Opinion ID: 3032245
Heading Depth: 2
Heading Rank: 3

Heading: Enforcement of Illegal Guarantees

Text: Goe contends that, as illegal contracts, the guarantees are unenforceable. We can reach this issue even though the district court certified for interlocutory appeal only the question of whether the guarantees violated the Executive Order. When reviewing a district court order certified under 28 U.S.C. § 1292(b), our jurisdiction “is not limited to deciding the precise question the district court certified to [us]. . . . [We] may address any issue fairly included within [the] order [we are reviewing].” Lee v. Am. Nat’l Ins. Co., 260 F.3d 997, 1000 (9th Cir. 2001). Here, the relevant district court order is the denial of Goe’s motion to dismiss. The motion contended that the guarantees were illegal and therefore unenforceable; the district court denied the motion because it concluded that the guarantees did not violate the Executive Order. Any issue material to the effect of the illegality defense on the propriety of dismissing the action is “fairly included” within the certified order. The question of enforceability is critical to determining the validity of the district court’s denial of the motion to dismiss, as the district court recognized when it decided that question in its order certifying the interlocutory appeal. A threshold question is whether California or federal law should apply to the enforceability question. This suit is a breach of contract action, with our jurisdiction premised solely on diversity of citizenship under 28 U.S.C. § 1332. The question whether a particular agreement is enforceable is one 7102 BASSIDJI v. GOE of substance, not procedure. Under Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938), the law of the forum state, California, would normally apply. In this case, however, Goe raises a federal law claim as a defense. While we recognize that federal law governs whether the transaction between Goe and Arshian was illegal, the enforceability of the illegal guarantees under general principles of contract law is a separate question. Courts have reached divergent conclusions concerning which law should be applied to determine enforceability in these circumstances. Kelly v. Kosuga, 358 U.S. 516 (1959), stated, flatly, that the “effect of illegality under a federal statute is a matter of federal law, even in diversity actions in the federal courts after Erie.” Id. at 519 (citation omitted); see also Sola Elec. Co. v. Jefferson Elec. Co., 317 U.S. 173, 176 (1942) (“When a federal statute condemns an act as unlawful[,] the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted.”). The Seventh Circuit has held, relying on Kelly, that “[w]hen the statute is federal, federal law determines not only whether the statute was violated but also, if so, and assuming the statute itself is silent on the matter, the effect of the violation on the enforceability of the contract.” N. Ind. Pub. Serv. Co. v. Carbon County Coal Co., 799 F.2d 265, 273 (7th Cir. 1986). This principle, however, has either been honored in the breach, or has come to encompass a corollary permitting the incorporation of the law of the forum state in some circumstances. In Torrez v. Torrez (In re Torrez), 827 F.2d 1299 (9th Cir. 1987), for example, without discussing the possibility of applying federal law, we applied California law to the question whether to enforce a contract that violated federal statutory dictates concerning subsidized irrigation water.11 11 Torrez presented the enforceability question in the bankruptcy context and involved real property located in California. See 827 F.2d at 1299. BASSIDJI v. GOE 7103 Similarly, a recent California Court of Appeal decision applied California law in determining the scope of the illegality defense as it relates to the same Executive Order here at issue, also without alluding to Kelly or Sola. See Kashani, 13 Cal. Rptr. 3d at 179-81. In this case, the result does not turn on whether we apply federal or state law, so we need not decide whether Kelly and Sola govern. Both federal law and California law begin from the core proposition that whatever flexibility may otherwise exist with regard to the enforcement of “illegal” contracts, courts will not order a party to a contract to perform an act that is in direct violation of a positive law directive, even if that party has agreed, for consideration, to perform that act. The Supreme Court in Kaiser Steel Corp. v. Mullins, 455 U.S. 72 (1982), stated this bedrock principle emphatically, stressing the difference between cases in which the courts are asked to order an illegal act and cases in which the relief sought does not seek directly to order illegal activity. Id. at 79-80. The Court recognized that there is considerable room for the balancing of equitable considerations in pursuit of the “ ‘overriding general policy . . . “of preventing people from getting other people’s property for nothing when they purport to be buying it.’ ’ ”’ Id. at 80 (quoting Kelly, 358 U.S. at 52021 (quoting Cont’l Wall Paper Co. v. Louis Voight & Sons Co., 212 U.S. 227, 271 (1909) (Holmes, J., dissenting))). Kaiser Steel made clear, however, that the realm of nuanced judicial determinations concerning enforcement when an illegality defense is asserted only begins “[p]ast the point where the judgment of the Court would itself be enforcing the precise conduct made unlawful by the Act.” Id. (quoting Kelly, 358 U.S. at 520) (internal quotation marks omitted) (alteration in original) (emphasis added). Where the relief sought does not pass that point — that is, where a promise can only “be enforced [by] commanding unlawful conduct,” id. at 79 — then the principle that “illegal promises will not be enforced in cases controlled by the federal law,” id. at 77, takes center 7104 BASSIDJI v. GOE stage and does not admit of exceptions. See also id. at 81-82 (emphasizing that federal courts’ authority to enforce agreements against public policy is “subject to the limitation that the illegality defense should be entertained in those circumstances where its rejection would be to enforce conduct that the . . . laws forbid”). Applying that core principle, Kaiser Steel first assumed the invalidity under the antitrust laws and § 8(e) of the National Labor Relations Act, 29 