts void by common law.

So once a finding has been made by the court that some type of illegality doctrine affects a particular type of contract or term within the contract, what then results. Several results are available depending upon whether the court decides the illegality is serious and the contract should be void in toto or less serious so only a bit of the contract is void or unenforceable only by the party responsible for the illegality.

Although I have divided discussion into 2 distinct sections – finding illegality and then looking at its effects, remember that often the judges in fact (and the more modern approach suggests this is the way to go) look at the effect a finding of illegality would make on the likely remedy and so then do not find illegality if it would harm a party unfairly or in reality defeat the very purpose of the legislation targeting the prohibited conduct.. 9

Now we will combine the categories to look at general effects of a finding of illegality either by statute or by the common law

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1. EFFECTS OF A CONTRACT BEING HELD TO BE ILLEGAL BY STATUTE OR BY COMMON LAW

There are 2 sub-categories to consider - illegal as formed and illegal as performed.

A. Illegal as formed

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If contract is illegal as formed ie. where the making of the contract is expressly or impliedly prohibited by statute it is void ab initio - Re Mahmoud and Ispahani [1921] 2 KB 716. Remember ex turpi causa non oritur actio (no cause of action arises from a base cause)

This means that neither party has any rights under the contract so the courts will not enforce the contract by either party.

So  no damages for breach  no right to recover an amount due under the contract, eg, a progress payment  no specific performance granted  no injunction to enforce a negative covenant, eg, a restraint of trade  no equitable remedies such as rectification  no return of money or property already transferred

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 no return of money or property

If property was transferred under the illegal contract to eg, the purchaser, the purchaser does not have to return it (even if he has not paid for it) as the vendor cannot enforce his right to payment under this illegal contract - so the purchaser makes a windfall gain, or the opposite, where the purchaser has paid over the 10 money in advance but got nothing for it the vendor gets to keep the money and makes a windfall gain. This follows a general rule, which is summarised in a Latin maxim - In pari delicto portior est conditio possidentis.

This means that where both parties to a transaction are equally at fault, property should remain with the party who has possession of it when the matter is disputed. An example of this result is Newcastle District Fisherman’s Co- operative Society v Neal (1950) 50 SR (NSW) 237.

Well this does not seem to be fair or just.

So naturally to get around this perceived injustice, there are certain exceptions. These exceptions allow the plaintiff to recover money, chattels or land transferred to the defendant pursuant to an illegal contract in the following circumstances. This list comes partly from McHugh J in Nelson v Nelson (1995) 184 CLR 538 at 608. The basis of these exceptions is that the Court thinks that really the parties are not equally at fault. McHugh said (at 613):

“The sanction of refusing those rights (to sue for damages) is not disproportionate to the seriousness of the unlawful conduct” the exceptions are

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 mistake of fact - David Securities Pty Ltd v Commonwealth Bank of Australia (1992) 175 CLR 353  independent cause of action  False statements  purpose of statute is to protect class of persons

Independent right

Where the plaintiff asks for relief by arguing its cause of action based upon an illegal contract, it cannot expect the court to grant relief. But if in a situation where possession but not title has been transferred, a party can base its claim on a legal right completely independent of the illegal contract, then it may obtain 11 relief such as tortuous damages. This principle is sometimes referred to as the “no reliance” principle.

In Bowmakers Ltd v Barnet Instruments Ltd (1945) 1 KB 65, Barnet sued Bowmakers for tortious damages for conversion. The plaintiff had transferred machinery tools to the defendant under an illegal hire purchase agreement. The defendant had kept some and sold some and refused to return the tools. It argued that the tools did not have to be returned as the contract was illegal under statute. The court held the plaintiff could sue in tort and not mention the illegal contract.

The Court said

“ In our opinion, a man’s right to possess his own chattels will as a general rule be enforced against anyone who, without any claim of right, is detaining them or has converted them to his own use, even though it may appear either from the pleadings, or in the course of the trial, that the chattels in question came into the defendant’s possession by reason of an illegal contract between himself and the plaintiff, provided that the plaintiff does not seek, and is not forced, either to found his claim on the illegal contract or to plead its illegality in order to support his claim”.

