Drafting Choice of Law Clauses for Commercial Contracts

Business parties typically have the freedom to decide the terms and conditions when writing international commercial contracts. The problem is that disputes arise more often than not, which can lead to litigation, arbitration or other forms of dispute resolution involving such agreements.

This is when some “overlooked” clauses, such as the choice of law provisions, gain more importance. Especially when dealing with parties from different countries, negotiating such provisions, as well as ensuring these are well-drafted by a lawyer, become a necessity.

This article is the first of a two-article series to explore some important aspects of this clause that often put the parties at risk in ways that could be easily avoided.

Choice of law – how important is it?

If you want to avoid the uncertainty of what law will apply during a moment where uncertainties are at plenty, you need a well-drafted choice of law clause stating the law that will govern the rights and obligations of the parties.

After all, when there is no choice of law clause or the clause is poorly drafted, establishing the applicable law is often a complex, expensive and complicated process. This happens because, in such cases, the parties are usually subject to the conflict of laws principles in the jurisdiction where the dispute is heard, and the outcomes of such process are not always predictable.

As laws of various jurisdictions might have some relationship to the agreement, courts can rely on both international rules and the law of the state where it sits to decide on applicable law. Also, some international conventions ratified by the parties’ countries may be applied automatically over international contract disputes. That would be the case of the Vienna Convention on the international sale of goods (CISG), which the parties must specifically opt out of the applicability in the contract to avoid being automatically bonded by its provisions.

Thus, the clause of choice of law is critical not only because it avoids the additional conflict between the parties to decide on which law to apply when a dispute is already in place, but it also provides more predictability and avoids the unnecessary loss of time and costs in the event of a dispute between the parties.

The scope of a choice of law provisions: what should it cover?

Parties can choose the law applicable to the whole contract or to only part of it, as well as different laws for different parts of the contract. Also, there is no required connection between the chosen law and the parties to the contract, or their transaction.

Despite this, some parties often miss the chance to explore their relationship’s complexities and apply the best law for each portion of the contract. For example, the standard-variety choice of law clause tends to be interpreted as regarding only a choice of substantive law (that governs the parties’ rights and obligations) rather than the procedural law (that dictates dispute resolution rules). However, in some circumstances, it is possible to state which procedural law should apply in the choice of law clause. For instance, in the U.S., the rules concerning statutes of limitation are procedural and, therefore, will follow the terms provided by the law where the court sits. Nonetheless, some parties had successfully imposed the application of another procedural law by detailing it thoroughly in the contract. Parties need to make such decisions strategically, based on what it is better for their business and its nuances.

Likewise, while in some countries, it is possible to mention that the law of such country will apply in case of disputes arising from the contract, in others, parties need to determine the law of which state shall apply. This is the case when choosing the American law as applicable: it is not enough to mention that the U.S. law shall apply, you’ll need to select a state since contracts in the U.S. are governed by state law.

Limits to the freedom of choice of law

Even though the parties’ freedom in the context of contracts is one of their most important principles, in specific scenarios, the parties will have their free will limited when deciding on applicable law.

For international contracts entered into within the European Union (EU), some matters cannot be decided under the law chosen by the parties. Insurance contracts, for instance, must follow the law of the country where the risk is situated at the time of the contract’s conclusion. Moreover, the Regulation No 593/2008, known as Rome I, provides that despite the parties choosing a law applicable to the contract, if another country has more elements relevant to the contract, the law of that place cannot be completely discarded.

This limitation can also be verified depending on the nature of the contract and the legal system. For instance, the European Court of Justice has ruled that, although the parties had chosen the law of Bulgaria to apply on an agency contract, the Belgian law should be the one applicable, since the agent was Belgian and such law was more favourable to him (United Antwerp Maritime Agencies (Unamar) NV v Navigation Maritime Bulgare).

In the U.S., courts may decide on two or more different laws to when the issues arising from the contract have different natures. For instance, while an allegation of breach of contract will be analysed in accordance with the law chosen by the parties, allegations concerning fraud or other types of torts are considered as extra-contractual claims and, as such, should be verified as per the law of the state where the alleged fraud or tort occurred (Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996).

Given the complexity surrounding the topic, there are many more layers to a clause of choice of law than a regular boilerplate draft may address. So, if you’re unsure about your choices after considering all these variables, you should safeguard your interests by engaging a lawyer to help you draft a contract with choice of law provisions and decide on the best strategy for your case.

Conclusion

Understandably, when entering into a contract, parties tend to expect only fruitful outcomes. Nonetheless, as in any relationship, disputes may arise, and the most prepared of the parties inevitably has the higher ground. Understanding your business and reflecting them in a choice of law clause is one of the critical steps to a successful dispute resolution. For more information, contact Jana King Allen with questions and comments.