Tag: illegality

Illegality Defense Doesn’t Defeat HVAC Subcontractor’s Damage Claim Versus General Contractor on Chicago Transit Authority Project (N.D. 2015)

I’ve written before on the illegality defense to breach of contract suits.  It’s bedrock contract law that an agreement to do something criminal (example – murder, arson, selling drugs, etc.) is unenforceable against the person who doesn’t perform (example: if I fail to pay a hit man, he can’t sue me for the $). 

The illegality defense also applies in the civil context where it can defeat an agreement that runs afoul of a State or Federal statute.  The policy underpinning for the illegality rule is that it would make a mockery of the justice system if you could sue to enforce an agreement to commit a crime.

Energy Labs, Inc. v. Edwards Engineering, 2015 WL 3504974 (N.D.Ill. 2015) examines contractual illegality in the context of a high-dollar subcontract to supply HVAC equipment to the Chicago Transit Authority (CTA).

The plaintiff air conditioning parts subcontractor was hired by the defendant to provide parts in connection with the defendant’s contract with the CTA.  When the defendant found out that plaintiff was procuring its parts in a foreign country, it cancelled the contract since the Buy America Act, 49 U.S.C. s. 5323 (“BAA”) required the parts used in the CTA project to be made in the U.S.

Plaintiff sued to recover damages resulting from the defendant’s contract cancellation since plaintiff had already designed and started making the HVAC parts.  Defendant moved to dismiss on the basis that the contract was illegal since it violated the BAA.

The court denied the motion to dismiss.  While the general rule is that a contract that violates a Federal statute is normally unenforceable, the court said the rule isn’t automatic.  Instead, the court considers the “pros and cons” of enforcing the putative illegal contract taking into account the benefits of upholding the contract against the drawbacks of doing so.

Even if a contract isn’t illegal, a Federal court can still refuse to enforce it when doing so would violated a clear congressional goal or policy. 

Illegality also applies where a contract isn’t illegal on its face but requires a contracting party to commit an illegal act carrying out its obligations. 

To determine whether a contract violates a Federal statute, the court compares the four-corners of the contract to the statutory text and any interpreting case law.(*3).

Here, the court found that the contract wasn’t explicitly illegal.  The purchase orders submitted by the general contractor defendant didn’t require it to pay for plaintiff’s services with Federal funds.  The defendant was free to pay the plaintiff with its own funds; not the government’s. 

In addition, the BAA doesn’t outlaw the sale of all foreign-made air conditioning units to government agencies like the CTA.  It instead only applies to projects that are paid for at least in part with Federal funds.  As a consequence, the contract wasn’t illegal on its face.

Next, the court rejected the defendant’s argument that allowing plaintiff to enforce the contract violated public policy.  In the procurement contract context, where there is a mandatory contract term that is based on a strong Federal policy, this policy is read into the contract by operation of law. 

However, this so-called Christian doctrine1 only applies to parties that contract directly with the government; not to subcontractors like the plaintiff.  This is because subcontractors contract with general contractors, not with the government. 

To impose a Federal procurement edict on a subcontractor who often doesn’t even know he is contracting for government work is plainly unfair. (*5).

Afterword:

An interesting discussion of the illegality defense in somewhat arcane context of Federal procurement rules.  The court gave a constricted reading to the illegality rule and looked at the underlying fairness if the contract was defeated. 

The fact that the plaintiff performed extensive work before termination figured heavily in the court’s analysis.  Another key ruling is that only general contractors, not subcontractors like the plaintiff here, have the duty to inquire into applicable procurement requirements.

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1.  G.L. Christian and Associates v. United States, 312 F.2d 418 (1963).

Contractual Illegality and Medical Fee-Sharing

A contract law axiom states that an illegal contract is unenforceable.  The prototypical example involves a plaintiff attempting to sue on a contract that violates a statute or encourages criminal or fraudulent conduct.  Those situations clearly give rise to an illegality defense.  But what if a contract term technically violates a statute, but the resulting damage is either trivial or nonexistent? A “no harm no foul” situation.  Can the illegal contract term still be enforced?

That’s one of the questions the First District recently addressed in Ritacca v. Girardi, 2013 IL App (1st) 113511 (Sept. 2013), where a plaintiff physician sued to enforce a settlement agreement stemming from an earlier, illegal fee-sharing agreement with two of his former business partners.

After the plaintiff paid over $60,000 to settle a lawsuit filed by an equipment lender (suing on loans which were the parties’ joint responsibility), he sued his two former business partners for reimbursement under a written agreement to operate a medical facility. 

Defendants moved for summary judgment on the basis that the written agreement was unenforceable since it called for doctors and non-doctors sharing profits. The trial court agreed and granted summary judgment for the defendants.

Holding: Reversed.  Plaintiff could enforce the agreement against the defendants.

Rules/Reasons:

The contract – that amended an earlier fee-splitting agreement – clearly violated the Illinois Medical Practices Act’s (the “MPA”) anti-fee-splitting section. 226 ILCS 60/22.2(a)(physicians and non-physicians are precluded from sharing professional fees).  The agreement involved improper fee-splitting between two doctors (plaintiff and one defendant) and a lay person (the other defendant) and so was facially illegal.  ¶ 9. 

However, the Court stressed that just because a new contract stems from an earlier illegal one, this doesn’t mean the later contract is always void. As long as the new/later contract isn’t a continuation or modification of the prior illegal contract, the new contract can be upheld.  ¶ 27.

Plaintiff’s suit was premised on a second agreement that made it clear that the underlying (and illegal) first agreement was dissolved and the parties were no longer conducting business.  ¶¶ 29-30.  This led the Court to find that the second agreement wasn’t a continuation or modification of the earlier illegal agreement.

The Court ruled that the two contracts were sufficiently remote in time and substance from each other so that the plaintiff could enforce the second agreement and seek money damages from the defendants. 

The Restatement of Contracts’ Balancing Test

The Court went further and held that even if the second Agreement was sufficiently intertwined with the earlier one, the Court would still enforce it.

In Illinois, a Court can void a contract if a public policy against enforcing the contract “clearly outweighs” upholding it.  ¶ 36.  The factors that weigh in favor of enforcing a contract that violates public policy include: (a) the parties expectations, (b) the forfeiture that would result if the contract ‘t enforced, and (c) the public interest in enforcing the contract. 

The factors weighing against enforcement are (a) the strength of the policy manifested by the legislature or judicial decisions, (b) the likelihood that refusing to enforce a contract term will promote that policy,  (c) the serious of the misconduct involved, and (d) the connection between the misconduct and the contract term.  Id.

Applying these factors, the Court held that if the latter contract wasn’t enforced, it would result in a $60K plus forfeiture by the plaintiff and unjust enrichment for the defendants – since defendants were jointly responsible for the loan. 

The Court also noted that the Medical Practice Act’s dual policies of (1) discouraging profit-seeking doctors from churning their services and (2) deterring non-physicians from recommending doctors out of financial self-interest weren’t served by voiding the second agreement as the parties had long ceased doing business together.  The Court ruled that the public policy against medical services fee-sharing didn’t “clearly outweigh” allowing plaintiff to sue on the second agreement.  ¶ 40.

Lessons: Ritacca emphasizes that a technical statutory violation won’t always result in a finding of illegality.  But if a facially valid contract continues or refers to an earlier illegal one, the “new” contract will be illegal and unenforceable.  By contrast, if that new contract is far enough removed from the prior contract in time and subject matter, the new contract can be enforced.