p. 367To be enforceable, contracts must have legal subject matter and must be able to be performed legally. They cannot violate either state or federal law. A contract overturned for illegal subject matter or for being illegal to perform is generally declared void. A contract need not be in violation of a statute to be illegal; agreements against generally accepted public policy are also illegal and unenforceable. Contracts that are made for an illegal purpose or that cannot be carried out by legal means are made void for two main reasons: First, making them void clearly indicates that such agreements are not socially acceptable, and, second, doing so prevents the legal system’s being used to promote agreements that are harmful to society.

What is the legal effect of entering into a contract for an illegal purpose?

CONTRACTS THAT VIOLATE STATE OR FEDERAL STATUTES

There are any number of ways in which contracts can violate a state or federal statute. Some of the more common ones are discussed below and summarized in Exhibit 16-4.

Agreements to Commit a Crime or Tort.    Again, contracts cannot be for illegal purposes or require illegal acts for performance. Any agreement to commit a crime or tort is illegal and unenforceable. However, should a legal contract be formed and its subject later become illegal under a new statute, the contract is considered to be discharged by law. Suppose Jim agrees to paint Hiroki’s house and, in exchange, Hiroki agrees to be a poker dealer at Jim’s casino, starting in two weeks. Before Hiroki can begin work, however, the state amends its gaming statute, making all games of chance other than slot machines illegal. Because it is now illegal for Jim’s casino to offer poker, it would be illegal for Hiroki to perform the contract. Because a change in the law has made the subject matter of the contract illegal, both parties are discharged from their obligations under the contract.

Licensing Statutes.    All 50 states have statutes requiring that people in certain professions obtain a license before practicing their craft. For example, doctors of all varieties, plumbers, cosmetologists, lawyers, electricians, teachers, and stockbrokers are all required to obtain a license before practicing. While this list is far from exhaustive, it demonstrates how widespread the licensing requirement can be. For most of these licensed professions, licenses are typically issued only after extensive schooling, training, and/or demonstrating some degree of competence. These requirements reflect the value society places on proper performance of duties in the licensed professions.

Licensing statutes have three main purposes in addition to indicating this value. The first is to give the government some control over which people, and how many people, can perform certain jobs. Second, by charging for licenses, the government can obtain revenue.

Exhibit 16-4
Contracts That Violate State or Federal Statutes

p. 368   The third purpose of licensing statutes, the protection of the public’s health, safety, and welfare, is related to the public interest. By imposing legal standards on a profession, the government can try to prevent harm to public health, safety, and welfare due to substandard work. For instance, it is not in the public’s best interest to allow an unqualified person to perform the delicate and complicated process of medical surgery. To limit the number of people who might be harmed during surgery, the government requires that prospective surgeons, even after extensive schooling, obtain a license.

Given these different reasons for licensing various professionals, different outcomes can result when someone enters into an agreement with a person who is unlawfully unlicensed, depending on the purpose of the licensing statute. The state in which the unlicensed person is practicing is relevant, because many licensing statutes occur at the state level and thus vary from state to state. In some states the rule is “no license, no contract.” These states will not enforce any agreement with an unlawfully unlicensed professional.

However, in other states the courts typically consider the purpose of licensing. If it is to provide government control over the profession or generate revenue, most states allow enforcement of the contract. Although the unlicensed professional is acting in violation of the law and is usually required to pay a fine for working without a license, there are no grave reasons the contract should not be carried out.

If the licensing statute is intended to protect the public’s health, safety, and welfare, however, the agreement is typically deemed illegal and unenforceable. For example, the public would not be made safer if the government allowed unlicensed people to perform surgery. Therefore, a person cannot enter into a contract for professional service with an unlicensed professional when the law requires a license out of intent to protect the public.

Legal Principle: If the licensing statute is intended simply to generate revenue, then the contract of an unlicensed person is valid; if the purpose of the licensing statute is to protect the public’s health, safety, and welfare, however, the agreement of an unlicensed person is typically deemed illegal and unenforceable.

Usury.    Almost as widespread as licensing statutes, statutes prohibiting usury are found on the books of nearly every state. UsuryThe lending of money at an exorbitant or unlawful rate of interest. occurs when a party gives a loan at an interest rate exceeding the legal maximum. The legal maximum interest rate varies from state to state, but it is easy to determine the rate of any given state.

While usury statutes act as a ceiling on rates, there are a few legal exceptions whereby loans may exceed the predetermined maximum. To facilitate business transactions and keep the economy healthy, for example, most states with usury statutes allow corporations willing to pay more to lend and borrow at rates exceeding the maximum. The rationale behind the corporation exception is that if a business needs money to expand and is willing to pay the higher interest rate, the corporation should be afforded the opportunity to borrow. The converse is that if a corporation is willing to borrow at a high interest rate, parties should be allowed to lend at that rate for corporations only. The intent is to facilitate business transactions in order to keep the economy in a healthy state.

Many states also allow parties to make small loans at rates above the maximum to parties that cannot obtain a needed loan at the statutory maximum. The belief is that if people need money and the statutory maximum is not inducing others to lend, certain parties will make the necessary loans at a higher rate as long as the loan is “small.” This exception allows cash advance institutions to operate.