U.S.C. § 158(e), of a collective bargaining agreement between Kaiser Steel and a union representing its employees. The agreement required Kaiser Steel to pay a penalty into the union trust funds for any coal purchased from employers who were not making contributions to the funds on their employees’ behalf. The Court then held that the purchased coal clause was unenforceable even after the collective bargaining agreement had expired and all work under it had been done, even though the agreement contained a clause providing for renegotiation at the behest of the union in the event the purchased coal clause was deemed illegal. Id. at 74-82. The reason for abjuring reliance on equitable considerations and permitting what was arguably a windfall to Kaiser Steel, the Court made clear, was that: If Kaiser’s undertaking is illegal under the antitrust or the labor laws, it is because of the financial burden which the agreement attached to purchases of coal from non-UMW producers, even though they may have contributed to other employee welfare funds. It is plain enough that to order Kaiser to pay would command conduct that assertedly renders the promise an illegal undertaking under the federal statutes. Id. at 79 (emphasis added). That Kaiser Steel establishes a limiting principle, not a general pronouncement about the enforceability through damages BASSIDJI v. GOE 7105 awards or otherwise of agreements in some respects illegal, has sometimes been overlooked. See, e.g., Nagel v. ADM Investor Servs., Inc., 217 F.3d 436, 440 (7th Cir. 2000) (stating that despite Kaiser Steel’s “ringing declaration, many cases continue to treat the defense of illegality to the enforcement of a contract as presumptive rather than absolute, forgiving minor violations and not allowing the defense to be used to confer windfalls” (citing cases)); Paul Arpin Van Lines, Inc. v. Universal Transp. Servs., Inc., 988 F.2d 288, 290 (1st Cir. 1993) (“This general rule [of not enforcing illegal contracts] . . . is almost as much honored in the breach as in the observance.”). Nuanced approaches to the illegal contract defense, taking into account such considerations as the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability, remain viable in federal court and represent no departure from Kaiser Steel, but only as long as the relief ordered does not mandate illegal conduct. See N. Ind. Pub. Serv. Co., 799 F.2d at 272-73 (applying an equitable, balancing approach, while recognizing that “where the contract itself is illegal — as it would be if it were . . . a violation of section 1 of the Sherman Act, or a contract to commit a bank robbery” — it would be “governed by Kaiser Steel”); Nat’l Souvenir Ctr. v. Historic Figures, Inc., 728 F.2d 503, 515 (D.C. Cir. 1984) (explaining that Kaiser Steel prevents courts from enforcing contracts where doing so would make them “effectively become a party to the allegedly illegal scheme”); Transfair Int’l, Inc. v. United States, 54 Fed. Cl. 78, 84-85 (2002) (relying on the Restatement (Second) of Contracts, Chapter 8); cf. United Food & Commercial Workers Int’l Union, Local 588 v. Foster Poultry Farms, 74 F.3d 169, 174 (9th Cir. 1996) (noting that courts will not enforce an arbitration award when it violates a public policy that is explicit, well-defined, dominant, and “one that specifically militates against the relief ordered by the arbitrator” (internal quotation marks and citations omitted)). California law is similar. Under California law, “the general rule [is] that the courts will deny relief to either party who 7106 BASSIDJI v. GOE has entered into an illegal contract or bargain which is against public policy.” Tri-Q, Inc. v. Sta-Hi Corp., 404 P.2d 486, 496 (Cal. 1965). Thus, while “[i]n situations in which no strong objections of public policy are present, a party to the illegal agreement may be permitted to enforce it,” 1 B.E. WITKIN, SUMMARY OF CALIFORNIA LAW § 451, at 401-02 (9th ed. 1987 & Supp. 2004), and the California courts will therefore give contractual remedies where an agreement is asserted to be illegal in a wide variety of circumstances, see, e.g., M. Arthur Gensler, Jr., & Assocs. v. Larry Barrett, Inc., 499 P.2d 503, 508 (Cal. 1972), California courts will not “fashion an equitable remedy” where doing so involves “enforcing the precise conduct made unlawful . . . in contravention of the legislative purpose,” Joe A. Freitas & Sons v. Food Packers, Processors & Warehousemen Local 865, 211 Cal. Rptr. 157, 162 (Ct. App. 1985) (citing Kaiser Steel, 455 U.S. at 84); see also Wong, 702 P.2d at 576 (“As this court emphasized in [Lee On v. Long, 234 P.2d 9, 11 (Cal. 1951)], a case in which a group of gamblers unsuccessfully sought to recover the spoils of their illicit activities: ‘No principle of law is better settled than that a party to an illegal contract cannot come into a court of law and ask to have his illegal objects carried out . . . .’ ” (further internal quotation marks omitted)). Illustrative is Kashani, a recent California Court of Appeal case concerning an illegality defense under the same Executive Order here at issue. Kashani recognized a wide variety of circumstances in which California courts will indeed give force to contracts that are in some respect illegal, listing, among other “exceptions to the statutory and judicial language that illegal contracts are void and unenforceable,” such considerations as unjust enrichment, imposition of a harsh penalty, interpretation of statutory penalties to exclude the illegality defense, lack of serious moral turpitude, termination of the agreement, and whether the underlying policy would be better served by enforcement. See Kashani, 13 Cal. Rptr. 3d at 180. At the same time, Kashani recognized the core principle that courts may not themselves order violations of the law, BASSIDJI v. GOE 7107 citing to and quoting from Wong v. Tenneco. Id. at 179. Kashani concluded that none of the available equitable considerations was sufficient to justify enforcement, given the strength of the public interest underlying the Executive Order and the “patently illegal contracts” at issue. Id. at 193. We therefore proceed to examine whether, given the facts alleged in the complaint, a plausible remedy exists for Bassidji that would not require a court to order a legal violation.