Anaya Nolan
When drafting an agreement, it is important to consider the choice of law that will govern it, as this determines which jurisdiction's laws will be applied in the event of a dispute. In the United States, contracts are typically governed by state law, and a governing law clause is often included to specify which state's laws will be followed. For example, an agreement might state that it shall be governed by and construed in accordance with the laws of the State of New York). However, the choice of law can become more complex in international contracts or when extra-contractual claims arise, and it is important to carefully draft these provisions to avoid potential issues.
| Characteristics | Values |
|---|---|
| Choice of law provision | The choice of law determines the governing law of the relationship in the contract, which is to say, which location's law will govern any dispute between the parties if the contract is broken. |
| Governing law | The governing law is determined by jurisdiction, which is any larger area that has its own specific local laws. |
| Jurisdiction | In the United States, contracts are governed by state law. |
| Choice of forum | The choice of forum determines the choice of location to resolve disputes. |
| Arbitration | Arbitration is an alternative to litigation, and it is desirable when there is an international element to the contract. |
| Contractual and extra-contractual claims | A U.S. court may apply different laws to different issues presented in the same case, such as contractual and extra-contractual claims. |
| Governing law clause | A governing law clause specifies which rules and laws will apply in the event of a legal dispute. |
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What You'll Learn
Choice of law provisions
A "choice of law" or "governing law" provision in a contract allows the parties to agree that a particular state's laws will be used to interpret the agreement, even if they live in (or the agreement is signed in) a different state. The purpose of a choice-of-law clause is to reduce legal uncertainty by prospectively selecting a law to govern the agreement between the parties. Choice-of-law clauses facilitate settlement because they identify the law that will be applied to resolve any potential dispute. They also reduce the cost of dispute resolution by making it unnecessary for the court to conduct a choice-of-law analysis should a dispute wind up in litigation.
In the United States, contracts are governed by state law, with rare exceptions. A choice-of-law clause is a contract provision that selects the law to govern the contract and (sometimes) claims relating to the contract. The courts should always apply the law of the jurisdiction selected in the choice-of-law clause to interpret the language in the clause. The selection of which state is used for governing law isn't usually a crucial negotiating issue. However, the selection of the state for jurisdiction can be more important: if there's a dispute, that's where everyone will have to go to resolve it.
A choice of law provision might also run into problems if it appears in an insurance contract because some states want to make sure their consumer protection laws relating to insurance apply to those within their borders. For example, Massachusetts prohibits choice-of-law provisions in insurance contracts. Some contracts involving secured transactions and the Uniform Commercial Code (UCC) could also conflict with choice-of-law rules. Additionally, contracts governing corporate behaviour usually must be decided by the law of the state of incorporation.
When a choice-of-law clause selects the “laws” of a particular state, a question arises as to whether the parties to the contract also intended to select any relevant provisions of federal law. In many cases, party preferences on this issue will be irrelevant; mandatory rules of federal law apply regardless of party intent. In cases where the relevant provisions of federal law are mere default rules, an interpretive question arises: did the parties intend to select state law to the exclusion of the federal default rule, or did they intend to select the federal default rule as an alternative to state law? This question arises most frequently with respect to two bodies of federal law: the Federal Arbitration Act (FAA) and the United Nations Convention on Contracts for the International Sale of Goods (CISG).
A U.S. court may apply different laws to different issues presented in the same case. For example, if the contract's choice of law provision states that the agreement shall be construed in accordance with the law of the State of California, but an alleged fraud occurred while the parties were negotiating the contract in New York, a New York court is likely to apply California law to a defence of "no breach", but New York law to the fraud claim.
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Commercial disputes
In the United States, contracts are governed by state law, with rare exceptions, such as certain contracts to which the federal government is a party. When drafting commercial agreements with connections to the U.S., it is important to be aware of some recurring issues that can complicate matters. For example, a U.S. court may apply different laws to different issues presented in the same case. In commercial disputes, one circumstance involves claims that arise under the contract in combination with extra-contractual claims. For instance, a defendant may argue that they did not breach the terms of the contract and that the plaintiff intentionally misrepresented certain material facts during negotiations. In such a case, the court may apply the law of the state specified in the contract to the contractual claim and the law of the state where the alleged fraud occurred to the fraud claim.
