REUTERS | Amit Dave

It’s a choice: your law or mine?

It can be easy to overlook the choice of governing law clause in a contract when negotiating issues which, on the face of it, appear more important, like price or time for delivery. However, the law applicable to the contract can have a considerable impact on:

  • Interpretation of the contract.
  • Performance obligations.
  • Consequences of breach, such as assessment of damages.
  • Expiry of obligations, including limitation.

The choice of law for a contract is an important issue in international contracts and one that can present great benefits or unpleasant surprises. Therefore, any contract you enter into should incorporate a clearly drafted governing law clause stating expressly the substantive law that will govern the rights and obligations of the parties to that contract.

Governing law clauses and choice of jurisdiction

In most jurisdictions, an express choice of law will be upheld by the courts. Without one, parties will be subject to the potential vagaries of the court or dispute forum where any dispute is to be heard.

However, situations arise where the most appropriate applicable law is not obvious, either because there is no choice of law clause or the choice of law clause is not clearly drafted. For instance, I was recently negotiating a contract where an English party with a Scottish registered office had contracted with a Polish entity to supply kit to a manufacturing plant in Germany. The choice of law clause was ambiguous so which law should apply?

Uncertain governing law clauses and Rome 1

In European Union (EU) countries the situation is made clearer by Rome 1, which applies to contracts made on or after 17 December 2009 and where at least one of the parties is based in a EU member state.

Rome I will not interfere where parties to a contract have explicitly stated their choice of law but, in the absence of party choice (subject to a few exceptions), it states that the applicable law will be:

“the law of the country where the party performing the service/selling the goods characterising the contract has its administrative base.”

It is worth remembering that Rome II applies to non-contractual obligations.

Which law to choose?

It is important to select the applicable law from the outset during contract negotiations to avoid any uncertainty. When selecting the applicable law, you should consider:

  • The law the parties are most familiar with.
  • The law that offers the parties the most certainty on key aspects of the contract.
  • Where the contract will be performed, if different from the location of the parties.
  • Which law will give the parties the most beneficial outcome.
  • Which jurisdiction and dispute forum the parties have selected for dispute resolution.

Advantages of an explicit governing law clause

The main advantage of an explicit governing law clause is the certainty that it offers the parties. Provided the clause is well drafted and takes into consideration the exceptions that can arise under Rome I, everyone will know exactly which law will apply.

If the governing law clause is poorly drafted, which law applies could vary depending on which court hears the case. Consequently, the choice of law clause should be considered closely with the choice of jurisdiction and dispute forum.

In my experience

There is often considerable negotiation over the choice of law and jurisdiction clauses. Ultimately, the outcome will depend on the bargaining strength of the parties.

For example, I recently acted for a foreign government procuring a major infrastructure project. The client wanted the contract to be governed by local law and for disputes to be resolved in the local courts. The contractor, an experienced international player, could see weaknesses in the local law and was uncomfortable with the local courts hearing disputes. The contractor’s position was simple: if the applicable law and jurisdiction was not changed, there would be no contract. Consequently, it was agreed that English law would apply and disputes would be settled by arbitration at a neutral venue.

Sometimes, however, without proper consideration the parties can be left with an incongruous position. For example, one client reached a compromise whereby disputes would ultimately be resolved by arbitration in Leeds but that South African law would apply. Clearly, this position would have resulted in a number of practical difficulties had a dispute proceeded to arbitration. It was sufficiently inconvenient for both parties to reach agreement.

A further key risk issue is different laws applying at different points in the supply chain. On large-scale process contracts, it is common for the ultimate employer to secure the application of its own law for a project in its country. However, suppliers of major pieces of equipment are often able to insist that their law applies to those supply contracts. Main contractors are often then left in the potentially invidious position of different laws applying in relation to the performance of the same piece of equipment. It is not hard to imagine that a different forum applying a different law may decide issues in a different way. Consistency is preferable, acknowledging that this is not always achievable.

So, choice of law is not as easy as it may first appear. Careful consideration should be given to which law will govern the contract, bearing in mind some of the factors discussed above and the difficulties that may arise if the clause is not drafted carefully.

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