Choice of law (or governing law) clauses are important contractual provisions and can serve to protect parties from the application to their contracts of a body of law with which they are unfamiliar. Choice of law clauses can also save litigants time and money in the event of a dispute, and can allow parties to apply a favourable substantive law to their contracts. This article provides an overview of choice of law and considers the factors that should be taken into consideration at the drafting stage to ensure that the parties’ chosen governing law is upheld.
What is a Choice of Law Clause?
A choice of law clause identifies the substantive law that will apply to and interpret a contract. This means that a choice of law clause will determine how the parties’ rights and obligations will be interpreted in the event of a dispute. It is therefore a clause whose implications cannot be overstated, as the terms of a contract may be interpreted differently in different legal systems. Choice of law also implicates the validity and the effect of the contract. A prudent choice of governing law, and its express inclusion into a contract, will provide the parties to that contract with a considerable degree of certainty as to their contractual (and non-contractual) rights and obligations.
Like choice of jurisdiction clauses, choice of law clauses can also be drafted to confer favourable conditions on the parties. For example, the law of England and Wales has always been a popular choice for parties to an international contract (even those with no connection with the jurisdiction), generally due to English law’s standing as a reputable jurisdiction with specialist courts. Parties may choose to apply English law to their financial agreements because the jurisdiction of England and Wales recognises the concept of trusts.
Most legal jurisdictions around the world defer to the principle of party autonomy and will therefore allow parties to a contract to choose their governing law freely, even where the chosen law is foreign to the jurisdiction in which the parties are based and to the jurisdiction to which the parties have elected to refer their disputes. Parties should choose the law that will govern their contracts at the outset of any agreement between them.
The parties’ choice of law will only be frustrated in some instances, including where that law is deemed incompatible with the public policy of the legal jurisdiction in which the dispute is being litigated. Some jurisdictions, like China, will also often refuse to apply a foreign law if the contract is exclusively domestic.
When Should you Choose a Governing Law?
While it is always advisable to choose a governing law, for bringing about certainty if for nothing else, it is particularly important that parties to an international contract do not neglect to include an express choice of law clause in their agreement.
In any situation where the parties are based in different legal jurisdictions or where the performance of the contract is to take place in a country that is not either (or both) of the parties' home jurisdiction, choice of law should be given particularly careful through. To minimise uncertainty to the fullest possible extent, any contract with a foreign element must contain a governing law clause.
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Neglecting Choice of Law: what could happen?
If no express choice of law is made and a dispute arises between the parties, the court hearing the dispute will apply complex conflict of laws rules to ascertain whether an implied choice of law was made by the parties. This will inevitably result in the loss of time and costs, and may not produce the outcome desired by one or both of the parties.
This will also be done as a preliminary issue, meaning it will delay the resolution of the dispute that brought the parties before the court at the outset.
Drafting a Choice of Law Clause: factors to consider
Generally, an express choice of law clause will be upheld if it is unambiguous and is clearly expressed. However, there are other basic factors to consider. For example:
1. Familiarity: Parties often choose the law with which they are most familiar, which is particularly useful where parties are experienced in international commerce and have always applied that law to their contracts.
2. The quality and reputation of the law: Not all laws are created equal - some legal systems have a better reputation for application to international commercial contracts than others. English law has been a preferred choice of law for this reason for many years. It also has a reputation for fairness and certainty, and English courts are very experienced in resolving commercial disputes.
3. Interplay with choice of jurisdiction: Regard should also be had for the chosen jurisdiction’s ability to interpret and apply a foreign choice of law.
4. The suitability of the governing law: Parties should consider obtaining legal advice from an expert on their prospective governing law to ensure that the application of that law to their contract is favourable. An expert will also be able to advise the parties on the likelihood of their choice of law being upheld by their chosen jurisdiction.
Parties choosing a governing law should also be aware that, even where an express choice of law has been made, it will always be the law of the forum (i.e. where the dispute is litigated) that will
govern procedural issues (such as limitation periods and evidence). It may be worthwhile to obtain advice as to any overriding mandatory rules of the law of the jurisdiction where the dispute is being determined (especially where the governing law differs from this) to ensure that the parties’ choice of governing law is not excessively distorted by these rules in such a way as to frustrate any strategic advantage that prompted the parties to choose it.
It is often overlooked that the governing law will also affect the parties’ non-contractual rights and obligations (e.g. a duty of care under tort law) and the parties' pre-contractual dealings. The choice of law clause should also be drafted such that it is broad enough to cover disputes arising out of non-contractual obligations or which may arise before the contract has been signed (e.g. claims for misrepresentation).
Parties must also bear in mind that a governing law clause and a jurisdiction clause are two distinct provisions. A jurisdiction clause identifies the court that will hear the dispute, and has no bearing on the law that will be applied. The chosen jurisdiction will not necessarily apply its national law to the dispute, meaning that parties should make sure to draft both clauses separately and to give each choice due consideration.
Even where the chosen jurisdiction is experienced at interpreting and applying foreign law, the parties will generally still have to present expert evidence on the principles of the chosen law in order for the relevant court to determine the issues before it. Parties who do not wish to spend the associated legal costs or expend time and energy to consult with experts on the foreign law may wish to simply choose a governing law that corresponds with the chosen jurisdiction.
Also, parties should be specific in identifying a governing law. For example, parties wishing to apply New York law to their contracts must specify that it is “the law of New York” and not “the law of the United States” that is to apply.
Parties wishing to side-step the more complex difficulties of choice of law and jurisdiction altogether can often do this by referring their disputes to arbitration rather than to national courts.
The Bottom Line
To ensure that the resolution of a dispute between the parties to an international contract will not be delayed by the preliminary determination of governing law, parties should make sure that their contracts include an express, unambiguous and favourable choice of law clause.