Severability
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Boilerplate Anatomy™
 Some dagging shears yesterday, suitable for severing things.
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Profound ontological uncertainty writ large. If one aspect of my contract is illegal, what does that mean for the rest of it?
This is really a way of looking at the question of illegality, the general proposition for which is that a contract which obliges its participants to do illegal things is void and unenforceable as a matter of pubic policy.
So if you hire an assassin to kill your spouse and the assassin takes your money but fails to, don’t expect her majesty’s courts to grant you damages, much less the courts of equity to award specific performance.
Straightforward enough. But still, hypotheticals fester, at least in the minds of assiduous draftspeople the world over. What if only a teeny little bit of it is illegal? Can I still get on with the rest of it? And if, otherwise, not, will it help if I say in my contract that any bit which later becomes illegal — or even turns out to have been illegal the whole time — doesn’t somehow count any more, so I can carry on with the rest of it?
On crystal balls and unexpected inequities
The JC’s general concerns about boilerplate are here writ large.
So, firstly, an illegality speaks to some serious misapprehension on the parties’ part as to the legitimacy of what they are agreeing to do. Even if their enterprise was kosher when they agreed it, we must presume, giving their intelligence the benefit of the doubt, that they didn’t seriously expect a country’s commercial courts to continue to uphold an enterprise that its criminal courts would put people in jail for.
This misapprehension might be fundamental enough to undermine their meeting of minds in the first place — in which case, what value a severability provision? — but even if it is not, it will be quite the stroke of luck if the lost benefit from the illegal, severed, part of the contract falls equally between the parties.
Odds are, that is to say, that the severance will 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 the agreed monthly retainer. 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. Yet this is what this boilerplate seems to do.
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
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.