Homami (Plaintiff) sued his brother-in-law, Iranzadi (Defendant) over an unpaid debt and testified that almost $40,000 of the money he had received had not been principal payments, but interest payments the two had agreed not to report to tax authorities.
A contract created with an illegal intent is void as against public policy.
Plaintiff loaned Defendant, his brother-in-law, $250,000 for a real estate transaction. The loan was secured by Defendant’s real property. The promissory notes gave Defendant two years to repay the loan, with no interest due. A modification the two agreed to at a later time included the start of interest payments. Defendant eventually stopped making payments on the loan and Plaintiff began foreclosure proceedings on Defendant’s real property. Plaintiff sued to recover the unpaid portion of the loan from the proceeds of the foreclosure sale and Defendant sought credit for almost $40,000 that he had paid. At trial, Plaintiff testified that the $39,324.68 was paid as interest payments that the two had agreed would be paid but not reported. The trial court characterized the payments as interest payments and not a reduction in the principal owed to Plaintiff. Defendant appealed.
Is a contract created with an illegal purpose valid?
(Brauer, J.) No. A contract created with an illegal intent is void as against public policy. In order to be valid and enforceable, a contract must have a lawful purpose. A well-established principle of contract law is that a contract based upon an illegal consideration or made for the purpose of forwarding an illegality is void. This rule furthers public policy and applies whether the contract is based on a transaction that is malum in se or on one that is prohibited by statute. In order to recover the money owed him, Plaintiff had to testify that he intended to get around tax liability by keeping the interest payments secret. Plaintiff was therefore not entitled to the $39,324.68 he collected as unreported interest. Reversed and remanded.
Many of the cases in which courts employ this legal principle involve unlicensed contractors who sue to collect on money owed them for their work. The courts routinely find against the contractor on the grounds that failing to obtain a license violates a law that is enacted in order to protect and benefit the public. A party who is unlicensed and violates the law by entering an agreement to perform the work cannot use the courts to enforce that agreement. Similarly, courts will not provide relief in cases involving illegal gambling or illegal attempts to avoid tax liability.