Mistake and Illegality PDF

8 Mistake and Illegality LEARNING OUTCOMES When you have completed this chapter, you should be able to: recognise when a client may need to argue that a contract is void for mistake or illegality; advise on the dif...

8 Mistake and Illegality LEARNING OUTCOMES When you have completed this chapter, you should be able to: recognise when a client may need to argue that a contract is void for mistake or illegality; advise on the different types of mistake; advise on when, and how, a contract may be illegal. This chapter is intended to provide you with an introduction to some of the basic legal principles governing mistake and illegality. You will be introduced to the different types of fundamental mistakes that may result in a contract being declared void, eg where both parties have been mistaken as to the existence of the subject matter –​there clearly cannot be a contract if there is nothing to contract about. You will also be made aware of the main ways in which contracts may be illegal, eg sometimes they will be illegal from the outset, but in other cases they may become illegal through the way in which they are performed. Covenants in restraint of trade commonly found in employment contracts and sale and purchase agreements of businesses are prima facie void, but they may be upheld if they protect a legitimate business interest and are reasonable. 8.1 Mistake 8.1.1 What is mistake? The first thing to appreciate in this area of law is that the word ‘mistake’ has a much more restricted meaning than in common parlance. Many examples might be given of situations where a ‘mistake’ in the popular sense is denied legal significance (eg because when viewed objectively the parties appeared to be in agreement) or otherwise where a remedy might be granted on some other ground such as misrepresentation. The doctrine operates only in exceptional circumstances where one party, or indeed both parties, can establish that the contract was entered into under a mistake which was so fundamental as to effectively negate agreement and therefore the existence of a contract. 8.1.2 Types of mistake There are basically three different types of mistake: common mistake, ie where both parties have made the same fundamental mistake; cross-​purpose mistake –​where the parties are literally at cross purposes about some crucial aspect of the contract; 181 Contract unilateral mistake –​where only one party is mistaken, eg mistaken as to the very identity of the other contracting party. In all cases, the mistake must precede the contract and have induced it. 8.1.2.1 Common mistake This is sometimes known as ‘identical mistake’ or ‘shared mistake’ because both parties have made the same fundamental mistake. As with frustration (which is a supervening rather than a preceding impossibility (see Chapter 5)), there are strict limitations on the operation of common mistake: It will not operate if one party is at fault. The contract must not make express provision on the matter. The mistake must be fundamental, ie render performance of the contract impossible or radically different from what the parties anticipated. One instance where the courts will find a fundamental mistake is where both parties are mistaken as to the very existence of the subject matter of the contract. For example, imagine I agree to sell you my car, but unbeknown to either of us my car has already been destroyed in a fire. Our contract will be rendered void as there is nothing to sell or buy. On the other hand, a simple mistake as to the quality of the subject matter will not usually be deemed sufficiently fundamental to affect the validity of a contract. This is illustrated by the case of Bell v Lever Bros AC 161. Bell and another (B and A) were made executive officers of a subsidiary of Lever Bros. The subsidiary was closed down, and Lever Bros entered into contracts with B and A terminating their service contracts in return for substantial compensation. It was then discovered that B and A had previously breached their service contracts and so could have been dismissed without compensation. It was accepted that both B and A had forgotten about the earlier breaches when they entered their settlement agreements with Lever Bros. Lever Bros sued B and A for the return of the compensation payments on the basis that the settlement agreements were void for mistake. Both parties had wrongly thought that the service contracts had been valid; but the House of Lords said the mistake was not fundamental enough to render the settlement agreements void. Because a mistake as to quality is unlikely to make performance radically different, it is generally viewed as a last resort argument, ie where there is no other cause of action open to the claimant, as was indeed the case in Bell v Lever Bros. A and B had not lied about the status of the settlement agreement –​they had genuinely (albeit conveniently) forgotten about their earlier breaches. So there had been no prospect of Lever Bros suing them for misrepresentation and/​or breach of an express term of the contract. Lever Bros’ only option had been to argue mistake. 8.1.2.2 Cross-​purpose mistake In the case of cross-​purpose mistakes, the problem is that although one or other party may assert that a contract exists, each on terms favourable to that party, objectively it is impossible to resolve the ambiguity over what was agreed. That being the case, the only possible conclusion is that there was no contract. A classic example of a cross-​purpose mistake is Raffles v Wickelhaus (1864) 2 Hurl & C 906. It concerned a contract to sell cotton ‘ex Peerless from Bombay’ (ie cotton from the ship named 182  Mistake and Illegality ‘Peerless’ which had sailed from Bombay). In the event, there were two ships named ‘Peerless’ which had sailed from Bombay –​one had sailed in October and the other in December. The seller brought an action against the buyer for failing to take delivery of the cotton from the ship that had sailed in December. The buyer argued that there was a latent ambiguity in the contract and that they believed the ship in the contract to be the one that had sailed in October. On an objective analysis, there was no