Illegally binding: will contracts survive the new trade war?

An illegal contract is one that involves the commission of an illegal act or is expressly prohibited by statute. Under Singapore and English law, the doctrine of illegality is only a shield, not a sword. In other words, it can be raised as a defence to resist enforcement of an illegal contract, but not brought as a claim to invalidate such a contract. Different rules may apply depending upon whether a situation involves either “domestic illegality” (that is, where a contract is illegal under its own governing law) or “foreign illegality” (that is, where a contract is illegal not under its governing law, but rather under the law of another jurisdiction to which it has ties). 

The common law on domestic illegality in England and Singapore is similar in substance, although the precise analysis has diverged in recent years. We address each in turn.

Domestic illegality under English law

Contractual provisions will normally require compliance with export control regulations. However, let us consider a hypothetical example: two companies enter into an English law contract for the sale and delivery of high-technology components from England to China – but the export of such components to China is in fact illegal under English export control law. If the seller fails to deliver the components and the buyer sues to enforce the contract, the seller might raise illegality as a defence to resist the claim. This would be a situation of domestic illegality, because delivery of the components is illegal under the governing law of the contract.

Traditionally, the defence of illegality has been based on two public policy reasons: one, a person should not be allowed to profit from their own illegal wrongdoing; and two, the law should be coherent, not self-defeating (by making certain acts illegal yet condoning illegal contracts). The current applicable framework to decide whether a defence of illegality will succeed was set out by the UK Supreme Court in the case of Patel v Mirza [2016] UKSC 42 (Patel).

Under the Patel framework, the court (or arbitral tribunal) must have regard to three considerations in deciding whether a claim will be defeated by an illegality defence: (a) the purpose of the prohibition which is violated, and whether denying the claim would enhance that purpose; (b) any other public policy which might be affected by denying the claim (that is, which would be better served by allowing the claim despite the illegality); and (c) whether denying the claim would be a proportionate response to the illegality. In deciding whether denying the claim would be proportionate, the court may consider various factors, including the seriousness of the illegal conduct, its centrality to the contract, whether it was intentional, and whether both parties were equally culpable or not. The Patel framework has been dubbed the “range of factors” approach, and offers flexibility in deciding each case on its particular facts.

In most cases where a party sues to obtain specific performance of an illegal act (or damages for failure to perform), the defence would be successful, and the claim denied. In our hypothetical example, it is likely that the buyer’s claim to have the restricted technology delivered to it would fail, because this would directly involve the commission of an illegal act. On the other hand, consider the following scenario: the buyer has paid a deposit to the seller, who then fails to deliver the components. If the buyer sues to recover its deposit, it is likely that the court may allow the claim, despite a potential illegality defence: in that case the claim would not be seeking to enforce the illegal contract, but rather to unwind it; and it would be unjust to let the seller be enriched by that illegal contract.

Finally, however, the court will normally not allow such claims to succeed if to do so would “stultify”, i.e. undermine, the fundamental public policy of the prohibiting rule. As an extreme illustration: if person A pays person B to murder someone, but person B eventually does not commit the crime, a court would normally not allow person A to recover the sums paid – to do so would encourage attempts at murder.

Domestic illegality under Singapore law

The current framework applicable to domestic illegality under Singapore law was restated in the Singapore Court of Appeal decision of Ochroid Trading v Chua Siok Lui [2018] SGCA 5 (Ochroid Trading). The decision rejected the Patel “range of factors” approach: if our two example companies enter into a Singapore law contract for the delivery of the components from Singapore – instead of England – to China, a court (or tribunal) deciding the buyer’s claim will be guided by the Ochroid Trading framework.

The two frameworks nonetheless have similarities: under Ochroid Trading, a court will also apply a “proportionality principle”, and weigh competing public policies in deciding whether to allow a claim under a contract which involves illegal acts. The court should look at the following general factors: (a) whether allowing the claim would undermine the purpose of the prohibiting rule; (b) the nature and gravity of the illegality; (c) the centrality of the illegality to the contract; (d) the object, intent, and conduct of the parties; and (e) the consequences of denying the claim (that is, whether other policy considerations might be better served by allowing it).

