Civil Law · contract law · Mercantile Law

To sever or not to sever! Understanding the ‘Blue-Pencil Rule’ of Severability under Contract Law.

Many a times, parties to a contract find, much to their dismay, that 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; an editorial exercise or a surgical operation, depending on which analogy intrigues you more!

Cutting straight to the chase : 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 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 perspective of the Indian Contract Law regime : 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, is not an absolute proposition and 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 u/s 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 suitably 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 broad-brush/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 SC in the case of Shin Satellite Public Co. Ltd. v. Jain Studios Limited, (2006 SC) 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, 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 reckon, 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 (auto-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, isn’t it. Once the tesla is taken off, 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).

 

 

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Mercantile Law

Injunction against Partners from competing

Comment : This pronouncement concerns a case where a partnership firm sought to injuct it’s ertwhile(retired) partners from carrying on competing business in contravention of Retirement Deed. The Court did not grant the relief for the reason that the plaintiff/applicants could not bring a prima facie – insofar as there was no apprehension objectively determinable that they start the business in the name of partnership firm, and in absence of such tangible fears no Injunction to be granted. 
Delhi High Court
Shri Gagandeep Singh S/O Shri … vs Shri B.R. Arya, Shri Ranbir Singh … on 18 April, 2006
Equivalent citations: 129 (2006) DLT 544
Author: M B Lokur
Bench: M B Lokur

JUDGMENT

Madan B. Lokur, J.

1. The Plaintiff has filed a suit praying for a permanent injunction restraining the Defendants, jointly or severally, from carrying on any business in the name and style of ‘Perfection House’ or its variations. In the suit, he has filed an application under Order XXXIX Rules 1 and 2 of the CPC praying for a similar injunctive relief.

2. In his written submissions, the Plaintiff has expressed the issue raised by him in the following words:

The issue that arises in the suit and in the application is whether the defendants No. 2 and 3 who are the former partners of the partnership Perfection Silk and Saree Kendra, after retirement, can be permitted to use the trade name in any form or not.

3. The grievance of the Plaintiff has arisen because Defendants No. 2 and 3 are using the premises bearing No. E-19, N.D.S.E. Part-I, New Delhi (owned by Defendant No. 1), for carrying on business under the name and style of ‘Perfection House’. According to the Plaintiff this is impermissible.

4. The Plaintiff, Defendants No. 2 and 3 and two others constituted a partnership firm carrying on business in the name and style of ‘Perfection Silk and Saree Kendra’. By executing a deed dated 1st April, 2000 Defendants No. 2 and 3 retired from the firm and their accounts were duly settled. Clause 6 of the retirement deed is of importance because it was strongly relied on by learned Counsel for the Plaintiff in support of his case. This Clause reads as follows:-

6. That first, second and fifth parties shall be entitled to and have exclusive right over goodwill of the partnership business including the name ‘Perfection Silk and Saree Kendra and the retiring partners Shri Ranbir Singh and Shri Manpreet Singh have no right, title or interest whatsoever in any asset or the partnership business including its goodwill and the name’ M/s. Perfection Silk and Saree Kendra.

5. Learned counsel for the Plaintiff submitted, on the basis of the above Clause read with Section 36 of the Indian Partnership Act, 1932 (the Act) that Defendants No. 2 and 3 had no right to use the word ‘Perfection’ in any business that they may be concerned with. Section 36 of the Act reads as follows:- 36. Right of outgoing partner to carry on competing business. – (1) An outgoing partner may carry on a business competing with that of the firm and he may advertise such business, but, subject to contract to the contrary, he may not, –

(a) use the firm name,

(b) represent himself as carrying on the business of the firm, or

(c) solicit the custom of persons who were dealing with the firm before he ceased to be a partner.

Agreements in restraint of trade. – (2) A partner may make an agreement with his partners that on ceasing to be a partner he will not carry on any business similar to that of the firm within a specified period or within a specified local limits; and, notwithstanding anything contained in Section 27 of the Indian Contract Act, 1872 (9 of 1872), such agreement shall be valid if the restrictions imposed are reasonable.

