Severability
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Boilerplate Anatomy™
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Severability
/sɪˌvɪərəˈbɪləti/ (n.)
The tolerance for having something chopped off and carrying on. With one exception, self-harming fusspottery.
If one aspect of my contract becomes, through the machinations of the steampunk state, illegal, what does that mean for the rest of it?
The general proposition for illegality is this:
“a contract which obliges its participants to do illegal things is void: unenforceable as a matter of pubic policy.”
So, should you hire an assassin to kill, say, your spouse and the assassin takes your money but fails to carry out the job, don’t expect his majesty’s commercial courts to award you damages, much less the courts of chancery to order specific performance.
Straightforward enough. But still, hypotheticals fester — tey do, at least, in the minds of our learned friends the world over. Commercial solicitors are given to fixating upon the unknowable hereafter. They divine our possible futures and prepare us for every contingency they might shower upon us, however remote.
So, what if only a teeny little bit of the contract becomes illegal? Or all of it is, but only slightly? Say it is punishable neither by imprisonment nor a fine, but is just sort of gauche?
If a mere corner of the accord transgresses some informal, but technically binding, guidance, can the parties still get on with the rest of the deal?
And if, otherwise, not, might it help if they say, “in this contract that any bit which later becomes illegal — or even turns out to have been illegal the whole time — just doesn’t count any more, so we can carry on with all the remaining good bits”?
On crystal balls and unexpected inequities
The JC’s general remarks about boilerplate are here writ large.
So, firstly, that a severability clause is even on the table speaks to some apprehension on the parties’ part as the business they are proposing to do. Doesn’t it? Either that, or a misapprehension: they labour under the incorrect impression that what they have in mind is, and will stay, legal for the period they are proposing to do it.
Second, even if their enterprise was fully kosher when they resolved upon it, we must presume they wouldn’t seriously expect the country’s commercial courts to continue to uphold an enterprise that its criminal courts, in the meantime, would put them jail for. So we must be talking about technical infringements and not fundamental ones.
Fundamental illegality — like our assassination hypothetical — would be surely enough to undermine a meeting of minds in the first place, but even if it did not, it would be quite the stroke of luck if the benefit that fell away by amputating a newly outlawed passage fell equally between the parties.
Odds are, that is to say, that the “severing” a contract will in fact favour one party over the other, in a way that, logically, they cannot predict before it happens.
Say I have agreed, for a monthly fee of ten pounds, to provide you with five services, one of which later transpires to be illegal. The other four services remain valid, as does your obligation to pay me an amount of money once a month. So is the contract simply severed to cut out the illegal service? Must you now pay me ten pounds for four services?
Equity says there should be some adjustment of the commercials; as we didn’t have a crystal ball, resolving this at the outset of a contract, with a severability clause seems cavalier. It would be much better for the parties to get together and restrike the deal in light of the changed services.
Yet a severability clause seems to head this approach off.
I know I keep banging on about complexity, but if there were ever a better example of forlornly trying to cater for a complex world with simple rules, this is it. Face facts: you are going to have to figure it out at the time. That such a prospect might give the heebie-jeebies to internal audit, and the poor sap in compliance whose job it is to police the organisation’s risk taxonomy, is an added frisson that some of you might find strangely satisfying. I know I do.
Lady Macbeth
There is an element, too, of the lady protesting too much here: why would you enter a contract if you thought part of it might be illegal? What kind of operation are you running?
If the choice is between blindly allocating unforeseeable losses at the start of the relationship with a severability clause, and hoping the parties can be adult enough to come together in good faith to sort out a compromise as and when the unforeseeable becomes a reality later — trusting each other, in other words, to be good eggs and not dicks — then the JC knows where he’d rather be, and who he would rather be trading with.
Finance contract boilerplate
So, why do we even have it? Finance contract envy. That’s why. While a severability clause seems counterproductive in most arms’ length, symmetrical commercial settings, there is one where it is not: an asymmetrical commercial setting. A loan. Here, day one the lender ponies up a lot of money, and has his posterior in the proverbial sling until the last day, when the borrower gives the money back. If the contract becomes tangentially illegal in the meantime, then cancelling it would be a really bad outcome for the bank.
Let’s say the bank lends you a hundred million dollars for a year. The terms of the loan are that you must repay in a year, together with fixed interest in the meantime and, on the scheduled repayment date the bank must deliver you a single bowl of M&Ms with the brown ones removed. As a gesture of fun and goodwill, and to reflect what a hip outfit the bank is. You could imagine Northern Rock doing this sort of thing.
Everyone happy, right?
Now: what should happen if, unexpectedly, a new government is enacted on a platform of irrational hostility to eighties metal bands, and they legislate for it to be illegal — punishable by imprisonment — to doctor M&Ms? Without a functioning severability clause, the contract might be void.
Absurd, you might say: this is obviously a meaningless formality. The parties would at once get together and agree to waive the need for the M&Ms. Plainly, no-one is materially affected.
But here is the thing. Imagine the borrower is a hedge fund. One of the especially venal, rapacious, locusty ones. It has just had a free option drop into its lap in the shape of a compelling legal reason it might not have to give back a hundred million dollars. God forbid it might opportunistically claim ~ to its horreur, naturally ~ that this contract cannot now be honoured, on pain of imprisonment. It will wheel out its compliance officer, who will mutter about formal compliance with rules and the firm’s duty to its shareholders. Or its investors. It will not be hard for it to contrive reasons that, even though it would love to give the money back, it just can’t.
Those who don’t believe this are cordially invited to consider the stupid banker cases: that is exactly what the hedgefunds did to Citi on the Revlon loan debacle.
But note how this only arises because of the extreme asymmetry of a loan contract. Few categories of contracts in the commercial world are like this: where one party takes such an enormous punt on the other, and by extension, on the regulatory environment continuing to support that punt while it remains in the air.