In Tinsley v Milligan [1994] 1 AC 340 the English court re-emphasized the no reliance principle from Bowmakers with Lord Browne – Wilkinson stating (at 370) “property in chattels and land can pass under a contract which is illegal and therefore would have been unenforceable as a contract… a plaintiff can at law enforce property rights so acquired provided that he does not need to rely on the illegal contract for any purpose other than providing the basis of his claim to a property right”

This case has been later criticised by tort lawyers as not fulfilling the conversion or detinue criteria of satisfactorily proving the right to immediate possession of the tools. More importantly, in Nelson v Nelson (1995) 184 CLR 538 McHugh remarked that Bowmakers had relied on a procedural point of how you plead your cause of action rather than merit. He said:

“A doctrine of illegality that depends upon the state of the pleadings or the need to rely on a transaction that has an unlawful purpose is neither satisfactory nor 12 soundly based in legal policy. The results produced by such a doctrine are essentially random and produce windfall gains as well as losses, even when the parties are in pari delicto… the Bowmakers rule has no regard to the legal and equitable rights of the parties, the merits of the case, the effect of the transaction in undermining the policy of the relevant legislation or the question whether the sanctions imposed by the legislation sufficiently protect the purpose of the legislation. Regard is had only to the procedural issues: and it is that issue and not the policy of the legislation or the merits of the parties that determine the outcome. Basing the grant of legal remedies on an essentially procedural criterion which has nothing to do with the equitable positions of the parties or the policy of the legislation is unsatisfactory, particularly when implementing a doctrine that is founded on public policy”.

The High Court in criticising Bowmakers as too inflexible has said that the real issue should be whether protection of the public is better served by allowing recovery of property than by disallowing it.

False Statement

Here equity will help if the plaintiff has been a victim of fraud, duress, undue influence or unconscionability by the defendant in relation to the contract.

The authority is the High Court decision of George v Greater Adelaide Land Development Co Ltd [1929] 43 CLR 91 (at 101). A person entering into an illegal contract because of the other’s fraud, who rescinds upon hearing of the unlawfulness, preserves his or her rights. Here the parties are not equally blameworthy (ie not in pari delicto) and the party seeking recovery is considered more innocent. Again the innocent party is not really arguing breach of contract. It is using another cause of action such as fraud, negligence, breach of s 52 of the Trade Practices Act or breach of a promise in a collateral contract.

Class of persons Where the object of the legislation in declaring the contract illegal is to protect a class of persons and the plaintiff is a member of that class that party can still recover property. In Kiriri Cotton Co. Ltd v Dewani [1960] AC 192 a tenant paid extra money to secure a flat, but Ugandan rent restriction legislation said this was illegal (it was a form of queue jumping for low income earners trying to gain accommodation) Despite the contract being declared illegal, the tenant 13 could get his money back as he was in the class of persons the legislation was trying to protect. The legislation aimed at stamping out exploitation of tenants by landlords when there was a housing shortage.

The 2nd sub-category is effect on contracts that are held to be illegal as performed.

B. Contracts illegal as performed.

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Where a contract is illegal because it is not performed as required by statute, the rights of the parties depend upon their role, if any, in the mis-performance. A party responsible for the illegality has no remedy. On the other hand, an innocent party has the normal remedies open to it. It can, for example, sue to recover damages for breach of contract or to recover money or other property that it transferred to the other party pursuant to the contract.

Thus, in Marles v Philip Trant and Sons Ltd v Mackinnon Third Party [1954] 1 QB 29, the defendant sold to the plaintiff a quantity of wheat as spring wheat. It was, in fact, winter wheat, and when the crop failed, the plaintiff sued for breach of contract. His action was successful, even though the sale was illegal as it contravened the Seeds Act 1920 (UK) in that the seller did not provide an invoice with the wheat when delivered. The Court of Appeal held that the illegality rendered the contract unenforceable by the defendant; the plaintiff, being an innocent party, retained the right to sue. In the words of Denning LJ at page 36-37 of the report:

‘There can be no doubt that the contract between the seed merchants and the farmer was not unlawful when it was made. If the farmer had repudiated it before the time for delivery arrived, the seed merchants could certainly have sued him for damages. Nor was the contract rendered unlawful simply because the seed was delivered without the prescribed particulars. If it were unlawful, the farmer himself could not have sued upon it as he has done. The truth is that it was not the contract itself that was unlawful, but only the performance of it. The seed merchants performed it in an illegal way in that they omitted to furnish the prescribed particulars. That renders the contract unenforceable by them, but it does not render the contract illegal’. 14

So here the court is talking about illegality of performance, but imposing a result of unenforceability only upon the guilty party. Hence the contract is not void ab initio.

