Suppose your business has had a long-standing contractual agreement with another party and both of you would like to continue to conduct business as per your agreement, but without either party’s knowledge, the government amends a law which directly affects terms of the agreement. The change might:

  • Render it impossible to achieve the object of the contract (e.g. object is now illegal); OR
  • Affect some key aspect of the agreement so that contractual obligations are now substantially different from what was originally intended; OR
  • Alter some aspect of the agreement which makes it more difficult to accomplish the object of the agreement, but it is still achievable by the parties.

If either of the first two scenarios are true, then your contract has been frustrated – typically this means it is void [Petrogas Processing Ltd. v. Westcoast Transmission Co. – para.49]. If the third scenario is applicable, then your contract will survive the change in law, and must still be fulfilled, notwithstanding any delayed performance or increased cost. The test for frustration of a contract is impossibility of performance and not increased difficulty.

However, in all of these cases, lack of knowledge of the law will not excuse you from having to follow the law. After all, if that was a permissible excuse it would encourage people to be as uninformed as possible, which is unacceptable for public policy reasons.

By structuring contracts carefully from the outset you can ensure they are robust enough to survive unforeseen shifts in the legal landscape, or at the very least cushion you from the associated costs. For example, parties may specify the assumptions on which pricing is based, or stipulate that pricing is subject to change with (or without) notice. The parties can include clauses which permit increased costs resulting from regulatory changes to be passed on to the customer; and the contract can refer to the payment of “all applicable taxes” without stating the specific rates of taxation. Parties may also include clauses which specify the contractual consequences of regulatory changes e.g. “Such obligations are conditional on the continued legality of in all of the following jurisdictions ”.

Severability

Another option available to you is the inclusion of a severability clause. In a nutshell, severability clauses can be drafted to allow the parties to ‘sever’ (or ‘cut out’) clauses which are or become or are found to be ‘illegal’.

 

Since a single illegal clause could potentially invalidate the entire contract, you can think of the severability clause as a way to keep the ship afloat. Much like a captain will jettison cargo if a ship is sinking, a severability clause may allow you to jettison anything that threatens to sink your whole agreement, if it is drafted carefully.

Note this example clause from our template Distribution Agreement:

If any part or parts of this Agreement shall be held [or become] unenforceable for any reason, the remainder of this Agreement shall continue in full force and effect. If any provision of this Agreement [becomes or] is deemed [illegal], invalid or unenforceable by any court of competent jurisdiction, and if limiting such provision would make the provision valid, then such provision shall be deemed to be construed as so limited.

However, some clauses are so central to the nature of the contract or transaction that severing them is akin to voiding the whole agreement. A carefully drafted long term agreement will include both a severability clause and the processes by which parties will deal with disputed clauses (e.g. deal with disputed terms through arbitration).

 

Takeaways

  • When entering into a long term contractual relationship consider the types of regulatory/legal changes which could affect the contract
  • Include clauses that specify what should happen if particular laws are changed
  • Draft clauses with language that can adapt to changes e.g. refer to ‘applicable taxes’ rather than a specific rate of taxation
  • Include a severability clause

Author: Sahil Kanaya

 

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