The illegality principle and claims for damages

Albert Mushai and Robert Vivian argue that without a specific clause in an insurance contract that excludes liability of the insurer for claims under the illegality principle, chances are insurers are repudiating claims for which they are liable

When one person commits a wrongful act against another causing patrimonial or other quantifiable loss, the law allows the innocent party to sue for damages. This position is universal.

However, it is also true that in order for a person to approach the courts for a remedy, such a person can only do so with “clean hands”. In other words, a person cannot approach a court for redress if that person is also guilty of illegal conduct.

This principle finds expression in the Latin maxim ex turpi causa non oritur action, which simply means “no cause of action arises from a base cause.” The application of this principle is clear from this simple hypothetical scenario: A and B decide to commit a robbery at a nearby convenient store. They agree to share the proceeds of the robbery equally.

The robbery nets them R5 000. A disappears with the entire amount without giving B his share and all attempts to force A to hand over B’s share of the loot are unsuccessful. Can B approach the courts for redress? The answer is clearly No because B’s own hands are dirty and the illegality principle applies.

The justification for applying the illegality principle in this and other similar cases is that it is against public policy for the law and indeed the courts to reward illegal conduct.

On paper, the illegality principle looks simple and straightforward. However, in practice its application is rather complicated. From the above hypothetical illustration, it is logical to think that whenever a person suffers loss at the hands of another in circumstances where both parties are complicit in an illegal act, no damages are recoverable.

The principle extends to other spheres like insurance. For example, does it mean that if a person insures their vehicle against loss or damage and they drive the vehicle in question negligently, they are not entitled to recovery under the policy?

This question gets even more complicated where the negligent driving that causes the accident leads to criminal prosecution. Can the insurer rely on the negligence of the insured to deny liability to pay the claim?

Most people, especially insurance practitioners, would be inclined to answer this question in the affirmative. However, that view is not correct certainly in the case of insurance because one of the main risks insurers agree to cover in most contracts of insurance, such as motor and liability, is negligence.

Therefore, the general proposition is that an insurer cannot agree to provide coverage against negligence and later on seek to rely on the illegality principle to avoid paying for the very risk they agreed to cover.

A recent case that came before the Court of Appeal in the United Kingdom (UK) further confirms the complexities of the illegality principle and its application. The case in question is Stoffel & Company versus Grondona [2018] EWCA Civ. 2031.

Ms Grondona entered into a contract with one Mr Mitchell in terms of which she agreed to buy and take mortgage loans in her own name. The mortgage loans were over four properties owned by Mitchell.

Furthermore, the agreement stated that Mitchell would make the mortgage payments under Grondona’s loans and maintain the properties. In return, Mitchell agreed to pay Grondona 50 percent of the net profit when the properties were sold. Therefore, in return for borrowing money in her own name on Mitchell’s behalf, Grondona stood to pocket 50 percent of the net profit on each property when sold.

The whole agreement was a masked fraudulent scheme to the extent that Mitchell was using Grondona’s good credit rating to borrow money in circumstances where he did not qualify for the loans, and the bank would not have lent him the money.

In that sense, Grondona and Mitchell were complicit in bank fraud. In the process of formalising this agreement, the lawyers who acted for Grondona failed to file land registry documents necessary to transfer the property from Mitchell to her. The lawyers actually admitted negligence and breach of duty in that regard.

Although there were other ancillary issues, the main one was whether Grondona deserved damages arising from the negligence of the lawyers in failing to file land registry documents. The lawyers argued that she was not entitled to any damages, since she had connived with Mitchell to commit fraud.

The trial court agreed that Grondona and Mitchell committed mortgage fraud to deceive the bank. It was the court’s view that the mortgage application was a sham to facilitate a fraudulent process where Grondona availed her good credit record to Mitchell in order to enable him to access finance that he could not have access to otherwise.

At the same time, it was never the intention of the parties that Grondona would acquire ownership of the mortgaged properties. However, the court ruled that the foregoing did not necessarily mean that her claim against the lawyers became invalid because of the illegality or ex turpi causa defence.

Instead, the court ruled that the test to determine whether the illegality defence applied is whether Grondona relied on the illegality to formulate her claim. The court found that this was not the case. Instead she relied on the lawyers’ negligence. Accordingly, the court dismissed the illegality defence as inapplicable.

The lawyers appealed the decision to the Court of Appeal. In the appeal, the issue was whether the participation by Grondona in the fraudulent and illegal mortgage fraud aimed at obtaining finance for Mitchell prevented her from suing the lawyers for negligently failing to file the land registry documents with the relevant authorities.

As a preliminary point, the Court of Appeal disagreed with the trial court on the issue that the mortgage agreement was a sham. On the contrary, the court said that even though the mortgage application was fraudulent, that, in itself, did not make it a sham transaction.

According to the court, for a transaction to be a sham, the parties must have a common intention that the transaction does not create the legal rights and obligations that the documents purport to depict. The court found that this was not the case in the agreement between Grondona and Mitchell.

The court further pointed out that the test to determine the applicability of the illegality principle that the trial court relied on needed refinement. Instead, the Court of Appeal reasoned that when assessing whether a claim for damages tainted by illegal conduct is contrary to public policy, it is necessary to evaluate three factors.

These are: (1) the main purpose of the prohibition violated by the parties, (2) other relevant public policies that could be undermined by the denial of the claim, and (3) proportionality between the transgression and denial of the claim.

As regards (1), the court pointed out that there was no public interest in allowing negligent lawyers (or anyone else for that matter) who are not party to, or know nothing about the illegality to avoid their professional obligations just because they happen to discover that the clients they represented made misrepresentations to the bank.

On (2) the court stated that there was a public interest in ensuring that members of the public are able to claim damages for negligence or breach of contract by professionals such as lawyers. Finally, on (3) the court pointed out that it would be disproportionate to deny Grondona’s claim for illegal conduct that was not relevant to the retainer she had with her lawyers.

The illegality defence is a very tempting device to fall back on when facing a claim. This is particularly so in transactions such as insurance. There are many cases where insurers attempt to avoid claims citing illegality. More often than not they succeed because the insured simply accepts that because of his/her violation of the law, the claim falls away.

The reality is far from certain (as the above case illustrates) and not least because insurance is a contract. Therefore, without a specific clause in the insurance contract excluding liability of the insurer for claims under the illegality principle, chances are insurers are repudiating claims that they are in fact liable to pay.    

Published by

Albert Mushai

Legally Speaking is a regular column by Albert Mushai from the school of Economics and Business Sciences, University of the Witwatersrand. Mushai holds a master’s degree from the City University, London, and was the head of the insurance department at the National University of Science and Technology in Zimbabwe before joining the University of the Witwatersrand as a lecturer in insurance. 
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