Opinion ID: 2232237
Heading Depth: 1
Heading Rank: 5

Heading: Illegality under Section 3-305

Text: Section 3-305 provides, in relevant part: [A] holder in due course    takes the instrument free from       (2) all defenses of any party to the instrument with whom the holder has not dealt except       (b)    illegality of the transaction, as renders the obligation of the party a nullity. (Ill.Rev.Stat.1989, ch. 26, par. 3-305.) The concern is whether noncompliance by Fentress with the Illinois Plumbing License Law gives rise to illegality of the transaction with respect to the contract for plumbing services so as to bar the claim of the Currency Exchange, a holder in due course of the check initially given Fentress. The issue of illegality arises under a variety of statutes. (Ill.Ann. Stat., ch. 26, par. 3-305, Uniform Commercial Code Comment, at 66 (Smith-Hurd Supp.1992).) In view of the diverse constructions to which statutory enactments are given, illegality is, accordingly, a matter left to the local law. (Ill.Ann. Stat., ch. 26, par. 3-305, Uniform Commercial Code Comment, at 66 (Smith-Hurd Supp.1992).) Even so, it is only when an obligation is made entirely null and void under local law that illegality exists as one of the real defenses under section 3-305 to defeat a claim of a holder in due course. (Ill.Ann.Stat, ch. 26, par. 3-305, Uniform Commercial Code Comment, at 66 (Smith-Hurd Supp.1992).) In effect, the obligation must be no obligation at all. If it is merely voidable at the election of the obligor, the defense is unavailable. Ill. Ann.Stat., ch. 26, par. 3-305, Uniform Commercial Code Comment, at 66 (Smith-Hurd Supp.1992). Historically, this court has recognized illegality to arise only in view of legislative declaration affecting both the underlying contract or transaction and the instrument exchanged upon it. ( Pope v. Hanke (1894), 155 Ill. 617, 628-30, 40 N.E. 839; Town of Eagle v. Kohn (1876), 84 Ill. 292, 295-96.) A contract or transaction which is void must certainly negate the obligation to pay arising from it as between the contracting parties. ( Pope, 155 Ill. at 626, 40 N.E. 839; Kohn, 84 Ill. at 296.) But, unless an instrument memorializing the obligation is also made void, an innocent third party who has no knowledge of the circumstances of the initial contract or transaction may yet claim payment of it against the drawer or maker. Pope, 155 Ill. at 626, 40 N.E. 839; Kohn, 84 Ill. at 296. Thus, illegality has been held to defeat the claims of holders in due course in cases involving contracts of a gaming nature or for retirement of gambling debts (see Ill. Rev.Stat.1989, ch. 38, par. 28-1). (See Riordon v. McCabe (1930), 341 Ill. 506, 173 N.E. 660; Pope, 155 Ill. 617, 40 N.E. 839; Kohn, 84 Ill. 292; Chapin v. Dake (1870), 57 Ill. 295.) Owing to a deep-seated hostility toward nongovernmental-sanctioned gambling, our legislature has declared that any instrument associated with such activity is void, independent of the status of who may possess it. (Ill.Rev.Stat.1989, ch. 38, par. 28-7; Riordon, 341 Ill. at 509, 173 N.E. 660; Pope, 155 Ill. at 628-30, 40 N.E. 839; Kohn, 84 Ill. at 295; Chapin, 57 Ill. at 298.) The absence of similar legislative declaration as for an instrument given upon a usurious contract must account, in part, for the conclusion that usury has not been held to give rise to illegality as a defense against a holder in due course. See Ill.Rev.Stat.1989, ch. 17, par. 6413; see also Marks v. Pope (1939), 370 Ill. 597, 19 N.E.2d 616; Richter v. Burdock (1913), 257 Ill. 410, 100 N.E. 1063; Ill.Ann.Stat, ch. 26, par. 3-305, Illinois Code Comment, at 180 (Smith-Hurd 1963). That the existence or absence of legislative declaration controls the issue was recognized by our appellate court in McGregor v. Lamont (1922), 225 Ill.App. 451, a case involving circumstances similar to those here. John T. Lamont was the maker of a note used to pay for shares of stock issued by the Corn Belt Farmers' Cooperative Association (Association). Lamont's note subsequently came into the possession of Robert Roy McGregor, a holder in due course. When Lamont failed to pay on the note, McGregor filed suit and obtained a judgment against him. Lamont moved to vacate the judgment. Lamont asserted that the purchase of the shares of stock was void under the Illinois Securities Law because the Association had not complied with its requirements. Because the transaction was void, Lamont concluded, the note given in payment must also be void despite McGregor's status as a holder in due course. The appellate court noted that the Illinois Securities Law did, indeed, make transactions for the sale of shares of stock void based on noncompliance with the Law's requirements. ( McGregor, 225 Ill.App. at 453-54, 455.) But the court noted that only the sale and contract of sale of shares of stock were expressly made void, not instruments exchanged upon such contracts. ( McGregor, 225 Ill.App. at 455.) Absent legislative declaration making such instruments void, the court declined to recognize a defense to McGregor's action for payment on the note. McGregor, 225 Ill.App. at 455. The same rule obtains in New Jersey. In New Jersey Mortgage & Investment Corp. v. Berenyi (App.Div.1976), 140 N.J.Super. 