Many a times parties to a contract find, much to their dismay, that, while their contract is broadly good and enforceable, some parts of their contracts are not legal and valid and, therefore, unenforceable. In such a situation, the question that arises is : Whether the taint attaches to the entire contract (and the entire contract falls), or the ‘bad’ (illegal) can be severed from the good (legal) and tossed away, while retaining the remaining contract and giving effect to the intention of the parties. When is the Court to pick up a scalpel (blue-pencil) and amputate the diseased limb (illegal part of the contract), to heroically save the patient (the contract itself).
This short write up is an attempt is to throw some light on the legal principles governing severability of contracts.
The act of severance, in contractual law parlance, is known as ‘blue penciling’ or the application of the ‘blue pencil rule’. The phrase owes its origin to an editor’s act of cutting out/editing portions of a text while proof-reading, by a blue pencil. According to Black’s Law Dictionary, the Doctrine of Blue Pencil is a judicial standard for deciding whether to invalidate the whole contract or only the offending words.
Blue-Pencil Rule allows the legally-valid, enforceable provisions of the contract to stand despite the nullification of the legally-void, unenforceable provisions. However, the caveat is that the revised version must, even after edits, still represent the original meaning; the rule may not be invoked, for example, to delete the word “not” and thereby change a negative to a positive.
Looked at from the standpoint of the Indian Contract Law: A part of the consideration/object of a contract being illegal and unlawful renders the entire agreement void. This is the clear mandate of Section 24 of the Indian Contract Act, 1872 (“ICA”).
24. Agreements void, if considerations and objects unlawful in part.—If any part of a single consideration for one or more objects, or any one or any part of any one of several considerations for a single object, is unlawful, the agreement is void.”
Illustration : A promises to superintend, on behalf of B, a legal manufacturer of indigo, and an illegal traffic in other articles. B promises to pay to A a salary of 10,000 rupees a year. The agreement is void, the object of A’s promise, and the consideration for B’s promise, being in part unlawful.
However, this is not an absolute proposition or without exceptions. In the above illustration, the good (legal) cannot be separated from the bad (illegal) since they are so inextricably intermixed.
A class of cases which can be considered as truly severable and, therefore, capable of being blue-pencilled would be cases covered under Section 57 of the ICA. The illustration attached to the section, is instructive in this regard:
Illustration to Section 57 : A and B agree that A shall sell B a house for 10,000 rupees, but that, if B uses it as a gambling house, he shall pay A 50,000 rupees for it. The first set of reciprocal promises, namely, to sell the house and to pay 10,000 rupees for it, is a contract. The second set is for an unlawful object, namely, that B may use the house as a gambling house, and is a void agreement.
Section 57 reads as under :
57. Reciprocal promise to do things legal, and also other things illegal.—Where persons reciprocally promise, firstly to do certain things which are legal, and secondly, under specified circumstances, to do certain other things which are illegal, the first set of promises is a contract, but the second is a void agreement.
Another illustration, and an example of the inclusion of the ‘blue pencil rule’ within the statute can be found in Section 58 of the ICA, which reads:
Section : 58. Alterative promise, one branch being illegal : In the case of an alternative promise, one branch of which is legal and the other illegal, the legal branch alone can be enforced.
Illustration : A and B agree that A shall pay B 1,000 rupees, for which B shall afterwards deliver to A either rice or smuggled opium. This is a valid contract to deliver rice, and a void agreement as to the opium.
Clear cases of sever-ability, aren’t they?
Apart from the above, blue-pencil rule is most frequently invoked in cases of ‘agreements dealing with restraints on trade, business and profession’; or in modern parlance ‘non-compete agreements’, where a restraint which is clearly illegal is excised and remaining contract given effect to. In fact, the rule of blue pencil owes its very genesis to cases where employers tried to impose unreasonable restraints on employees/ex-employees/good-will sellers etc, and the Courts did a balancing act, and separated and salvaged the good from the ugly.
These are classic Section 27 ICA cases.
Arguably, the first reported case on blue-pencil is the oft quoted landmark case- Nordenfelt v Maxim, Nordenfelt Guns and Ammunition Co (House of Lords).
