The “Illegality” Defense to Partnership Formation

November 14, 2022

Food trucks have become as ubiquitous on the streets of Manhattan as pigeons in Central Park. Unsurprisingly, the New York City food truck business is highly regulated, requiring licensure of those participating in the enterprise.

For one hapless food truck investor, his hopes of securing a legal remedy for loss of his alleged equity interest in a food truck general partnership foundered on his alleged failure to obtain a vendor’s license, for which the Court found the alleged partnership “unenforceable as an unlawful contract.”

The decision, Bakr v Shaker (Decision and Order [Sup Ct, NY County Oct. 31, 2022]), is a fitting springboard to consider the common-law “illegality” defense to partnership formation and enforcement.

The Petition and Supporting Papers

According to his petition and an accompanying affidavit, in July 2020, Bakr entered into a written agreement to purchase for $60,000 a one-third ownership interest in a general partnership formed to operate a food truck.

The ultra-bare bones Sale Agreement, which Bakr claimed proved the existence of a general partnership, stated that Bakr bought a 33% interest in a “mobile food vending operating location” in Times Square.

Originally, Bakr and his co-venturers “would alternate weeks working at the location.” But beginning in September 2021, Bakr’s partners allegedly “systematically and purposefully excluded” him from “working either on the food truck or at the location” and refused to distribute any profits from the business.

Bakr moved by order to show cause for dissolution under Partnership Law § 62 (1) (b), which provides that dissolution of a general partnership occurs without breach of the partnership agreement “[b]y the express will of any partner when no definite term or particular undertaking is specified.” Bakr also asked the Court to order his co-partners to “account,” to pay him “one third of the profits generated by the vending business” from September 2021 to the present, and to restore him physically to work at the location.

The Opposition and Reply Papers

Respondents opposed with a document entitled “Opposition to Order to Show Cause,” two letters purporting to be affidavits from witnesses to the Sale Agreement disputing whether Bakr actually paid for his interest, and an uncertified copy of the New York City Department of Health’s “Rules and Regulations for Mobile Food Vending.”

Bakr replied with affidavit from himself and two others.

Notably missing anywhere in the parties’ papers was any legal briefing on the law of unenforceability of contracts under the doctrine of illegality. Neither side said a word on the subject.

The Decision

The Court began its analysis by citing a regulation no side briefed, and for which, as far as I can tell, there is no citing reference in published New York case law, Section 17-307 of the New York City Administrative Code, which provides, “It shall be unlawful for any individual to act as a food vendor without having first obtained a license therefor . . . .”

Applying this regulation, the Court ruled:

The record is devoid of any evidence that Bakr has obtained any such license; nor is there any allegation or attestation to that effect in the record. Consequently, this court cannot possibly conclude that a lawful partnership was created by virtue of the Sale Agreement, thus mandating denial of the petition’s request for an order dissolving the purported partnership or enforcing the Sales Agreement. Neither can this court grant the petition’s request for a judgment awarding Bakr any share of the profits derived from the subject mobile food vendor business as an equity owner, for the same reason.

The Court concluded, “Because Bakr cannot possibly succeed on any aspect of relief sought in the petition, the petition is dismissed.”

Court of Appeals Case Law on Contract Illegality

Is Bakr consistent with the case law? In a trio of decisions, the New York State Court of Appeals has consistently ruled that courts should avoid applying the doctrine of illegality in a heavy-handed manner to cause a “forfeiture.”

In Glassman v ProHealth Ambulatory Surgery Ctr., Inc. (14 NY3d 898 [2010]), the Court reversed a lower court decision disqualifying an ambulatory surgery center from collecting medical billings for lack of an “operating certificate” to perform medical services offsite.

“Forfeitures by operation of law are disfavored,” Glassman held, “and allowing parties to escape their contractual obligations, freely entered into, is especially inappropriate where there are regulatory sanctions and statutory penalties in place to redress violations of the law” (id. [quotations omitted]).

In Benjamin v Koeppel (85 NY2d 549 [1995]), the Court ruled that an attorney was not disqualified from recovering legal fees because of failure to file a biennial registration statement, commenting that “courts are especially skeptical of efforts by clients or customers to use public policy as a sword for personal gain rather than a shield for the public good.”

And in Lloyd Capital Corp. v Pat Henchar, Inc. (80 NY2d 124 [1992]), the Court addressed the dichotomy under New York law of illegality based upon “malum in se, or evil in itself,” and “malum prohibitum,” or evil merely because it is prohibited.

Explained the Lloyd Court, “Where contracts which violate statutory provisions are merely malum prohibitum,” so long as the statute “does not provide expressly that its violation will deprive the parties of their right to sue on the contract, and the denial of relief is wholly out of proportion to the requirements of public policy the right to recover will not be denied” (id. [quotations and brackets omitted]).

Partnership Illegality Case Law

Applying these concepts, there are at least two New York decisions rejecting challenges to general partnership agreements as unenforceable, illegal contracts.

In Unger v Leviton (5 Misc 3d 925 [Sup Ct, Nassau County 2004], affd 25 AD3d 689 [2d Dept 2006]), retired Justice F. Dana Winslow, for whom I worked what feels a lifetime ago as a law student, “rejected” a challenge to enforcement of a partnership agreement for the sale of property based upon alleged false statements the co-partners made to the U.S. Department of Housing and Urban Development in violation of a federal statute.

Unger ruled that the alleged illegality was “collateral to the contract to be enforced,” and in any event, would “disproportionately penalize” one side while the other would “derive a windfall.” The Court concluded that “denying enforcement would yield the unjust result of punishing one wrongdoer and rewarding the other for the same joint act.”

In Artache v Goldin (133 AD2d 596 [2d Dept 1987]), the plaintiff alleged that she entered into an “express oral partnership agreement” with the defendant to “live together and hold themselves out as husband and wife,” for plaintiff to assist in the “management and administration of his dental practice” and to share in its profits, and for the defendant to “as soon as possible, obtain a divorce from his wife.”

The Court ruled that there was “no question but that the parties’ alleged express oral partnership agreement contains various illegal aspects, to wit, an agreement to engage in adultery and an agreement to share the profits of the dental practice” in violation of the rule against doctors splitting fees with non-doctors.

But Artache ruled that “where an agreement consists in part of an unlawful objective and in part of lawful objectives, the court may sever the illegal aspects and enforce the legal ones, so long as the illegal aspects are incidental to the legal aspects and are not the main objective of the agreement” (id.). The Court concluded that the “issue of whether the household and dental office services alleged to have been rendered by the plaintiff are severable from the illegal aspects of the parties’ agreement is a factual question which must await a trial” (id.).

In Bakr, none of the parties had the opportunity to brief these issues, the Court deciding the question of illegality for lack of a vendor’s license sua sponte. It’s a shame because I suspect the outcome might have been different if the issues had been briefed. The outcome of Bakr seems to me a total “forfeiture” of an alleged partnership interest, just what the case law says courts ought to strive to avoid.