Illegal Contracts and Unjust Enrichment: Who Wins Out?
Posted in Commercial, Fraud

What is an illegal contract and is it enforceable?  If an illegal contract is unenforceable, does the party who received its benefit get to keep that windfall?  The short answer to the first question is that a contract is illegal when it is either contrary to a statute or is contrary to public policy.  Generally, illegal contracts are not enforceable.  The answer to the second questions is “it depends”.  Often, a court will decline to enforce an illegal contract but then find a remedy that deprives the party who received the benefit from profiting as a consequence of their participation in some illegal or immoral act. 

The case of Mr. Tsoi and Mr. Lai is a good example.  Mr. Lai ran an illegal mah-jong business and would lend money to his customers at outrageous interest rates.  Mr. Lai asked Mr. Tsoi to lend him $50,000 to fund these loans.  Mr. Tsoi agreed provided Mr. Lai paid him simple interest of 60% annually (Section 347 of the Criminal Code precludes interest greater than this).  For a time, Mr. Lai paid Mr. Tsoi the required interest but then stopped.  Mr. Tsoi sued for breach of the unwritten loan agreement and for unjust enrichment.

The first issue was whether Mr. Tsoi knew whether the loans would be used in the mah-jong business.  If so, Mr. Tsoi was involved in the promotion of an immoral and illegal activity.  On this ground, Mr. Loi argued that the loan agreement was unenforceable.  Mr. Tsoi’s claim could not, in the words of the legal authorities, “be founded upon a base cause . . . that was against public policy” (otherwise known by the Latin maxim ex turpi causa non oritur action).  The Court found that Mr. Tsoi had sufficient knowledge of Mr. Loi’s illegal purpose in borrowing the money to conclude the loan agreement was illegal and unenforceable. 

The Court then needed to consider whether there was some exception to this general rule that would prevent Mr. Loi from being able to keep the $50,000.  The recognized exceptions which relieve a party of the consequences of illegality include:

  1. Where the party claiming the return of the property is less at fault than the defendant;
  2. Where the claimant “repents” before the illegal contract is performed; and
  3. Where the claimant has an independent right to recover the property (such as recovery in tort despite an illegal contract).

Mr. Tsoi chose option #1 and argued he was less at fault than Mr. Loi who, after all, actually ran the mah-jong business and charged his customers interest rates far in excess of the criminal rate.  As Mr. Tsoi only indirectly benefited from the illegal activity and was not directly involved in the mah-jong loans, the Court agreed that he was less at fault than Mr. Lai. 

The next issue was whether or not in those circumstances it would be unjust to allow Mr. Lai to “enjoy an unjustified windfall” by keeping the $50,000.  An unjustified windfall can provide grounds to override the court’s concern about illegality.  In this case, the Court held that the unjust windfall outweighed the illegal contract.  As a result, Mr. Lai was order to repay the $50,000 loan but Mr. Tsoi’s claim to any further interest (other than court ordered interest) was denied.

The moral of the story is that if you enter into an agreement with another person and you know or have reason to suspect the bargain has some taint of illegality or immorality, this may be enough to prevent you from seeking to enforce your bargain.  Don’t take the risk.



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