A. Legality of Contract an Essential Element.
Any agreement to violate the law and any agreement forbidden by law is void.
An illegal agreement cannot be a contract. "Illegal contract" is a contradiction in terms, although a frequent phrase and from usage permissible.
Contracts are illegal for two reasons: first, because their object is illegal; second, because though the object is perfectly legal, the manner of making them is against the law.
A distinction is taken between contracts illegal in character and contracts merely unenforceable as being against public policy - for instance, gambling agreements and agreements in restraint of trade. The one is absolutely illegal, the other is illegal only in the sense it is unenforceable on account of being against public policy.
B. Particular Classes of Illegal Agreements.
(i) Contracts whose objects are in violation of law.
Contracts in restraint of trade are good if not unreasonable under the circumstances of the case and if not unlimited as to territory.
(a) Contracts in restraint of trade, when reasonable, are valid.
A contract in restraint of trade is a contract whereby a person undertakes that he will not engage in trade or in some particular line of trade; usually entered into by one who sells his business to another. It is valid if not unreasonable, and what constitutes unreasonableness we must determine, but first let us notice why such a contract, if reasonable is valid.
The common law and also our statutory law has developed upon the assumption, first, that the country ought not to be deprived of the services of a person who is possibly skilled in one trade and that trade only, by any contract he may make with another agreeing not to exercise his calling; second, that such a person ought not be permitted from the standpoint of public policy to create a situation that will compel him to leave the country in order to make a living, and third, and more important that competition between persons in trade is a good thing and beneficial to the community. From these considerations, it would appear that the common law would condemn all agreements in restraint of trade, but here another phase of public policy runs counter and results in compromise. If a person has built up a business, public policy requires that it be a transferrable business, otherwise its building up would be discouraged, and many things might interpose to destroy it or impair its usefulness to the community. But, it cannot be sold unless that most valuable and intangible part of it can be delivered to the purchaser, namely, the good will, the expectation of continued custom hard to define and composed of many elements. This good will is not deliverable unless the vendor shall be allowed to say that he will not next day set up a competing establishment in the neighborhood, perhaps upon adjoining premises and by his reputation draw to himself all of that good will which is the most valuable asset of the business sold. The law therefore says that it will allow a person or corporation to enter into a contract in restraint of trade 89a provided it is in reasonable restraint, that is to say is such restraint
(1) as is necessary for the protection of the purchaser against the competition of the vendor, and
(2) provided also it is not unlimited as to the territory of the country even if the business in question is so large as to really require unlimited restriction for the protection of the vendee; but on this last clause there is a difference of opinion as we shall see.
(b) Contracts in unreasonable restraint of trade are invalid.
Let us consider what constitutes unreasonableness of restraint. Whether or not a covenant in restraint of trade for the protection of good will is reasonable or not depends upon the facts of the case; that is to say, on whether the area covered by the covenant not to compete is substantially greater than the area covered by the business affected.
Example 49. B, a dentist, having an established business drawing customers from various points in the county, sold to T, a dentist, and agreed not to compete in the county. Afterwards B opened an office within the county. At A's suit, an injunction was granted.90
89a. Harris v. Theus, 10 L. R. A. N. S. 204. 90. Tillinghast v. Boothby, 20 R. I. 59.
Example 50. An incorporation of fish dealers in a sea port town, with provision in the bill of sale of each business to the corporation, that the seller will not engage or become in any way interested in the same business in that and an adjoining county, and within a hundred miles from the town in a period of ten years; and it appearing that the business engaged in by the corporation so formed was at least co-extensive with the territory prohibited, held to be valid.91
Example 51. A had a cracker and biscuit business which extended over an area of approximately 100 miles' radius. B bought it. As a part of the contract of purchase, A agreed not to engage in the same business within a radius of 1000 miles. He afterwards started a business within a radius of 100 miles. Held, that the covenant was unreasonable and therefore void.92
If a contract is in unreasonable restraint of trade, whether limited or unlimited as to area, it is void for that reason, as we have seen; it is conceivable, however, that the business may be of such magnitude that it requires a general restraint of trade to protect the purchaser. In such a case it was stated in the earlier English cases, which have been followed by many of our courts, that the agreement was void. Any restraint was considered unlimited as to space which covered the entire country. The ground of this view was that under the operation of an agreement, the vendor would likely be forced into another country where he could pursue the sort of business or calling which he had formerly followed in the home country. Some of the American cases have followed this doctrine and in applying it treat either the whole country or the entire state as an unlimited area, for the reason stated.93
91. Moorehead Sea Food Co. v. Way, 169 N. C. 679.
92. Althen v. Vreeland, 36 Atl. (N. J.) 479.
But in other courts, this doctrine has been departed from, and a covenant by a vendor of a business which is of such a scope that unlimited restriction is necessary to protect the buyer from the seller's competition, is upheld.94
(d) Covenants in restraint of trade unlimited in time.
It is not necessary that there be any limitation as to time to make a restraint legal.
(e) Contract in restraint of trade not good unless ancillary to a contract protecting good will.
As was explained in the beginning, contracts in restraint of trade are permitted merely for the purpose of protecting the good will where ancillary to another contract which is almost always one of a sale of the business. A contract in restraint of trade entered into by itself is void.
(f) Invalidity does not impair rest of contract.
A provision in a contract which is invalid because of unreasonably restraining trade does not impair the rest of the contract. Such a contract will stand, though the restraint falls.
93. Henschke v. Moore, 257 Pa. St. 196, L. R. A. 1917 F. 450 (entire country) ; Lanzit v. Mfg. Co., 184 111. 326 (state).
94. Hall Mfg. Co. v. Western Steel & Iron Works, 227 Fed. 588, L. R. A. 1916 C. 620 (annotated).