Ireland: How Can A Contract Be Unlawful And Yet Enforceable?

Last Updated: 26 August 2015
Article by Paul Keane

Paul Keane examines this question in the context of the Supreme Court's recent ruling on the litigation between the Quinn family and the IBRC

Is a contract or other arrangement a dead letter if it is found to be in breach of the law?  Is a loan or guarantee unenforceable if it can be shown that the bank can be shown to have acted contrary to some obligation imposed upon it by the law?  What if the bank was not in breach of the law itself, but knew that the transaction was unlawful?  Would it make a difference if the bank knew of the illegality but the customer did not?

On the face of it, most people would expect that the courts would not enforce a transaction that is unlawful.

Lawyers are well known for their affection for Latin and there is a maxim in that language which is frequently quoted "ex turpi causa non oritur actio".  This generally means that the court will not lend its aid to a case based upon an immoral or illegal act.  The maxim did not contemplate the extreme web of statutes that now delegate almost every aspect of life.  Breaches of statute can range from minor and technical on one side to extremely grave on the other. 

A strict rule of unenforceability could give rise to potential injustice and it may be merely a matter of luck as to where the benefit or burden of unenforceability would fall.  Thus, for example, if the issue of unenforceability arises after a loan transaction has been completed, the borrower will receive an unexpected windfall.

The Quinn mega-case

The enforceability of contracts alleged to be contrary to law is at the heart of the enormous litigation between the family of Sean Quinn and IBRC.  The sums involved are gigantic, exceeding €2.5 billion.  In essence, the Quinn family argue that loans and related guarantees to which they are party are in breach of provisions of the Companies Acts and those are not repayable or enforceable.  The transactions related to the purchase of shares in the bank.  The Quinns say that the transactions fall foul of provisions which regulate the giving by a company (in this case the bank)  of financial assistance in connection with the purchase of its own shares and the of rules that prohibit the unlawful manipulation of the share price in quoted companies.

Not a simple question

Certain preliminary issues were identified in the case, which have been decided on appeal by the Supreme Court. 

The elaborate decision of the Court identifies that the position is not nearly as straightforward as one would imagine.  There are many shades of unlawfulness.  Some rules attach a criminal penalty for breach.  Others make it clear that any contract in contravention of the provision is invalid and unenforceable.  In many cases, however, the statute is silent and the courts have to decide, based on a range of criteria, whether the legislature intended that a transaction which does not comply with the statute, is enforceable or not.

The criteria to be applied

The Supreme Court identified the principal criteria to be applied:-

  • If the legislation expressly states that a contract is to be treated as void or unenforceable, that is an end to the matter.
  • If the legislation is silent on the point, the court must consider whether the requirements of public policy and the policy of the legislation concerned require the additional consequence of treating the contract unenforceable.  This would be in addition to the specific consequences set out in the legislation.
  • In that context, the courts will give weight to the general undesirability of courts becoming involved in the enforcement of contracts tainted by illegality, (especially where that illegality stems from serious criminality) unless there are significant countervailing factors.
  • Those countervailing factors include:-
    • whether the contract in question is designed to carry out the very act which the relevant legislation is designed to prevent;
    • where the language of the statute implies that the specified consequences are sufficient, without rendering the contract unenforceable;
    • whether the legislation is designed to apply equally to the parties or whether it is exclusively or principally directed towards one party;
    • whether unenforceability would be counterproductive to the aims of the statute contravened;
    • whether the range of specific adverse consequences set out in the statute are sufficient to secure the legislative purpose of the statute, without adding the additional sanction of unenforceability;
    • whether the imposition of unenforceability would be disproportionate to the seriousness of the unlawful contract.

The result

Applying those principles to the Quinn case, the Supreme Court determined in relation to financial assistance, that the section itself set out the circumstances in which a contract would be unenforceable and that those circumstances did not apply in this particular case.

In relation to the manipulation of the share price, the legislation did not expressly deal with the validity of the contract.  Applying the criteria that it had elaborated, the court determined that the unenforceability of the contract was not to be implied.  The court attached particular importance to the point that the unenforceability of the contract would impose an additional burden on investors in a company whose shares have been subject to market abuse and that would not serve the purpose of the statute.

Accordingly, it was decided that the underlying lending contracts were unenforceable, even if they were illegal as alleged.

Does it matter if you are the innocent party?

It appears from press reports that efforts to settle the litigation have foundered and that an application has been made to amend the pleadings.  This would appear to be for the purposes of seeking to make an argument that the guarantee and other security arrangements are unenforceable, in circumstances where the Quinns allege that they were innocent of the illegal activity, even though the court has determined that the underlying lending contracts are enforceable.  At the time of writing no decision has been made in relation to that application.

How awfully unlawful?

Whether an unlawful contract is enforceable is, accordingly, not a simple question.  In many cases, it will depend on how awfully unlawful it is!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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