Enforcing contracts whose performance may be illegal

What happens if the performance of a contract is illegal? For example if the act becomes prohibited (e.g. under FEMA or following the imposition of sanctions) or the agreement requires parties to commit an illegal act (e.g. insider trading or attempting to claim excessive tax rebates for films shot in the UK)?

Will an English court enforce such contracts?

The old law was strict (Tinsley v Milligan [1994] 1 AC 340). It was based on ex turpi causa non oriter actio i.e. the court would not grant relief to a person who brought an action based on their illegality.

Recent law is more flexible. It allows judges some discretion, and agreements that were illegal/ irregular in part have been upheld (Magdeev v Tsetkov [2020] 4 WLUK 148).

This article discusses the law when the performance of a contract is marred by illegality.

Patel v Mirza [2016] UKSC 42 continues to be good law. Mr Patel gave Mr Mirza £620,000 to place bets on a bank’s shares with the benefit of insider information. The information was not received and shares were not bought but Mr Mirza did not return the £620,000.

The Supreme Court of the United Kingdom unanimously held that Mr Patel was entitled to £620,000. It held that generally speaking, the courts will not enforce a claim if to do so would be harmful to the integrity of the legal system. To assess this, the court will consider:

a) Whether the illegal purpose would be enhanced by denying the claim (here, would insider trading get an impetus if Mr Patel was denied his £620,000)

b) Is the decision impacted by public policy (here, public policy upholding integrity in the stock markets)

c) If granting the claim would be proportionate to illegality. Within this, the court would consider the seriousness of the illegality along with other factors.

Older Approach

The English court will not enforce a contract that is illegal at the place of performance (Ralli Brothers [1920] 2 KB 287).  

In the century-old case of Ralli Brothers concerning the delivery of jute in Spain, the price contracted exceeded the price cap for jute under Spanish law. The buyers refused to pay above the threshold and the sellers sued for the balance in England. The House of Lords held the contract was invalid. It would not enforce a contract that was illegal at the place of performance. Whether or not the parties intended to commit an illegal act, or, were aware that their actions were illegal, did not matter.

Even though the decision has been somewhat controversial and has been sparingly applied, it has not been overturned, just refined. Ralli Brothers has not been applied in very many cases because in those cases performance was not found to be illegal or performance was not required at the place of where it was illegal. For example, if an Indian borrower / guarantor says they cannot repay a loan in England because it would contravene Indian FEMA regulations (an often argued point) then the English Court could hold that performance need not have taken place in India, and repayment could have occurred in England.

In Foster v Driscoll [1929] 1KB 470, a syndicate of persons decided to acquire a ship, load it with Scotch whiskey and send it to prohibition-era USA. The plan ran into difficulties and the whisky never left Scotland. In cases brought by members of the syndicate against each other, one defence was that the agreement was void and contrary to public policy. That defence was upheld.

Foster is distinct from Ralli Brothers. Foster does not require it to be shown that performance involves an illegal act; it is sufficient if the object and intention of the parties was the performance of an illegal act.

Ralli Brothers and Foster were upheld by Viscount Simonds and by Lord Keith respectively in a later case called Regazzoni v Sethia [1958] AC 301. Regazzoni was another jute case in which parties agreed to export jute bags from India to South Africa, which was then prohibited under Indian law. It was held that the contract was unenforceable.

Modern Approach

Things were simple in the 1900s. The three cases we saw in the previous section concerned simple facts. Modern trade is more complex.

In Ryder v Woo, a 2015 Hong Kong Court of Appeal case, parties agreed to manufacture mobile phones in China in a contract that was governed by Hong Kong law. Goods were imported duty-free into China, but used by a company that did not import them, in contravention of Chinese law. Neither party intended to commit this illegality and the illegal act was not a necessary part of the contract. Lord Collins (the author of modern day Dicey on Conflict of Laws) upheld the contract.

One would think this contravenes Ralli Brothers, but that is not the case. The reasoning in Ryder is that there is no necessary illegality and the contravention was not serious because the breach of import duty was found to be a mere administrative contravention. This is adopted into English law - see Magdeev v Tsvetkov [2020] EWHC 887 (Comm).

In Magdeev, Justice Cockerill held that domestic illegality is different from foreign illegality. She reminded us that domestic (English) illegality is based on ex turpi causa i.e. a person cannot benefit from his/ her illegal act (see Patel v Mirza). Foreign illegality is, however, based on public policy considerations (see Ralli Brothers). Justice Cockerill refined the older Ralli Brothers principle on foreign illegality because it did not address the following issues:

- Would a term that is illegal at the place of performance render a different legal obligation that is part of the same contract / trade unenforceable? (Ralli Brothers)

- How is Foster v Driscoll to be applied when parties have more than one object, a part of which is legal?

In Magdeev, an investment agreement with a return by way of interest was dressed up as an employment agreement in the UAE. Although the English Court observed that visa fraud was a serious offence, based on the evidence before it, the judge held the UAE authorities may not have taken it seriously. It was a small incident in a perfectly legitimate transaction and on that basis she upheld the contract.

The decision in Magdeev was subsequently applied in Haddad v Rostamani [2021] EWHC 1892 (Ch) at [85]-[88] and in Jones v McCarthy [2022] EWHC 2186 (Ch) at [118]-[126].

More recently in a sanctions case, Celestial Aviation Services Ltd v UniCredit Bank GmbH [2024] EWCA Civ 628, which upheld but continued to refine the Ralli Brothers principle, it was held that a party will not be excused from performance if performance could be rendered legal by the grant of a license. In the UK, licenses to pay / release assets to sanctioned parties are granted by OFSI (in the US, they are granted by OFAC). The English Court held that unless a party can demonstrate that (i) it made reasonable efforts to obtain the necessary licence or (ii) such efforts would have been in vain because the licence would have been refused, the court would uphold the performance of the contract.

English Courts are now willing to uphold a contract if an illegality in performing it is peripheral.

About the author: Karishma Vora is a Barrister at 39 Essex Chambers. Parshva Shah is a junior counsel at the Chambers of Karishma Vora.

If you would like your Deals, Columns, Press Releases to be published on Bar & Bench, please fill in the form available here.