It is a practice in the legal world of today to insert a severability clause in legal documents. The purpose is to protect the survivorship of the whole contract. A legal document with a severability clause is to ensure that the validity of the other clauses continues to survive should certain clauses be held to be invalid by the court of law.
It is also known as ‘illegality clause’ or a ‘saving clause’, and in Latin it is known as salvatorious clause. Even in Islamic financing documents such as the Bai Bithamin Ajil contract, Istisna and Murabahah agreement, the clause survives. It is of course a common insertion in conventional financing.
Effect of saving clause
The insertion of a saving clause in a contract allows for the terms of the contract to be independent from one another, so that if a term in the contract is deemed unenforceable by a court, the contract as a whole will not be deemed unenforceable.
If there were no severability clause in a contract, a whole contract could be deemed unenforceable because of one unenforceable term. Most contracts include a savings clause, which is meant to ensure that the contract remains enforceable even if part of the contract is later held invalid. In the absence of a savings clause, it is possible that if a single clause is held invalid, the entire contract will also be rendered invalid.
There are many types of saving clause such as:
“Should any provision of this Contract be held unenforceable, then such provision will be modified to reflect the parties’ intention. All remaining provisions of this Contract shall remain in full force and effect”; or
“Invalidity or unenforceability of one or more provisions of this Agreement shall not affect any other provision of this Agreement. If any provision or provisions of this Agreement shall be held to be invalid, illegal, unenforceable or in conflict with the law of any jurisdiction, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby”; or
“If any provision or provisions of this Agreement shall be held to be invalid, illegal, unenforceable or in conflict with the law of any jurisdiction, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby”; or
“In the event that any one or more of the provisions contained herein shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions of this agreement, but this agreement shall be construed as if such invalid, illegal or unenforceable provisions had never been contained herein, unless the deletion of such provision or provisions would result in such a material change so as to cause completion of the transactions contemplated herein to be unreasonable”; or
“If a provision of this Agreement is or becomes illegal, invalid or unenforceable in any jurisdiction that shall not affect:
I. the validity or enforceability in that jurisdiction of any other provision of this Agreement; or
II. the validity or enforceability in other jurisdictions of that or any other provision of this Agreement.”
In re Tousa’s case
A recent decision in the US Bankruptcy Court for the southern district of Florida, In re Tousa held on the 13th October 2009, the court rejected the lenders’ arguments that the “savings clauses” contained in the 2007 financing documents prevented the transfers from being fraudulent, even though such clauses, on their face, purported to reduce the obligations incurred and liens granted by the conveying subsidiaries to the extent necessary to prevent their insolvency.
The Bankruptcy Court’s rejection of the “saving clauses” went beyond the specific facts of the case and, instead, held that “saving clauses” in general “are a frontal assault on the protections that section 548 of the Bankruptcy Code provides to other creditors” and are “entirely too cute to be enforced.”
This decision avoided over US$400 million of liens and co-borrower obligations on the basis that such liens and obligations were fraudulent conveyances under section 548 of the Bankruptcy Code and applicable state fraudulent conveyance or fraudulent transfer law.
The saving clause in this case provided: “Each borrower agrees if such borrower’s joint and several liability hereunder, or if any liens securing such joint and several liability, would, but for the application of this sentence, be unenforceable under applicable law, such joint and several liability and each such lien shall be valid and enforceable to the maximum extent that would not cause such joint and several liability or such lien to be unenforceable under applicable law, and such joint and several liability and such lien shall be deemed to have been automatically amended accordingly at all relevant times.”
The court found that saving clauses of this type are unenforceable. The saving clause was held to be invalid and against the core provisions of the Bankruptcy Code and furthermore it is a frontal assault on the protections that section 548 provides to other creditors.
The court further added that the savings clauses were unenforceable under Section 541(c)(1)(B) of the Bankruptcy Code in that they attempted to prevent property (such as a fraudulent conveyance claim) from becoming property of the estate due to the financial condition or insolvency of the debtor.
The saving clause and Maslahah Istiqrar wa Ta’ammul
Istiqrar wa Ta’amul which means that market players are given the freedom to trade, accept and trust each other in their transactions to ensure that the market runs smoothly. Istiqrar means settle down. Ta’ammul means to ponder, to think whether to proceed or not to proceed with the contract.
In several verses such as Surah al-Fatir verse 29 which describes the aspiration of traders not to incur losses. Allah. states: “For them, they secretly and openly hope for a commerce that will never fail.”(Surah AI-Fatir: 29). Similarly in Surah al- Taubah verse 24, which describes the worry over a losing concern. Allah. states:..“…the commerce in which you fear a decline” (Surah aI-Taubah: 24). In another hadith prophet explained that parties to a contract are at free to contract.
“Two people contracting still have options as long as they are not separated….” The hadith elaborates the importance of intention and mutual will of the parties in the contract.
This decision sent shockwaves to the world of finance as it renders saving clauses to be of dubious value. Saving clauses have always been used in many documentation involving kafala, qard, and other financing facilities in Islamic financing.
It is worth taking this precaution. Eventhough the contract upholds privity of parties to contract, the court may invalidate either certain clauses or the whole contract despite there being a consensus of parties. This gives rise to a need to seek other avenues to safeguard the enforceability of the transaction.
The re Tousa case went for appeal. If the decision is upheld, the case will present challenges for commercial transaction documentation that rely on saving clauses for their survival.