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It makes no difference whether the contract has been partially or wholly performed. Rather, the test is whether the plaintiff requires the aid of the illegal transaction to establish his case. If the plaintiff cannot open his case without showing that he has broken the law, the court will not assist him, whatever his claim in justice may be upon the defendant.
Homami and Iranzadi were brothers-in-law. At the time of this transaction, they had been involved in various business dealings together both in Iran and in the United States. On January 9, 1984, Homami wrote a check for $ 250,000 to California Land Title in order to fund a real estate transaction on behalf of Iranzadi. The close of escrow was delayed until March 22, 1984. In the interim Homami kept the money available to make the loan. The $ 250,000 loan was evidenced by two identical promissory notes dated March 22, 1984, in the amount of $ 125,000 each. Each note provided that it was all due and payable in two years and each recited that it would bear no interest. One note was secured by property known as the "Pinehill" property, and the other by property known as the "Outlook" property. Iranzadi, who was not fluent in English, had granted Homami a power of attorney. Pursuant to this power Homami routinely wrote checks for his brother-in-law. On March 25, 1984, three days after the loan was funded, Homami signed a check to himself for $ 2,104.68 on Iranzadi's account. The check bore a notation in Persian that it was for interest to March. According to Homami, this amount represented interest lost to him by virtue of the fact that he had kept the $ 250,000 accessible for two and a half months. He testified that Iranzadi had agreed to pay him the difference between the interest he was earning in his regular bank account and the 12 percent he would be receiving from Iranzadi. Thereafter, checks were drawn to Homami on Iranzadi's account more or less on a monthly basis for approximately a year. For the first few months Homami signed the checks. The last six checks were signed by Iranzadi's son. With the exception of two payments, all of the checks were for $ 2,500. That would be the exact amount of monthly interest on a debt for $ 250,000 bearing a rate of 12 percent per annum. The total amount paid to Homami from Iranzadi, including the initial payment of $ 2,104.68, was $ 39,324.68. On March 18, 1985, Homami and Iranzadi signed a document entitled "Modification Agreement" for each of the promissory notes. The modification agreements were identical except for their reference to the respective notes and deeds of trust. Thereafter, two more payments of $ 2,500 were made, on May 22, 1985, and June 23, 1985. No further payments of any amount were made. On August 14, 1985, Homami filed notices of default on the ground that Iranzadi had failed to pay the monthly installment of interest due July 22, 1985. Foreclosures were commenced on both properties. Iranzadi found a buyer for the Pinehill property and escrow closed at the end of January, 1986. Homami was paid through that escrow the full principal balance of $ 125,000 on the one note, plus interest at 18 percent from June 22, 1985, as per the modification agreement, and foreclosure fees; however, Iranzadi expressly reserved the right to claim a credit for approximately $ 40,000, plus fees and costs, against the second note. The Outlook property sold in June 1986. Homami submitted a demand for the full $ 125,000 plus interest on that amount from June 22, 1985, and foreclosure fees. Iranzadi, maintaining he had paid $ 39,324.68 on the principal balance between March 1984 and June 1985, claimed a credit in that amount. Escrow closed but the sum of $ 43,500 was held out of the proceeds and delivered to Albert Ham, a stakeholder, pending resolution of the dispute. Homami filed suit October 15, 1986, alleging breach of a written contract. Attached to the complaint were the two promissory notes and modification agreements. Iranzadi filed a cross-complaint for declaratory relief, alleging that he had paid $ 39,324.68 towards reducing the principal, and seeking a determination of rights as to the monies held in trust. He also pleaded a cause of action for conversion of the $ 39,324.68 and prayed for compensatory relief and punitive damages against Homami. The trial court found that the payments made by Iranzadi to Homami totalling $ 39,324.68 represented interest only, and no principal reduction. Therefore Iranzadi still owed Homami that amount on the loan.
Are the contracts between Homami and Iranzadi valid, so as to give rise to liability to pay the principal?
Here Homami entered into a written agreement which specifically provided that he would be paid no interest. The purpose of the provision was to enable him to avoid compliance with state and federal income tax regulations. He then secretly collected interest income which he had no intention of reporting. And when a dispute developed, he sought the aid of the court to enforce the secret agreement so that he could keep the money he had collected. Homami has taken the position that he was not seeking enforcement of the side agreement to pay 12 percent interest; rather he was simply suing to collect the principal balance due on the promissory note plus interest at 18 percent as per the written modification agreement. He pointed out that neither the promissory notes nor the modification agreements are facially illegal. And he claimed that the issue of the $ 39,324.68 paid was first raised as a defense and was not necessary to pleading or proving his case on the written documents. First, even though a written contract is legal on its face, evidence may be introduced to establish its illegal character. And if the substance of the transaction is illegal, it matters not when or how the illegality is raised in the course of the lawsuit. Whether the evidence comes from one side or the other, the disclosure is fatal to the case. The fact is that Homami, in order to state his claim to the funds held out of the escrow proceeds, was obliged to testify and did testify that he collected interest secretly in order to circumvent income tax laws. As the cases have repeatedly pointed out, "the test . . . is whether the plaintiff can establish his case otherwise than through the medium of an illegal transaction to which he himself is a party." It was clear that Homami could not do so.