The facts of the case are pretty straightforward : Nordenfelt, a manufacturer specialising in armaments, sold his business to Hiram Stevens Maxim. They had agreed that Nordenfelt ‘would not make guns or ammunition anywhere in the world, and would not compete with Maxim in any way for a period of 25 years’.
The House of Lords, having regard to the fact Nordenfelt had received a handsome amount for the sale, did not find the whole restriction bad. Having said that, the Court found the latter part of the restriction unreasonable and severed it to read : “for the next 25 years, would not make guns or ammunition anywhere in the world ,
and would not compete with Maxim in any way” . The latter part was considered too ‘catch-all’/all-encompassing and, therefore, an unreasonable restriction.
This is where the roots of this principle lie.
In another popular decision (Rose & Frank Co v JR Crompton & Bros Ltd), the Blue Pencil Rule was invoked to strike out an unacceptable clause in an MoU which operated to to exclude the jurisdiction of the courts, which of course, is something that the parties cannot do, legally.
The Indian Supreme Court in the case of Shin Satellite Public Co. Ltd. v. Jain Studios Limited, (2006 SC) also elaborated a bit on the principle. In this case, the parties had entered into a contract which had an arbitration clause. So far so good. However, even the best craftsmen commits an error or two, especially in the arbitration clauses (midnight clauses which are finalised at the very end when the champagne is ready to pop and parties are exhausted after a prolonged back and forth on the commercials); Coming back, one of the clauses in the contract presented some difficulty; it provided that the arbitral award (delivered by the arbitrator) would be final and could not be challenged by either party, in any court or forum. This particular part of the contract was potentially illegal, being in restraint of legal proceedings, and having the practical effect of giving the arbitrator a complete carte blanche (license) to pass any decision, without any redress against it. Such an agreement, as students of contract law would know, would not pass judicial muster, being illegal and also against public policy. (Parties cannot opt out of/derogate from basic legal principles and remedies of Indian Law). The Court was faced with a predicament and called upon to decide whether this particular restraint would infect and render the whole contract bad; or could easily be amputated, like a diseased limb, to save the patient. The Court went on with the latter view, saved the contract as well as the arbitration clause by running a blue pencil over the portion which excluded judicial remedies and jurisdiction of the Court. The Court must have felt that throwing away the whole contract for this rather trivial (and at any rate, something that goes to the root of the matter) would be tantamount to ‘throwing the baby away with the bathwater‘.
While doing this, the Court did recognise the limitations of this rule : A contract has to be severed by caution (lest the courts be accused of re-writing bargains). Only if ‘severability’ is substantively possible and contract capable of surviving post the surgical operation, that this exercise of running a blue pencil down should be embarked upon.
The court held : “the proper test for deciding validity or otherwise of an agreement or order is ‘substantial severability’ and not mere ‘textual divisibility’. It is the duty of the court to severe and separate trivial or technical part by retaining the main or substantial part and by giving effect to the latter if it is legal, lawful and otherwise enforceable.
When asked to pick up the scalpel or the blue pencil to excise/cut-off a part of the Contract, the court may be guided by the following considerations, which are well-established now :
a) The unenforceable provision can be severed without the necessity of adding or modifying the wording of what remains. (The idea being to cut-off and not re-write or modify).
(b) The remaining terms continue to be supported by adequate consideration. (example : X contracts to sell a Tesla (self-driven) car and five tyres to Y for 10K USD. For some reason, the sale of Tesla is outlawed, however, five tesla tyres can still be sold and purchased; X seeks specific performance of the contract, asking the part insofar as it concerns sale of Tesla Car to be excised and thrown-away, and part where sale of tyres is envisaged enforced. This would be absurd, won’t it? Once the Tesla is taken-out of the bargain, there is little consideration left for Y and no court would enforce something like this. Blue pencil off, please!!!)
(c) The severance of the unenforceable provisions does not distort the parties’ bargain so much that it materially differs from the contract the parties entered into (“does not so change the character of the contract that it becomes not the sort of contract that the parties entered into at all”). (tesla example, again!)
(d) The Court cannot take away the very heart and soul of the contract under the guise of blue pencil rule. Only a limb can be amputated, not the heart and brain!
(e) The Contract, post surgical operation, should be one that parties, operating as people of ordinary prudence, would have entered-into (even with the offending part struck out).