6. I am afraid that on a plain reading of the retirement deed and Section 36 of the Act, the Plaintiff has not made out any case for the grant of an injunction. The language of Clause 6 of the retirement deed, as also Section 36 of the Act, make it clear that Defendants No. 2 and 3 cannot carry on business in the name and style of ‘Perfection Silk and Saree Kendra’. There is nothing to show that these Defendants are carrying on business in the name and style of ‘Perfection Silk and Saree Kendra’. Nor is there anything in the retirement deed or Section 36 of the Act that prevents these Defendants from using the word ‘Perfection’ in any business that they may be carrying on. Ex facie, the Plaintiff has not been able to make out any case in his favor. In the absence of any restrictive covenant in their agreement with the Plaintiff or any restrictive provision in the Act, Defendants No. 2 and 3 are free to use the word ‘Perfection’ in their business. The Plaintiff has failed to make out any prima facie case in his favor.

7. Even otherwise, there is no injury caused to the Plaintiff. In paragraphs 7 and 8 of their written statement, Defendants No. 2 and 3 have stated that the Plaintiff had closed down his business of ‘Perfection Silk and Saree Kendra’ about five years ago. It is stated as follows-

It is submitted that neither the plaintiff nor the other 2 partners continued the business of ‘PERFECTION SILK and SAREE KENDRA’ and in fact after about 6 months of the retirement deed dated 1.4.2000 the plaintiff and others closed down the business of ‘PERFECTION SILK and SAREE KENDRA’ and sub-let the premises to Metro Shoes and presently the show room at Metro Shoes is in operation and running from premises No. A-6, South Extension Part-I, New Delhi for last about 5 years.

8. The Plaintiff has filed a replication but he has not denied this averment of Defendants No. 2 and 3. What he says is this:-

7-8. The submissions of paras 7-8 are denied and it is submitted that subsequent to the retirement of the Defendant, the plaintiff reconstituted the Partnership as indicated in the documents filed Along with the suit. It is also submitted that the averments of the Defendant with regards to discontinuance of the business are wrong and misconceived. It is also submitted that pursuant to the rights vested in the plaintiff exclusively the plaintiff inter alia continues to use the name Perfection in the name and style of Perfection Silk and Saree Kendra Along with Perfection House Collection without any interruption and/or interference whatsoever.

9. It appears that this issue came up for consideration when the injunction application was heard on 29th September, 2005 and learned Counsel for the Plaintiff took time to file an affidavit explaining the factual position with regard to the contents of the above paragraphs. An affidavit dated 3rd October, 2005 was filed by the Plaintiff but unfortunately this does not at all advert to the averment of Defendants No. 2 and 3 that the Plaintiff is not carrying on any business called ‘Perfection Silk and Saree Kendra’ and that in the premises where that business was being carried on (before it closed down about five years ago) a showroom of Metro Shoes is operating. In the absence of any clear denial by the Plaintiff, the averment made by Defendants No. 2 and 3 must be deemed as accepted. This being the position, it cannot be said that the Plaintiff will suffer any injury if the injunction is declined.

10. On the issue of balance of convenience, Defendants No. 2 and 3 have categorically stated in their written statement that there are two businesses in garments in the same vicinity using the word ‘Perfection’, while in Delhi there are about five other businesses in garments using the ‘Perfection’. For this reason, it was submitted that the Plaintiff cannot seek to restrain Defendants No. 2 and 3 from using the word ‘Perfection’ in their business. Learned counsel for the Plaintiff clarified that he is not making out a case of passing off, but only a case of violation of the terms of the retirement deed and Section 36 of the Act. Under these circumstances, it is not necessary for me to consider this contention, since it has already been held that there has been no violation of the retirement deed or the Act.

11. In view of the above, the application for injunction is dismissed. The Plaintiff will pay costs of Rs. 5000/- to Defendants No. 2 and 3 within four weeks from today.

12. Any observation touching the merits of the case is only for the purposes of disposing of this application and will not bind the parties in the trial of the case.