Exceptions to non-return of property by guilty party

The exceptions referred to above in formation illegality also apply to performance illegality. In addition there is another exception:

 repentance before execution of illegal conduct

If the transferor repents before there has been a substantial degree of performance of the illegal contract then recovery of property is permissible. What constitutes substantial performance is a question of fact depending upon the circumstances of the particular case.

In Clegg v Wilson [1932] 32 SR (NSW) 109 in the casebook at 1154 - the plaintiff claimed rescission of a contract in which the defendant said he would refrain from giving evidence in a criminal trial against her son in return for transfer to him of her house. Before the trial, she sought recovery of the house. Long Innes J said (at 125)

“While the illegal purpose remains wholly executory, this court should grant equitable relief by ordering the repayment of money paid, goods delivered, or property transferred to the defendant pursuant to the contract, notwithstanding that there is an element of turpitude in the contract, and that both parties are in pari delicto”.

What was interesting in that case was the fact that the plaintiff only repented because the contract had been frustrated as the police had abandoned the prosecution –so repentance does not have to have a subjective element attached to it.

MODERN APPROACH TO RETURN OF PROPERTY

The exceptions referred to are from traditional cases. The High Court has signalled a more liberal approach can now be considered. In Fitzgerald v F J Leonhardt Pty Ltd, Fitzgerald, a contractor, drilled 5 water bores believing that 15 the owner had obtained the necessary licences under the Water Act. The Act said “a person shall not unless authorized under the Act permit a bore to be drilled (fine $5000)”

The owner had only obtained 2 licences. In an action by the driller to get paid, the owner as defendant argued an illegal contract by legislation. Traditionally, if the court found the contract was illegal at formation due to non- compliance with the legislation (eg, as in Mahmoud v Ispahani) the court would rule the contract void and neither party, including the innocent driller, could enforce. Hence the owner would make a windfall gain at the expense of the driller. The court found that the contract formed or performed was not prohibited by the legislation.

The second issue before the court was as a matter of public policy whether the court should decline to enforce the contract on the ground that it was associated with an illegal activity. The court held that the driller’s actions were insufficiently associated with the owner’s breach of the Act. The drilling contractor could recover as denying a remedy would be disproportionate to the seriousness of the offence. In deciding whether the contractor could recover his expenditure McHugh and Gummow JJ advocated a more flexible approach. The court adopted the approach suggested by McHugh J in Nelson v Nelson who said that you should enforce a contract (or at least allow a claim for return of money or property) unless:

 statute expressly indicates the intention of parliament is to make the contract unenforceable in all circumstances or  non-enforcement is proportionate to the seriousness of the unlawful conduct and  non-enforcement is necessary to protect the object of the legislation and  statute by implication disclosures an intention that the sanction under the statute is not to be the sole sanction

The court found that object of the Water Act to control the right to bore for water was sufficiently protected by the fine.

To summarise, Kirby, Toohey, Gummow and McHugh JJ found for the driller as otherwise the owner would obtain a windfall gain of 3 free water bores at the 16 expense of the driller and such no- enforcement of the contract would be disproportionate to the seriousness of the offence.

2. Contracts void by statute or by common law

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Remember a statute might say directly that a contract is void eg. Trade Practices Act section 45. The only effect of such a declaration is that the agreement cannot be enforced. The parties may perform it if they wish but enforcement is left to their sense of honour. Money or property transferred under it is normally recoverable by the transferor. But you must look to the particular statute to see if the statute limits rights.

Remember sometimes the statute only makes a contract void eg against the Commissioner of Taxation. The parties can enforce the contract amongst themselves.

Sometimes a statute only knocks out one term but leaves the rest in tact.

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SEVERABILITY

The contract may not be void in toto; it is void only as far as is necessary to remove the affront to public policy as revealed by common law or statute. Accordingly, for example an objectionable restraint on an employee will not prevent the employee or employer exercising the normal contractual rights available to them in such contracts; merely remove the restraint of trade clause.

The court may remove the objectionable term. See Thomas Brown and Sons Ltd v Fazal Deen (1962) 108 CLR 391. There are 3 broad tests to be satisfied before a term of a contract can be severed.