way to resolve the ambiguity, so the court found for the buyer, ie the contract was void. 8.1.2.3 Unilateral mistake Unilateral mistake (ie where only one party is mistaken) is often relied on where there has been a mistake as to the identity of the other contracting party. However, only a genuine mistake of this nature where the identity of the other party is of vital importance will render the contract void. If the mistake is as to anything less (eg a mistake simply as to the other party’s attributes such as creditworthiness) then it will not generally affect the validity of the contract. A case in which the identity of the other party was held to be crucial is Cundy v Lindsay (1878) 3 App Cas 459. It involved a contract concluded by written correspondence. A rogue set up business under the name ‘Blenkarn’ at 37 Wood Street. A reputable company, Blenkiron and Co, traded at 123 Wood Street. The rogue ordered goods from the plaintiff, making their signature look like ‘Blenkiron’. The plaintiff sent the goods to ‘Blenkiron and Co’ at the rogue’s address. Before the rogue paid for the goods though, the rogue resold them to innocent purchasers. The plaintiff’s only hope to recover the goods was to argue mistaken identity on the basis that it intended to deal specifically with Blenkiron and Co and not with whatever firm happened to be operating from 37 Wood Street. The plaintiff’s argument succeeded, and the contract was held to be void for mistake. In the above case, the plaintiff could not rely on misrepresentation to recover the goods as rescission was barred. The goods had been resold to innocent purchasers. Where a bona fide purchaser has already acquired the goods, there are two innocent parties –​the mistaken party and the innocent purchaser. Only one of them will be entitled to the goods; the other will be left suing the rogue (if the rogue can be found) for damages. The mistaken party’s damages claim would be for breach of an express term and/​or misrepresentation. The innocent purchaser’s claim would be for breach of the statutory implied condition in contracts for the sale of goods that the seller has title to the goods which they can pass on (Sale of Goods Act 1979, s 12, in relation to business-​to-​business contracts and Consumer Rights Act 2015, s 17, in relation to business-​to-​consumer contracts). Of the two innocent parties, the courts tend to have less sympathy for the mistaken party –​hence why mistaken identity rarely succeeds where the deal was struck in a face-​to-​face situation. As a general rule in face-​to-​face situations, it will be much more difficult for a person to argue they intended to deal with someone other than the person physically present in front of them. In Lewis v Averay 1 QB 198, the plaintiff advertised their car for sale. The man who turned up claimed to be the well-​known actor, Richard Greene (who had played Robin Hood in a long-​running TV series). He signed a cheque ‘R.A. Green’ and produced photographic identification in the form of an official pass for Pinewood Studios. On that basis, the plaintiff let the man take the car and log book in return for the cheque. The man then sold the car to an innocent purchaser (the defendant). The man’s cheque was dishonoured and he turned out to be a fraudster. The plaintiff’s only hope of getting back their car from the defendant was to establish mistake (as rescission for misrepresentation would be barred –​see Chapter 6). But the court said that the plaintiff had been more concerned about the creditworthiness of the man, rather than what he actually called himself. So, it was a mistake as to an attribute (rather than identity) and as such was not fundamental enough to invalidate the contract. So, if faced with a particular set of facts, how do you work out whether the contract is voidable (for misrepresentation) or void (for mistake)? Looking at the case law, it is far from straightforward, but the following guidelines can be deduced from it: 183 Contract (a) If the parties are dealing face-​to-​face, there is a strong presumption that the innocent party intends to deal with the person in front of them (ie the rogue) rather than the person being impersonated. In that case, the contract is unlikely to be declared void for mistake, although it might be rescinded for misrepresentation. (b) Where dealings are conducted exclusively in writing, the above presumption does not apply. Instead, the written agreement must be construed to determine with whom the innocent party intended to contract. If it was with someone other than the rogue then the contract might be void for mistake. (c) The nature of the transaction may indicate to the rogue that it is vital the rogue possess a particular attribute and, if they do not do so, the offer is not addressed to the rogue. For example, if someone orally commissions a portrait from an unknown artist passing themselves off as a famous painter, the rogue could not accept the offer. In other words, there would be no contract with the rogue. (d) If the person/​entity whom the rogue is pretending to be actually exists and is known to the mistaken party (eg a registered company), it suggests that the offer is not addressed to the rogue. So, again, there could be no contract with the rogue; it would be void. 8.2 Illegal contracts 8.2.1 Illegality The other argument for saying that a contract is void is because it is illegal. Contracts may be illegal either at the time of formation (eg because they involve the commission of a crime) or because of the way they have been performed. A contract is illegal where its formation, purpose or performance involves the commission of a legal wrong, eg breach of a statutory provision or violation of public policy. Consequently, as a general rule, illegal contracts are void, and courts will not allow recovery of benefits conferred in the performance of an illegal contract. Examples of contracts that are illegal in themselves are not difficult to identify (eg a contract to commit a crime). Some contracts, however, are formed legally but then carried out in a way that is illegal. If the illegal act is purely incidental to performance of the contract, it is unlikely to affect