It is a legal maxim that when a contract is illegal, courts will leave the parties where they find them. The result is that, if a party to a contract tries to recover on the contract, it will not get any aid from the courts. But what if the claim is not enforcement of the illegal contract, but a request for recovery of monies paid pursuant to the unenforceable contract – on an equitable theory of unjust enrichment? There, the question may turn on just how “illegal” the contract was, as a recent Kentucky court’s opinion reveals.
The opinion came out this week from the U.S. District Court for the Western District of Kentucky, and the case is captioned Boling v. Prospect Funding Holdings, Civil Action No. 1:14-CV-00081-GNS-HBB, 2018 U.S. Dist. LEXIS 88753 (W.D. Ky. May 29, 2018). Boling filed a personal injury lawsuit, and “used the prospective recovery from that suit as collateral to obtain and secure loans” from, inter alia, Prospect Funding Holdings, LLC. In the same federal court, Boling prevailed against Prospect, first in a ruling where the federal court held that Kentucky law governed the contracts, and later in an opinion where the court held that the contracts were unenforceable based on Kentucky law’s prohibition against champerty and usurious interest rates. In the second of those opinions, the court also said that Prospect could pursue its equitable claims in order to recover the funds it sent to Boling, as well as to proceed with claims for breach of implied duty of good faith and fair dealing, negligent misrepresentation, and conversion.
Boling and Prospect filed competing motions for summary judgment. Boling argued that Prospect’s claims failed as a matter of law, and that Boling should be awarded the sanction of attorneys’ fees based on Prospect’s attempts to litigate against Boling in the Kentucky federal court and elsewhere. Prospect claimed it was entitled to judgment as a matter of law, and that the motion for sanctions was baseless.
In its unjust enrichment claim, Prospect argued that Boling obtained a benefit at Prospect’s expense – namely, the retention of $30,000 loaned to Boling – and that Boling’s continued retention of the benefit is unjust.
The court said that Boling appeared to concede that Prospect’s claim met the elements of an unjust enrichment claim, but argued that Prospect was barred from recovery because, for one, the contract was illegal, and for another, Prospect’s unclean hands prevented equitable relief.
The court said that the cases cited by Boling in advancing the illegality argument were distinguishable. One case involved prostitution, and the other involved the unlicensed sale of securities. The court cited the Restatement of Contracts for the proposition that, in general, a court faced with an illegal contract will leave the parties where it finds them:
In general, if a court will not, on grounds of public policy, aid a promisee by enforcing the promise, it will not aid him by granting him restitution for performance that he has rendered in return for the unenforceable promise. Neither will it aid the promisor by allowing a claim in restitution for performance that he has rendered under the unenforceable promise. It will simply leave both parties as it finds them, even though this may result in one of them retaining a benefit that he has received as a result of the transaction.
(Emphasis in original). But in these cases, the illegality was self-evident, whereas in the current matter, it was not as clear, said the court:
“[T]he illegality of prostitution was such a foregone conclusion that Kentucky’s highest court did not cite any authority to support it . . . . On the other hand, the illegality of litigation funding agreements was not a foregone conclusion at the time the parties entered into the loan agreements; in fact, it is still somewhat of an open question under Kentucky law. . . . This conclusion is underscored by the fact that this Court could not find a Kentucky stat court decision addressing the issue and had to instead rely on a federal decision of this Court ‘predict[ing] that the Kentucky Supreme Court would prohibit’ such agreements . . . . “
(Emphasis in original.)
The court went on to say that, as the Restatement of Contracts provides, a court may chose to avoid a ruling that provides a disproportionate forfeiture. “In this instance, allowing Plaintiff to retain the $30,000.00 Defendant loaned to him – and to avoid payment of the fees associated with said loans – results in a disproportionate forfeiture.” Moreover, were the court to leave the parties where it found them, Boling would receive “an enormous windfall at no cost whatsoever.”
Turning to the unclean hands argument, “the uncertainty under Kentucky law regarding the validity of loan agreement[s]” meant that it would be “overly harsh” to conclude that Prospect’s “violation of Kentucky’s champterty laws is determinative of unclean hands.” Further, Prospects attempts to litigate in other proceedings were not unconscionable. Because Boling did not prevail on the defenses of illegality and unclean hands, and further because Boling appeared to concede that Prospect’s claim met the elements of unjust enrichment, the court granted Prospect’s motion for summary judgment on its restitution/unjust enrichment claim.
Prospect also prevailed on its promissory estoppel claim, while the court Boling summary judgment on Prospect’s negligent misrepresentation, conversion, and breach of implied duty of good faith and fair dealing claims.
In addition, the court found that Prospect’s “alleged misconduct is not sufficiently unreasonable and vexatious to justify an award of attorney’s fees” for Boling.
To sum up, the court concluded that leaving the parties where it found them would result in an “enormous windfall” for Boling that would have constituted a “disproportionate forfeiture” – and, therefore, ruled in favor of Prospect on its unjust enrichment and promissory estoppel claims. The court’s analysis did not delve into the relative nature of what may be disproportionate to one party or another, but appeared to lead to the result of preventing a windfall. Litigation funders may conclude that there is a risk that other courts would have reached different conclusions about what is disproportionate and whether illegality of champertous or usurious contracts is self-evidently illegal.
An earlier Secondary Insurance Market Blog post about the litigation is here: Champerty Still Valid Defense In Kentucky, So Litigation Funding Agreements Are Void, Says Court.