Supreme Court approves new test for recovering money under an illegal contract

In a landmark decision, the Supreme Court has moved the illegality defence away from a rigid test to a more flexible approach based on a “range of factors”.  Although uncertainty remains as to how the test will be applied in practice, in theory it should make it easier to recover sums paid under illegal contracts.

Facts of the case

In Patel v Mirza, Mr Patel transferred £620,000 to Mr Mirza on the understanding that Mirza would use this money to bet on the movement of shares in RBS using insider information.  The insider information never materialised and the bet was never made. Patel sought repayment of the £620,000 and Mirza refused on the basis that the money was paid under an illegal contract.

The High Court agreed with Mirza and decided that Patel could not have his money back.  The High Court applied the “reliance test”, which prevents the recovery of monies if a claimant relies on illegal conduct as part of its claim.

The Court of Appeal overturned this decision and the Supreme Court agreed, but in doing so outlined a new approach to the illegality test.

The new test

The Supreme Court preferred a ‘range of factors’ approach to the illegality test and expressed an aversion to the reliance test, which it considered could lead to unjust results.  The High Court decision being a case in point; surely it makes no sense at all for the law to prevent Patel from recovering from Mirza? Arguably Mirza was the more guilty party in attempting to obtain the insider information so why should he benefit from the failed scheme leaving Patel out of pocket?

The following three factors should now be considered in deciding whether to apply the illegality defence:

• The underlying purpose of the prohibition which has been transgressed and whether that purpose will be enhanced by denial of the claim.
• Any other relevant public policy on which the denial of the claim may have an impact.
• 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.

Impact of the new approach

Critics of the new test consider that it gives too much discretion to judges who will decide whether to apply the defence more or less on a case by case basis.  However, supporters claim that the new test is a welcome clarification and will encourage sensible and pragmatic decisions.

It will be interesting to see how the decision is applied over time.  What seems clear is that the new test should allow a claimant to recover monies paid pursuant to an illegal contract on a restitutionary basis (i.e. restoring the status quo).  Profiting from an illegal contract remains unlawful.  This could have an impact in the business crime arena; for instance, if a company pays money to another company pursuant to a contract tainted by bribery or some other form of illegality, the new test should make it easier for these monies to be recovered on a restitutionary basis.