An insight into illegal contracts after Patel v Mirza

Introduction

It is trite that when the subject matter of a contract is illegal, it is void for illegality. But what if the contract had already been performed or partially performed? This article examines the case of Patel v Mirza [2016] UKSC 42 and the Malaysian courts’ approach in light of this case.

The case of Patel v Mirza

Using advance insider information, which Mirza expected to obtain from Royal Bank of Scotland (“RBS”) contacts regarding an anticipated government announcement that would affect the price of RBS shares, Patel paid Mirza £620,000 in an agreement to bet on the price of the RBS shares. Such betting amounts to a conspiracy to commit insider dealing, an offence under section 52 of the Criminal Justice Act 1993. The scheme ultimately fell through and as a result, the intended betting did not take place. Mirza subsequently made promises to repay the money to Patel, but failed to do so. Consequently, Patel brought a claim against Mirza for recovery of the sums paid.

The crucial issue in this case is that, by allowing Patel’s claim, the court could be condoning a cause of action which was made on an illegal basis. As explained by Lord Mansfield in Holman v Johnson (1775) 1 Cowp 341, 343 “no court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act”. The essential rationale of this illegality doctrine, as explained by the Supreme Court of Canada in Hall v Hebert [1993] 3 RCS 159, is that it would be contrary to the public interest to enforce a claim if to do so would be harmful to the integrity of the legal system.

The judge in the High Court, applying the “reliance principle” from Tinsley v Milligan [1994] 1 AC 340, held that Patel’s claim to recover the sum paid was unenforceable because he had to rely on his own illegality to establish his claim.  He also could not establish that his circumstances fell within the policy exception to the reliance principle known as the doctrine of locus poenitentiae, since he had not voluntarily withdrawn from the illegal scheme.

At the Court of Appeal, the majority agreed with the judge on the reliance issue, but disagreed with him on the application of the locus poenitentiae exception. They held that it was enough for the claim to succeed as the scheme had not been executed. It should also be noted that Gloster LJ agreed with the majority that Patel’s claim should succeed, but took a different approach in reaching the conclusion.

In the subsequent and final appeal, the UK Supreme Court unanimously dismissed Mirza’s appeal, holding that Patel could recover the money he had paid to Mirza. Further, the court held that the formal test in Tinsley v Milligan was no longer representative of the law, as it is inconsistent with the coherence and integrity of the legal system.

In his leading speech in Tinsley v Milligan, Lord Browne-Wilkinson held, as his starting point that title to property can pass under an unlawful transaction. However, the court would not assist an owner to recover the property if he had to rely on his own illegality to prove his title. In his judgment, Lord Toulson of the UK Supreme Court in Patel v Mirza noted that the case of Tinsley v Milligan has been subject to much criticism over the years.

Lord Toulson further held that a claimant, such as Patel, who satisfies the ordinary requirements of a claim for unjust enrichment, should not be debarred from enforcing his claim by reason only of the fact that the money which he seeks to recover was paid for an unlawful purpose. Instead, the court should consider whether it would be contrary to the public interest to enforce the claim, if to do so would be harmful to the integrity of the legal system.

In assessing whether the public interest would be harmed in that way, it is necessary:

• to consider the underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim;
• to consider any other relevant public policy on which the denial of the claim may have an impact; and
• to consider whether denial of the claim would be a proportionate response to the illegality, bearing in mind that punishment is a matter for the criminal courts.

Application of the principles generally in Malaysian Law

The case of Patel v Mirza has been heralded as “a significant development in the law relating to illegality at common law” in the case of Stoffel & Co v Grondona [2020] UKSC 42. In Stoffel & Co, the Supreme Court applied the trio of considerations in Patel and held that Grondona’s claim is not barred by the illegality defence. In light of Patel v Mirza, the Malaysian approach to contract illegality should be considered.

Illegality in Malaysian legislation

A notable difference between the contract laws of the UK and Malaysia is that in Malaysia, contract principles are enshrined in legislation (the Contracts Act 1950) as well as common law.

Section 10(1) of the Contracts Act 1950 provides that all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void (emphasis added).

Section 24 of the Contracts Act 1950 defines lawful considerations and objects in the negative, where the consideration or object of an agreement is lawful unless:

• it is forbidden by a law;
• it is of such a nature that, if permitted, it would defeat any law;
• it is fraudulent;
• it involves or implies injury to the person or property of another; or
• the court regards it as immoral, or opposed to public policy.

In essence, any agreement which consideration or object falls within the five categories above is void.

The effect of a void contract (whether the agreement is discovered as void or eventually becomes void), as described in section 66 of the Contracts Act 1950, is such that any person who has received any advantage under the agreement or contract is bound to restore or make compensation for it, to the person from whom he received it.

Specific application of the Patel v Mirza principles in Malaysian case law

Generally, Malaysian courts welcomed and adopted the considerations and principles in Patel v Mirza.