1st the nature of the illegality must not taint the contract as a whole - ie. the illegality must be of a relatively minor degree of moral turpitude eg. restraint of trade clause rather than a clause to commit murder (remember we are in the category of effects of finding a contract is void rather than illegal). 17

In North v Marra Developments Ltd (1981) 148 CLR 42 a stockbroker helped his client inflate the market price of stock involved in a company the subject of a take over by buying shares on the stock market to inflate the price. When the stockbroker sued the client company for unpaid fees the court held the stockbroker’s actions in the market were illegal and could not be separated or severed from the remainder of work undertaken by the stockbroker under the contract with the client. In Amoco Australia Pty Ltd v Rocco Bros Motor Engineering Co Pty Ltd (1973) 133 CLR 288 the restraint of trade clause was also held to be an integral part of the lease so could not be severed.

2nd, severance cannot occur where what would be severed is a substantial part of a party’s consideration. If you wipe out the offending term, then there will be no consideration for the opposite promises. In Brooks v Burn Philp Trustee Co (1969) 121 CLR 432, the wife’s promise not to sue for maintenance was linked to the reciprocal promise of the husband to pay voluntary maintenance. Since the wife’s promise was held to be void as it attempted to oust the jurisdiction of the court, it could not be severed from the contract as it was the consideration for the reciprocal promise from the husband.

3rd, the term must be severable in the technical sense. The term will only be severable if its elimination does not change the nature of the contract but only its extent. If the elimination of the offending term would leave the contract meaningless, severablity is not technically possible. To restate, the court will not rewrite the contract. This is sometimes referred to as the blue pencil test.

As an adjunct to this test, it may be that only part of a term offends so may be severed. In that case the term must consist of “divisible” parts so that the offending part can be severed leaving the balance of the term still meaningful. eg, “any other business” in the Nordenfelt case. That part was held to be unreasonable but the rest of the clause was ok.

In Thomas Brown and Sons Ltd v Fazal Deen [1962] 108 CLR 391-casebook p1143 the contract was of bailment where the plaintiff deposited with the defendant gems and gold bars. At the time a statute prohibited private citizens from keeping gold. The defendant refused to return the property alleging illegal contract. HC held it was illegal and unenforceable in respect of the gold but not the gems so that part of the contract of bailment relating to gems could be severed and enforced. 18

So to summarize, severance can only be used if available to delete a term, that is, cross it out with a blue pencil, not rewrite it.

In New South Wales, the common law rules in regard to severing the objectionable portion of an otherwise valid restraint of trade stipulation are subject to the Restraints of Trade Act 1976. It was found that the common law rules above often led to prolixity ie. the clauses were drafted broadly with riders - if the court finds this restraint of trade unenforceable then the following clause will apply. So the parties never knew unless they went to court which variation of the restraint of trade clause was the correct one. So legislation stepped in. This Act provides that a restraint of trade is valid to the extent to which it is not against public policy whether or not it is in severable terms: s 4(1).

Therefore, if a restraint of trade term is unreasonable it will be enforceable up to the point at which it would become unreasonable eg. if restriction for 15 years but 5 is reasonable, court will enforce the provision for up to 5 years.

The courts can also recast the restraint to make it reasonable, ie. It is not merely confined to striking out words. But the ability to rewrite under section 4 is limited by subsection 3 of that section which says that the court cannot rewrite if the party had made no attempt to make the term reasonable in the first place - Orton v Melman [1981] 1 NSWLR 583.

SUMMARY RE POLICY OF ILLEGALITY

Illegality law is messy! In England the judges tried to clean it up by instituting a broad test called the “public conscience” test. The test was whether it would is an affront to public conscience to grant the relief sought. So it would be a balancing test of the consequences of granting relief weighed against the consequences of refusing relief. But in Tinsley v Milligan [1994] 1AC 340 the House of Lords thought this discretionary test created too much uncertainty so rejected it. The English position therefore remains with the non-recovery principle unless Bowmakers can be used.

Is our High Court heading for more flexibility after Nelson v Nelson and Fitzgerald? Will the court increasing lean towards using the law of restitution and unjust enrichment to have discretion to craft the appropriate balance between enforcing public policy and allowing freedom of contract? 19