Key Takeaways

  • A divisible contract allows duties to be divided into matching pairs so that each portion of performance is independently enforceable.
  • Divisible contracts differ from severable contracts but still count as single contracts, governed by general contract law principles.
  • Courts examine intent, apportionability, and equivalence of consideration to decide if a contract is divisible.
  • In bankruptcy and restructuring, courts sometimes treat divisible contracts differently for assumption or rejection.
  • New theories like reverse divisibility and subsequent modification expand how breaches or modifications affect obligations.
  • Compensation for performed portions may be allowed even if other portions are breached.

To define a divisible contract, it is a contract in which the duties to be performed by the participating parties are divided into matching pairs such that both parties consider the duties to be equal. The duties in each pair exist and can be performed independently. An example of a divisible contract is an installment contract. The performance of a segment does not preclude the obligation of the other party from performing the other segments.

For instance, Alekra and Manning enter into a contract where the performance of each is as follows:

  • In the first month, Alekra will ship 1,000 pounds of building materials to Manning and Manning will pay Alekra $5 per pound.
  • In the second month, Alekra will ship 1,000 pounds of wiring materials to Manning and Manning will pay Alekra $6 per pound.
  • In the third month, Alekra will ship 1,000 pounds of roofing materials to Manning and Manning will pay Alekra $7 per pound.
  • In the fourth month, Alekra will ship 1,000 pounds of fencing materials to Manning and Manning will pay Alekra $8 per pound.
  • In the fifth month, Alekra ships building materials and the cycle keeps on going for a period of three years.

Such a contract is divisible since the performances of Alekra and Manning can be apportioned into equal pairs. More importantly, the agreement treats each pair as equal and matching. It should be noted that in divisible contracts, the party that carries out one or more sections of the contract is entitled to collect the agreed-upon amount for those parts, even if other sections of the contract are breached.

In the above example, if Alekra ships building materials in the first month, wiring materials in the second month, and PVC materials in the third month, it has breached the section of the contract that obligates it to send roofing materials on the third month. However, since Alekra has performed the part of the contract that covers the first two months, it is entitled by law to collect the contracted price for the building and wiring materials, though it breached the section of the contract covering the third month.

Severable Contracts

A contract is severable if, by its purpose and nature, it is susceptible to apportionment and division, and has multiple parts that are not dependent on each other and not intended by both parties to be so. Such a contract is one where it is established that individual partial performance on one side is exchangeable with individual partial performance on the other. Failure to carry out one of the partial parts does not stop recovery for the performance of another. Various consequences are applicable once a particular contract is said to be divisible.

If the exchangeable performances can be divided into a corresponding pair of partial performance, such that individual parts of the corresponding pairs is regarded by both parties as equivalent, then performance of a partial pair by one party forces the other party to perform the corresponding partial pair, just as it would be if the contract contained only that particular pair of performances.

Tests Courts Use to Determine Divisibility

Courts often apply several tests when deciding whether a contract is divisible:

  • Apportionability of Performance: The agreement must be capable of being broken down into distinct units of performance that correspond with payments or duties. For example, contracts based on installment deliveries often qualify.
  • Intent of the Parties: Courts look to whether both parties intended each part of the contract to stand on its own. This is typically determined by examining the contract language and the surrounding circumstances.
  • Equivalence of Consideration: Each divided part must be supported by consideration that is proportionate and fair. If one side’s partial performance cannot be matched with reasonable compensation, divisibility may not apply.

These tests ensure that a divisible contract is not used to unfairly excuse one party from obligations while still benefiting from the other’s partial performance.

Divisible Contracts Are Still Single Contracts

Consequently, if one party breaches part of the divisible contract, that party is not barred from obtaining any and all considerations allocated to the contract section that was performed. However, this doesn't mean that the pairs of corresponding parts are treated as separate contracts since divisible contracts are still single contracts. As such, the customary rules governing the formation and execution of contracts are applicable.

Divisible Contracts in Bankruptcy Context

Divisible contracts often arise in bankruptcy, where a debtor may seek to assume the beneficial portions of a contract while rejecting burdensome ones. Courts generally resist cherry-picking within a single indivisible contract, but divisibility allows them to separate obligations.

For example, in In re Hawker Beechcraft, the court permitted a debtor to assume two master purchase agreements but reject specific schedules within them. The reasoning was that the schedules operated as divisible sub-agreements that could be evaluated independently.

This distinction plays a critical role in restructuring cases, as it determines whether ongoing obligations can survive bankruptcy proceedings.

Performances Are Not Exchangeable Under Two Contracts

If two separate contracts exist between the two parties, the performance of one party in the first contract is not exchangeable with the performance of the other party in the second contract. Also, the failure of one party to perform the duties under one contract has no effect on the obligation of the other party to perform its duties stipulated in the second contract.

Reverse Divisibility and Subsequent Modification

Recent scholarship has introduced the concept of reverse divisibility, where parties argue that what appears to be multiple agreements should instead be treated as one unified contract. This strategy is sometimes used to expand the consequences of breach or justified non-performance.

Another emerging principle is subsequent modification, where a later agreement alters how divisible portions of an earlier contract are enforced. Courts may allow these modifications to redefine the scope of divisible performance, especially when equity favors protecting the non-breaching party.

These evolving doctrines highlight how divisibility can work in both directions: limiting liability for breaches of part of a contract, or consolidating obligations to prevent strategic avoidance of duties.

Compensation Claims

If there are uncured material failures by both parties, either party may claim compensation(s) for the parts already performed; however, either party cannot enforce that contract on any of the other pairs of the corresponding part. These rules provide that contracts which are induced by fraud are rendered voidable, thus allowing aggrieved parties to defend themselves against lawsuits that try to enforce the terms of the agreement.

Practical Examples of Divisible Contracts

Divisible contracts commonly appear in commercial transactions such as:

  • Installment Sales Contracts: A supplier delivers goods in monthly shipments, with payment tied to each shipment.
  • Construction Contracts: Work may be divided into phases (e.g., foundation, framing, roofing), with compensation owed upon completion of each phase.
  • Service Agreements: A consultant may provide services on a quarterly basis, with each quarter’s services billed separately.

In these scenarios, failure to perform one portion does not negate the right to recover for completed portions, provided that each segment can stand independently and meets the criteria for divisibility.

Frequently Asked Questions

  1. What is the main difference between a divisible contract and a severable contract?
    A divisible contract is still considered one single contract, though its performance can be broken into parts. A severable contract is treated as multiple independent agreements.
  2. How do courts decide if a contract is divisible?
    Courts examine whether performance can be apportioned, whether the parties intended divisibility, and whether consideration for each part is proportionate.
  3. Can divisible contracts be partially enforced if breached?
    Yes, a party may still recover for portions performed, even if other sections of the contract are breached.
  4. How does divisibility affect contracts in bankruptcy?
    Divisible contracts allow debtors to assume or reject parts of agreements, subject to court approval, while indivisible contracts must be accepted or rejected in full.
  5. What industries commonly use divisible contracts?
    Divisible contracts are common in installment sales, construction projects, long-term service agreements, and supply chain transactions.

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