In Tan Keen Keong v Tan Eng Hong Paper & Stationery Sdn Bhd & Ors and Other Appeals [2021] 2 CLJ 318 Tan Keen Keong (“TKK”) moved three separate petitions to wind-up three companies, i.e. the respondents. TKK petitioned to wind up these companies on the grounds that it was just and equitable to do so under section 218(1)(f) of the Companies Act 1965 (now section 465(1)(h) of the Companies Act 2016) because the affairs of the companies had been conducted in an unfair, unjust and inequitable manner by the persons in control of the companies. Amongst the allegations, it was alleged that there was illegality involved by claiming the existence of a ‘family fund’, where monies were siphoned from the companies and its subsidiaries due to illicit activities. At the High Court, the judge identified breaches of the Income Tax Act 1967 pertaining to the ‘family fund and under-counter activities’. The court agreed with the considerations set out in Patel v Mirza. It is necessary for the court to consider the purpose of the statute as well as to whether any other policy will be undermined or affected before striking down contracts or in this instance, winding-up corporations on the ground of illegality even if there are criminal penalties involved in the contraventions.

In particular, the Court of Appeal in Public Bank Bhd v Ria Realiti Sdn Bhd & Ors [2021] 4 MLJ 537 extensively explored the application of the Patel trio of considerations. The appellant brought a claim for the repayment of a loan against the respondent. The High Court had earlier dismissed the plaintiff’s claims on the grounds that the loan was to finance the purchase of native lands by non-natives (in contravention of section 17 of the Sabah Land Ordinance). The Court of Appeal, in allowing the appeal, held that the appellant was entitled to repayment of the loan. In reaching this decision, the learned judge Ravinthran JCA elaborated on each limb of the Patel considerations as follows:

(a) Consider the underlying purpose of the transgressed prohibition

On this issue, His Lordship began by analysing the purpose of the Sabah Land Ordinance (Cap 68) (“Ordinance”), specifically sections 17 and 64. His Lordship observed that the purpose of the prohibition in sections 17 and 64 of the Ordinance is to protect native ownership of the land held under native title and customary tenure. As the appellant is only seeking to enforce remedies under the loan and guarantee agreement, this would not have any impact on native ownership land nor amount to recognition of the first respondent (i.e. Ria Realiti Sdn. Bhd.) as the actual owner or recognition of the second respondent as a native nominee. The judge concluded that the purpose of the prohibition contravened will not be enhanced if the appellant is denied relief.

(b) Consider whether any other public policy would be affected by denial of the claim

On this limb, the Court of Appeal took into consideration that if the appellant was denied relief, a heavy burden would be placed on banks to investigate the purpose of loans and details of transactions involving nominees and actual purchasers. As observed by Zulkefli Makinudin FCJ in the case of Chang Yun Tai & Ors v HSBC Bank (M) Bhd and other appeals [2011] 7 CLJ 909, the courts should not impose requirements that would impede the flow of commerce or on the particular facts, render banking business impracticable or burdensome. Consequently, this favours the granting of relief to the appellant.

(c) Would denying the claim be a proportionate response to the illegality?

In considering proportionality, the Court of Appeal weighed the fact that there was a lack of intention on the part of the appellant, who is a mere financier. This was in contrast to the culpability of the respondents, whose, as described by His Lordship, “blatant and unmitigated illegality runs like a thread throughout the transaction…” His Lordship also observed that the prohibitions against dealings in native land by non-natives under the Ordinance is only directed at the immediate parties to a sale transaction, with no provisions outlawing a bank from financing such a transaction.

The judge also pointed out that the respondents are guilty of approbating and reprobating, as well as guilty of bad faith. He observed that none of the respondents contested the illegality argument during the winding up proceedings of the first respondent. Additionally, in this action, the second and fifth respondents are claiming that the appellant cannot rely on the loan agreements and related documents, yet, they are seeking the court’s aid for the return of the lands which were charged in the same transaction (by way of counterclaim).

Premised on the above, the court concluded that “the second to fifth respondents are unjustly using their own illegal actions to seek to reap a multi-million dollar windfall from a financial institution”. Consequently, denying the appellant relief would be an “unconscionable and totally disproportionate response”.

Applying the trio of considerations, the court concluded that the appellant is entitled to seek relief.

Commentary

As described by Harmindar Singh Dhaliwal JCA in Pang Mun Chung & Anor v Cheong Huey Charn [2018] 8 CLJ 663, the Patel approach is “consistent with upholding the integrity and harmony of the law by achieving an equitable result based on the facts of the case”. The landmark change in approach brought about by Patel v Mirza towards restitution of illegal contracts marks a welcomed change in the right direction, as the courts now may apply the necessary considerations to arrive at an equitable outcome. An example of one such consideration is where the person who had breached the contract had been unjustly enriched and should therefore make restitution to the other party.

The courts have gone to great lengths to point out that restitution may only be justified where the unlawful act, which is the subject matter of the illegal contract, has not been performed. In such circumstances, not permitting restitution to the aggrieved party would unjustly enrich the party who committed the breach of contract.

If you have any questions or require any additional information, please contact Jeyakuhan S K Jeyasingam or the Zaid Ibrahim & Co. partner you usually deal with. This article was prepared with the assistance of Tee Kai Yan, a Trainee Associate in Zaid Ibrahim & Co.