Severance Clause
Courts have power to remove any parts of contracts to remove illegality.
Where illegality exists and cannot be severed due to the rules which apply to severability of contracts, the contract is likely to be considered a void agreement, and have no legal effect.
That may be the consequences of the operation of:
- a statute, such as the Criminal Justice Act, Competition Act
- public policy, such as:
- provisions of a contract which involve criminality
- provisions which operate as penalty clauses or forfeitures
- restrictive covenants
- contracts not to sue: words ousting the Court's jurisdiction (which are normally assumed to be severable)
- simply illegal under the general law, such as a contract clause which amounts to bribery.
Severance clauses set out a procedure which the parties intend to take where a court rejects the bad parts of a contract. The outcome is that what is left are the enforceable and valid parts of the contract.
There are however limits to the power of the court to sever parts of a contract.
Blue Pencil Test
The blue pencil test is a structured approach to severance.
A three-part test applies to sever parts of a contract:
- can the illegal provision be removed without modifying the words of the remaining terms. If it still makes sense, the illegal provision can be removed.
- The remaining terms following the "blue pencil" must be supported by consideration
- Following the blue pencilling of the illegal parts, the contract must continue to be the same sort of contract that the parties entered into in the first place.
In order to provide that this is what the parties intend, severance clauses are inserted into many business contracts.
If a substantial part of the contract is removed so as to offend the principles set out above, the entire contract is declared void.
Severing Terms of Contracts
Courts take a minimalist approach to severance of illegality in contracts. The least amount that can be removed from a contract is removed. First, at the phrase level, then at the clause level.
Limitations on the severance process include...
Type of Contract
If removal of a word, phrase or section would change the kind of contract which was agreed.
That would be enforcing something to which the parties had not agreed.
Removal only permits changes to the extent of the contract only
Rewriting Contracts
Courts will not re-write contracts during the process of severance of illegality
So where it's not possible to simply to strike out the offending word or words, severance is out of the question.
Courts only have the printed words on the page to work with.
It can’t introduce new words into the agreement as part of severance.
Scope or Intention of the Agreement
Severance which would result in altering entirely the scope and intention of the agreement is not permissible
Statutory Illegality
When a contract or deed is made contrary to statute, either part of contract or all of the contract is void and of no legal effect. It's a nullity.
Illegal Consideration
Where illegal consideration is the only contractual consideration which would be severed, severance is not possible.
The same rule applies when the invalid restraint forms "the real consideration", "the main consideration" or "the whole or substantially the whole consideration" for the promise to perform.
It can also be the case that the promise would not have been given but for the invalid restraint. Provided that consideration is sufficient, the contract can usually be enforced after severance of the invalid provision.
Saving the Agreement
If the contract is able to be saved by removing the unlawful parts of the contract, the remaining parts of the contract constitutes the contract between the parties, which is then read for its legal effect.
The process of severance therefore attempts to avoid rendering the entire contract totally invalid.
The minimum amount is deleted from the contract to render it lawful. If that end result can’t be achieved, then the contract is void ab initio.
Purpose of Severance clauses
Severance clauses frequently appear in commercial contracts which contain restrictive covenants, which are:
- franchise agreements
- contracts for the sale of businesses
- consultancy agreements
- employment contracts
Restrictive covenants:
- are contractual commitments whereby one party agrees not to do something: such as an employee working with a competitor for a limited period when the contract ends
- must protect the legitimate interests of the party relying on them and go no further. Where that line falls for any particular employee is not always clear, because it depends on so many different factors, including:
- the terms of the contract, and
- what happened in the real world
- are frequently challenged.
But severance provisions can appear any sort of contract as part of the boilerplate provisions.
Example of Severance in Action
Supposing a contractor agrees to a restrictive covenant in a consultancy agreement for delivery of IT services. The contractor commits to a restrictive covenant which provides that the contractor will:
“not compete in the fields of IT Services or sale of paper cups with the Company in the UK, European Union or Australia for 12 months”
Suppose a court was to find that inclusion of Australia in the non-compete clause (which is a type of restrictive covenant) above made it too broad, and therefore unenforceable.
Principles of severance could be applied to remove parts of the clause with the following result:
“compete in the fields of IT Services or sale of paper cups with the Company in the UK, European Union or Australia”.
The severance has not changed the meaning of the clause. What is left is a reasonable restrictive covenant which is able to be enforced.
Even then though, the definition of "IT Services" for the employer or principal business looking to rely on the clause.
For example:
- junior contractor, narrow skill set: if a junior contractor is a C# developer, and the definition of "IT Services" applies to any sort of IT Services - such as systems administration or first-level user support, it's probably too wide and unenforceable
- senior executive, wide skill set: if the company supplies a broad range of IT Services (think IBM for a moment), and senior executive has market expertise in only 1 or 2 of those fields, and IT Services is defined to mean any IT Services in which the company is engaged, it's probably too wide and unenforceable
- back-office middle-management: if IT Services includes sales based roles, it is probably too wide because back-office staff do not usually have contact with customers of the business
Example: Severance clause
If any provision of this contract is found by a court to be invalid, unenforceable or illegal, the remaining provisions shall remain in force. If any invalid, unenforceable or illegal provision would be valid, enforceable or legal if some part of it were deleted, the provision shall apply with whatever modification is necessary to give effect to the commercial intention of the parties.
Severance clauses tend to restate the general law.
When they do, they are redundant.
In cases of illegality in contracts, there may be a collateral contract which allows a recovery of all or part of the contract. If that is enforceable recovery may be possible, under the collateral contract, provided that it is not equal to enforcing the illegal contract.
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