406, 356 A.2d 421, a holder in due course of a note was permitted to maintain a claim for its payment even though the note had been initially obtained by a corporation in a transaction which violated an injunctive order. No statute rendered the note void, and the holder in due course had no knowledge or notice of the injunction. ( Berenyi, 140 N.J.Super. at 408, 356 A.2d at 423.) But in Westervelt v. Gateway Financial Service (Ch.Div.1983), 190 N.J.Super. 615, 464 A.2d 1203, the illegality defense was held to bar the claim of a holder in due course of a secondary mortgage and note because New Jersey's Secondary Mortgage and Loan Act specifically made void [a]ny obligation on the part of the borrower arising out of a secondary mortgage loan. ( Westervelt, 190 N.J.Super. at 620, 464 A.2d at 1205.) Westervelt involved what Berenyi did not: applicability of a direct statutory expression that an instrument, itself, arising from a particular contract or transaction was void. Westervelt, 190 N.J.Super. at 623, 464 A.2d at 1207. Several other jurisdictions also find reason to draw a distinction between the voidness of a negotiable instrument and the underlying contract or transaction upon which it is exchanged. (See Annot., 80 A.L.R.2d 465, 472-76 (1961) (summarizing several State decisions in which holders in due course were permitted to claim payment of instruments executed in favor of foreign corporations doing business in States without complying with local licensing requirements).) Although recognition of that distinction is not universal (see Columbus Checkcashiers v. Stiles (1990), 56 Ohio App.3d 159, 565 N.E.2d 883; Wilson v. Steele (1989), 211 Cal.App.3d 1053, 259 Cal.Rptr. 851 (holding that illegality need only be present in the underlying contract between an unlicensed contractor and the drafter of a negotiable instrument to bar the claim of a holder in due course)), we are convinced it remains the better rule. A plaintiff is precluded from recovering on a suit involving an illegal contract because the plaintiff is a wrongdoer. (See Bankers Trust Co. v. Litton Systems, Inc. (2d Cir.1979), 599 F.2d 488, 492 (citing the Restatement of Contracts and Restatement (Second) of Contracts).) Enforcement of the illegal contract makes the court an indirect participant in the wrongful conduct. See Litton, 599 F.2d at 493. But a holder in due course is an innocent third party. ( Litton, 599 F.2d at 492-93.) Such a holder is without knowledge of the circumstances of the contract upon which the instrument was initially exchanged. (Ill.Rev.Stat.1989, ch. 26, par. 3-302(1)(c) (defining a holder in due course, in part, as a holder who is without notice    of any defense against or claim to [the instrument] on the part of any person).) The same rationale that precludes recovery by a wrongdoing plaintiff is inapplicable in determining such a holder's right to claim payment. ( Litton, 599 F.2d at 492-93.) Enforcement of that claim does not sully the court. Litton, 599 F.2d at 492-93. The holder in due course concept is intended to facilitate commercial transactions by eliminating the need for elaborate investigation of the nature of the circumstances for which an instrument is initially exchanged or of its drafting. ( Litton, 599 F.2d at 494.) If illegality means simply negation of the initial obligation to pay, a holder in due course enjoys no more protection than a party to the original contract or transaction. The real defense of illegality is reduced to a personal one. See Vedder v. Spellman (1971), 78 Wash.2d 834, 839-40, 480 P.2d 207, 210 (Neill, J., concurring). It is, therefore, not enough simply to conclude that the initial obligation to pay arising from a void contract or transaction is void. Negation of that obligation as between the contracting parties has little bearing on whether a holder in due course of an instrument arising from the contract or transaction should nevertheless be permitted to make a claim for payment. The local law (Ill.Ann.Stat., ch. 26, par. 3-305, Uniform Commercial Code Comment, at 66 (Smith-Hurd Supp.1992)) of this State has been formulated upon this court's recognition, in cases predating the UCC, of legislative prerogative regarding negotiable instruments. In adopting the UCC and, in particular, section 3-305, our legislature chose to confer upon a holder in due course of a negotiable instrument considerable protection against claims by persons to it. Our legislature also continues to declare certain obligations void because of the circumstances of the agreements from which they arise and without regard to the status of who may claim ownership. (Ill.Rev.Stat.1989, ch. 38, par. 28-7(b) (subjecting [a]ny obligation made void by reason of gambling to be set aside and vacated by any court).) The selective negation of obligations reflects a legislative aim to declare what will and will not give rise to illegality in cases now governed by the UCC. As legislative direction indicates which obligations are always void, legislative silence indicates when the protection afforded a holder in due course must be honored. We therefore reaffirm, today, the view this court has consistently recognized in cases predating the UCC. Unless the instrument arising from a contract or transaction is, itself, made void by statute, the illegality defense under section 3-305 is not available to bar the claim of a holder in due course.