In the last issue of the Corporate Practice Newswire we discussed practical issues with notice provisions. In this issue we will be addressing problems and unintended consequences that can be caused by severability clauses, because how you decide to “slice and dice it” does matter.
The purpose of a severability clause is to deal with a potentially unenforceable or illegal provision in an agreement, and in general, to sever such a provision while keeping the remainder of the agreement intact and in effect. However, drafters of contracts sometimes will cut and paste a severability clause from a recent contract into a document and move on, with what may be a false sense of security because they failed to reflect upon the nuances of these clauses and the objectives of the parties.
Clearly, lawyers should be on higher alert when dealing with provisions that are more likely to be subject to challenges as to their enforceability. If an agreement contains provisions that are frequently scrutinized by courts or are regularly drafted in ways that may run afoul of laws or public policy, the impact that a severability clause may have on these provisions, and the agreement as a whole, may be profound. The following are examples of provisions whose legality and validity are commonly called into question:
- interest rate;
- choice of law;
- penalty or liquidated damages; or
- any provision drafted in a manner that may be deemed unfair, unconscionable or an agreement to agree.
Lawyers should consider which of the numerous approaches to designing severability clauses might be most appropriate for the particular circumstances at hand, especially in cases where any of the above types of provisions come into play. While there is no “correct” way to structure a severability clause, the various ways to address the issue of severability can each lead to starkly different outcomes. Pausing while drafting to reflect on whether certain of these outcomes would be unacceptable to the parties might prevent major headaches down the road.
Dealing With Unenforceable Provisions One consideration when drafting a severability clause is determining what should be done with a provision in an agreement which has been deemed to be illegal, invalid, unenforceable or against public policy. A typical boilerplate severability clause will state that such a provision will simply be deleted, or otherwise held to be ineffective, while the remaining provisions in the agreement remain in full force. However, this standard severing mechanism may result in the elimination from a contract of a concept or matter which is of significant consequence to either or both of the parties.
In order to avoid this outcome, the severability clause may be drafted so that invalid provisions are replaced with a valid and enforceable provision covering the same subject matter. Alternatively, the clause may require that the invalid provision be modified in such a way that it becomes valid and enforceable. Along similar lines, some severability clauses state that invalid provisions will be narrowed, and deemed effective only to the extent they are enforceable. For drafting purposes, clauses requiring replacement of, or modification to, an invalid provision may be enhanced by specifying that such replacement or modification shall be composed in a way most closely akin to the parties’ intent. Language that makes clear that a replacement or modified provision must adhere as strictly as possible to the parties’ original business purposes or other objectives will provide clearer direction when implementing a severability clause.
Execution of a Severability Clause
The question of who exactly will execute the performance that may be required under a severability clause is a second consideration when drafting such a clause. Certainly, a standard severability clause which simply deletes an invalid provision will not cause much concern in this respect, as the ineffective provision will be struck automatically. But if the clause requires a replacement or narrowing of, or modification to, an invalid provision, who is responsible for these acts, which essentially function as amendments to the agreement? Too often, severability clauses require such revisions to be made, but are silent as to whom the parties intend to draft the alterations necessary to make the provision enforceable.
One option is for the severability clause to call for the court which finds a certain provision to be illegal or invalid to itself replace, modify or narrow the provision. However, not all courts will take on this obligation. Another means to come up with an effective provision is for a mediator or some independent third party to be engaged to perform this undertaking. Choosing either of these options as a solution takes the process out of the hands of the parties to the agreement, which may or may not be desirable. Hopefully this approach will result in the severed provision being replaced or modified as required, but a third party’s attempts to fairly perform this responsibility (even when required to stick as closely as possible to the apparent intent of the parties) may leave one party feeling that with the provision so restructured, they will no longer attain the full benefit for which they bargained.
Perhaps because of this concern, the task of preparing a legal and enforceable replacement or modified provision is frequently left to the parties to the agreement. However, a severability clause that goes this route should not extend beyond requiring the parties to negotiate (perhaps in good faith) to replace or modify an ineffective provision, in order to avoid creating an agreement to agree which may itself be unenforceable. Drafters of severability clauses should also specify exactly what happens if the negotiating parties are unable to settle on a replacement or modification to an invalid or unenforceable provision. It should be made clear if the intent of the parties is to terminate the agreement or unwind the transaction in such an event.
Carving Out Essential Provisions
Special attention must be paid to the possibilities that the replacement or modification of an invalid provision may prevent the parties from reaping the full benefits for which they bargained, or that the parties left to their own devices may not be able to negotiate a mutually satisfactory replacement or modification and are therefore left to walk away from their agreement. The significance of these possibilities leads to a third consideration when constructing a severability clause — whether certain provisions in a contract should be deemed more important than others because they represent the crux of the agreement.
When forming a severability clause, the parties and their counsel should be aware of whether there are circumstances when a severed or otherwise replaced or modified provision should not be applicable as a solution. By and large, these considerations arise in situations where severing, replacing or modifying an invalid provision in an agreement would damage or materially impact the essence of the contract or a core part of the agreement.
A severability clause may be drafted to provide for a carve-out, by stating that its method of dealing with an invalid provision would not apply if any of the essential terms of the agreement was invalid. This general carve-out statement expresses the parties’ understanding that certain provisions are too important to simply sever or modify, but it may leave the determination of what constitutes an essential term up for interpretation. If the parties desire, the clause may be more explicit, providing a list of specific provisions which, if invalidated, would not be subject to the severability clause. If this more precise version of the severability clause is chosen, the parties must first identify the key provisions which if severed, replaced or altered would deprive a party of a major element of the agreement, one that was critical or indispensable to that party during negotiation.
While the inclusion of a carve-out ensures the parties that the severability clause will not be used to deny a party of the advantages of a vital term, it also leads to the question of what happens when these essential terms are not enforceable. If the basis of the bargain is so thoroughly affected by an invalidated provision, will the whole agreement be void? Again, clauses are often silent as to this next step, but the termination of the entire contract may be inferred from such silence. If parties wish to avoid this and come up with a middle ground, they must think through to these potential outcomes and expressly state their intent.
As this discussion makes clear, raising one question about how to deal with a severability clause often leads to another, and then another. What at first may seem to a contract drafter to be a boilerplate “throw-in” clause may quickly become a tangled vine of possibilities and methods to handle the various consequences. Failure to consider these consequences may prove detrimental to all involved.
When drafting severability clauses, it is best to approach the situation carefully and assess the best means to resolve potential enforceability issues while protecting clients from having major benefits of their contract inadvertently gutted. In this light, an old carpenter’s axiom comes to mind — in the matter of severability, the wise craftsman measures twice, and cuts just once.