the validity of the contract; it is enough that the wrongdoer is punished for what they did. For example, a contract to deliver goods would not be voided if the driver delivering the goods was caught speeding. A case which illustrates this is St John Shipping Corp v Joseph Rank Ltd 1 QB 267. A statute made it an offence to load a ship to such an extent that the load line was below water. The offence was punishable by payment of a fine. When the plaintiff charterers committed this offence, the defendant sought to withhold payment for the goods on the basis that there was an illegal contract. The court held that the statute did not prohibit contracts performed in breach of the load line rule. It was enough that the charterers should be fined for the breach. Where a contract is performed illegally, it is possible for either both, or only one, of the parties to intend illegal performance. Where both parties were aware that performance was illegal then the courts tend to take the view that neither party should be entitled to enforce the contract; the contract is void. This is illustrated by Ashmore, Benson, Pease & Co Ltd v AV Dawson Ltd 1 WLR 828. The defendant agreed to transport boilers owned by the plaintiff and did so by carrying them on lorries which could not lawfully carry them. The plaintiff knew this to be the case. The boilers were damaged in transit and the owner sued for damages. Needless to say, the claim was rejected on the basis that the owner had effectively participated in the illegality. 184  Mistake and Illegality On the other hand, where one party did not know of the illegal performance of the contract by the other party, the innocent party may be able to enforce it. Clearly, the illegal performer should not be permitted to enforce the contract. 8.2.2 Contracts illegal under statute Identifying contracts that are illegal under statute is not difficult. For example, the Competition Act 1998 renders unenforceable contracts that have the effect of restricting, preventing or distorting trade within the UK. 8.2.3 Contracts illegal at common law The courts will refuse to enforce some contracts at common law on the basis that they are contrary to public policy or morality, eg contracts that challenge the sanctity of marriage, contracts which are sexually immoral and contracts that seek to challenge the jurisdiction of the court. 8.2.3.1 Covenants in restraint of trade Common form clauses which are prima facie void as being contrary to public policy are covenants in restraint to trade, eg clauses in employment contracts restraining senior employees from working for a competitor when their employment ends, or clauses in a sale and purchase agreement of a business stopping the seller setting up a competing business nearby. As a matter of public policy, individuals and businesses should be able to work and operate to generate income for themselves. However, restraints of trade may be enforceable if: there is a legitimate business interest to protect, eg customers, employees and trade secrets; and the restraint is reasonable in terms of geographical area, duration and scope of the prohibited activities. Example NW Coaches Ltd (NWC) is a coach operator based in the north west of England. It employs a wide range of people, including coach drivers, business development managers and senior executives. In relation to the coach drivers, it may be argued that NWC has no legitimate business interest to protect, eg it is unlikely the coach drivers will be privy to confidential information, and if they leave and work for a competitor it is unlikely to adversely affect business. So, any covenants in restraint of trade in the contracts of employment of the coach drivers may well be unenforceable. With the more senior employees, however, NWC may well have legitimate business interests to protect (eg trade secrets and goodwill), but any restraints of trade would have to be reasonable, eg limited to working for a coach operator in the north west of England for an appropriate length of time. It would be unreasonable to restrain them after termination of employment from working for a coach operator, say, based in Scotland, or otherwise from working for a ‘tour operator’ when the extent of NWC’s business interest is coach operator. In terms of duration, the longer the duration of the restraint, the more likely it is to be unreasonable, but it depends on all the circumstances. For example, a reasonable period of restraint for a senior executive is going to be longer than that for a recently appointed business development manager. 185 Contract Where there are legitimate business interests to protect, it makes sense for contracts of employment to incorporate covenants in restraint of trade, but they must be drafted appropriately. They must be reasonable in scope in relation to individual employees and their status and seniority within the organisation. Provided the clauses are reasonable, they will be upheld and the former employer will be granted injunctive relief and/​or otherwise awarded damages to compensate for loss suffered as a result of any breach (see Chapter 4). Figure 8.1 Enforceability of covenants in restraint of trade Covenants in restraint of trade void Legitimate business interest to protect? No Yes Restraint is Reasonable in terms of geographical area, unenforceable duration and activity? Yes No Restraint is enforceable SUMMARY There are three kinds of mistake: common, cross-​purpose and unilateral. The mistake must be fundamental and precede the contract. The effect of mistake is to render a contract void. Mistake tends to be pleaded as a last resort where there is no other effective cause of action (eg there was no breach of contract or misrepresentation). Contracts may be illegal from the start or otherwise illegal in the way in which they are performed. Contracts may be illegal because they violate a statutory provision, the common law or public policy. As a general rule, illegal contracts are unenforceable. Covenants in restraint of trade are prima facie void as being contrary to public policy. However, if there is a business interest to protect and the restraint is reasonable, the covenant will be enforceable. 186