I Fought the Law and Everyone Lost: Rescinding Commercial Contracts for Illegality

Could Pablo Escobar sue for breach of contract? Can a Tony Soprano get an agreement enforced by court order? You might think that in a commercial lawsuit, if a party admits having intended to break the law, their case is over. However, the reality is much more nuanced.

In dismissing a recent appeal, the B.C. Court of Appeal (BCCA) confirmed that the courts have a broad discretion over whether or not to enforce contracts entered into for an illegal purpose. That may include deals structured to mislead or disadvantage third parties, such as lenders, investors, or tax authorities.

The case, Youyi Group Holdings v. Brentwood Lanes Canada, concerned a dispute over the sale of the REVS Bowling Centre in Burnaby. The owner agreed, in a collection of commercial agreements, to a sale and lease-back arrangement for around $30 million. Subsequently, new zoning opportunities for the site became available, dramatically increasing the bowling centre’s value. The vendors sought to rescind the agreements, claiming that: (1) the purchasers and a joint agent had conspired to mislead the vendors about the zoning; and (2) the various sale agreements and documents contained provisions designed to mislead third parties. The purchasers vehemently disagreed that the vendor could rescind the agreements and sued for specific performance.

After a 77-day trial, which the trial judge described delightfully as a “festival of deceitfulness”, the court refused to enforce the agreements, essentially awarding the vendors a huge windfall. The trial judge found that the parties had structured the documents to inflate the sale price, mislead investors, and artificially increase rent in order to mislead mortgage lenders. The appeal centred on the defence of illegality, or ex turpi causa: where an agreement is illegal, or has an illegal purpose, a court can refuse to enforce it.

The BCCA upheld the trial judge’s findings that the contracts should not be enforced. In doing so, the BCCA rejected two technical arguments advanced by the purchasers by: (1) refusing to consider the legality of each different contractual document separately (as they were all part of the same illegal transaction); and (2) rejecting the “reliance rule”. The reliance rule stems from old English case law, and holds that the illegality defence only applies where a plaintiff has to rely on the illegal contract in order to plead its case. The BCCA rejected this approach, finding instead that the modern Canadian approach is broader and more purposive. In short, the courts are not to be hamstrung by technical contractual arguments where there is an overarching concern for illegality, however that may manifest itself in any particular case.

Both findings are important. The BCCA expressly safeguarded the courts’ wide discretion to deal illegality, and signalled a move away from a traditional or doctrinal analysis. Similarly, the BCCA confirmed that the decision of whether or not to enforce an illegal contract or a contract that is tainted by illegal purpose is entirely a matter of discretion for the trial judge based on the findings of fact made in each particular case. As a result, the BCCA refused to disturb this trial judge’s findings or conclusion. The BCCA also rejected the vendors’ cross-appeal, refusing to overturn the trial judge’s finding that there was insufficient evidence of a conspiracy to deceive the vendors in relation to zoning.

Key takeaways:

  • where a party is seeking to enforce a potentially illegal contract against you, that illegality may provide a full defence;
  • the BCCA affirmed that illegality is treated on a principled basis, and technical rules of legal construction no longer apply to constrain the court’s discretion;
  • accordingly, trial judges have significant discretion over both a finding of illegality and the resulting remedy;
  • appealing such decisions, based on factual findings and discretion, will be very difficult; and
  • if a party enters into an agreement where there is even a partial illegal purpose, it runs a serious risk of being unable to enforce any aspect of that agreement.

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