Applying this “proportionality principle” approach, it is likely that a court would also deny the buyer’s claim to have the components delivered to China from Singapore. As to a claim for the return of the deposit, the Ochroid Trading framework also generally allows such claims to succeed despite illegality, provided enforcement does not stultify the relevant public policy.

“Supervening” domestic illegality

The examples we have reviewed above concern a contract that was illegal from the outset: the export control laws were already in place before the parties contracted for the sale and delivery of the restricted technology components. What happens in a scenario where the export control law is passed after the contract is entered into, suddenly making it illegal (that is, when the illegality is “supervening”)?

In such a scenario both English and Singapore common law have traditionally considered that the contract is automatically “frustrated” by the supervening illegality: its performance has become (legally) impossible, and so it becomes unenforceable. That said, it remains to be seen whether proportionality will now also be considered in cases of supervening illegality.

If, say, a US company and a Chinese company enter into a contract and choose English law or Singapore law as a neutral governing law for the contract, but the contract is in fact illegal (or it later becomes illegal) under US or Chinese law, the case would be one of “foreign illegality”. Both English and Singapore law apply the same rules in these cases. In cases of foreign illegality, English/Singapore law is not concerned with the proportionality of domestic laws versus an illegal act; instead, the rules are grounded in the public policy principle of international comity (that is, the respect of one jurisdiction for the sovereign laws of another).

“Preceding” foreign illegality

There are two distinct rules depending on whether the illegality precedes the conclusion of the contract, or is supervening. 

The rule concerning “preceding” foreign illegality is originally taken from the English decision of Foster v Driscoll [1929] 1 KB 470 (Foster v Driscoll). Under the Foster v Driscoll rule, where the real object and intention of a contract (from the outset) is to perform in a foreign and friendly country some act which is illegal by the law of that country, and the parties have chosen English/Singapore law for the purpose of avoiding the foreign illegality, the contract is void and unenforceable. The courts will not order performance of the contract, nor award damages for its breach.

To take a further hypothetical example: two companies enter into an English or Singapore law contract for the sale and delivery of high-technology components from the US to China, but the export of such components to China is in fact illegal under US export control law, the components are not delivered, and the buyer seeks to enforce the contract. In such a scenario, the seller will be able to rely on the rule in Foster v Driscoll to defend the claim: the English/Singapore courts will not enforce a contract which is to be performed in a foreign and friendly country (such as the US), but is illegal under the laws of that country. (However, under this rule the buyer will also normally be allowed to recover its deposit.)

Supervening foreign illegality

Consider now a different scenario: a Chinese company grants a US company a license, governed by English or Singapore law, covering patented technology it has developed in China. At the time the license is entered into, the contract is legal; however, some time later, China passes a new technology transfer restriction law which renders the licensing of such technology to US companies illegal.

In such a scenario, English/Singapore law is unlikely to invalidate the licence as a result of the change in foreign law: the US company will still be able to use the technology transferred under the license (outside of China). However, the case will fall under the rule stated in the case of Ralli Brothers v Compañia Naviera Sota y Aznar [1920] 2 KB 287 (Ralli Bros). Under the Ralli Bros principle, English/Singapore law will hold a contract to be invalid and unenforceable insofar as its performance is illegal by the law of the place of performance. In other words, the courts would not force a party to commit an illegal act under the law of the country where the act must be performed.

This means that in our example, the US company could still validly use the technology it already controls under the license. However, if new improvements to the technology – which would otherwise be covered by the license – are developed in China, the courts will not force the Chinese company to transfer the new improvements from China; that would violate, in China, the new technology transfer law. There may, however, be limitations to this principle where the contract could actually be performed outside Chinese territory.