To avoid confusion and potential disputes, it is important to include a governing law or jurisdiction clause in the contract. This clause specifies which rules and laws will apply in the event of a legal dispute. For example, the clause may state that the agreement "shall be governed by and construed in accordance with the laws of the State of New York." If a contract lacks a governing law clause, the contract will be governed by the law of the jurisdiction with the strongest ties to the contract, which may be determined by factors such as the parties' residence and the location of the contract.
There are several methods for resolving commercial disputes, including litigation, mediation, and alternative dispute resolution (ADR). Litigation is often reserved for the most complex disputes and can result in a win-lose scenario, which may be a crucial factor to consider when future commercial relationships are at stake. Mediation, on the other hand, emphasizes a mutually beneficial agreement between the disputing parties and can help maintain or improve business relationships. Alternative dispute resolution, offered by organizations like the AAA, provides efficient and effective case administration for business-to-business (B2B) claims and allows for creative solutions tailored to the specific needs of the parties.
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Arbitration
The history of arbitration in the US can be traced back to the Industrial Revolution, when merchants became dissatisfied with the common law rule that agreements to arbitrate were revocable by either party. This led to the New York Arbitration Act of 1920 and the United States Arbitration Act of 1925 (now known as the Federal Arbitration Act), which made agreements to arbitrate valid and enforceable. The FAA broadly authorises arbitration and has been interpreted by the Supreme Court to cover almost the full scope of interstate commerce, preempting many state laws on the subject.
The arbitration process is governed by its own rules, as defined by the contract. The Financial Industry Regulatory Authority, for example, holds securities arbitrations, which are used to resolve disputes between brokerage firms and their customers. Pre-dispute arbitration agreements are common in this industry.
While arbitration offers benefits such as speed and cost-effectiveness, it has also faced scrutiny due to concerns about arbitrator selection bias, conflicts of interest, and the absence of a court-supervised discovery process. Some states have implemented court-ordered arbitration in certain areas, such as family law, but these processes are typically non-binding and advisory in nature.
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Governing law clauses
A ""Governing Law" clause is a clause used in legal agreements that specifies which rules and laws will apply in the event of a legal dispute. A commercial contract establishes the terms under which the contracting parties will do business. However, depending on which country's laws govern them, the meaning and effect of those terms can differ significantly. A governing law clause aims to express the parties' preference for the applicable law. These clauses are usually included in standard Terms and Conditions agreements for websites or mobile applications.
For agreements in the United States, the governing law can be of a specific state or a specific country if the agreement is international. In the United States, contracts are governed by state law, with rare exceptions (such as certain contracts to which the federal government is a party).
The primary purpose of a choice-of-law clause is to avoid uncertainty over the law that would govern any disputes that may arise out of the relationship created as a result of that agreement. However, many deal professionals and their counsel fail to give appropriate attention to the actual language used in a choice-of-law clause, and that failure can result in untoward consequences that threaten the certainty sought to be achieved by the choice of a particular jurisdiction in the choice-of-law clause.
Additionally, it is important to understand the difference between governing law and jurisdiction. Jurisdiction refers to the court or court system where your case will be heard. For example, a jurisdiction might be something like "state courts of New York", with "state laws of New York" as the governing rule.
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Jurisdiction
Choice of Law Provisions:
The choice of law provision in an agreement specifies which state's laws will govern the interpretation and enforcement of the contract. For example, an agreement may state that it will be "governed by and construed in accordance with the laws of the State of Delaware" or "the laws of the State of California." This choice of law provision determines the jurisdiction whose laws will be applied in resolving disputes.
Court Jurisdiction:
Agreements often include clauses designating the specific courts that will have jurisdiction over disputes. For example, the agreement may state that any disputes shall be resolved exclusively in the courts of a particular state, such as "the courts of the State of Delaware" or "the courts of the State of Texas." This ensures that only the specified courts have the authority to hear and decide on matters related to the agreement.
Arbitration Clauses:
In some cases, agreements may include arbitration clauses instead of, or in addition to, court jurisdiction clauses. Arbitration is a private and confidential process where disputes are resolved by an impartial third-party arbitrator. Arbitration clauses typically specify the location of arbitration, such as "arbitration proceedings shall take place in Israel." The decision of the arbitrator may then be enforced by a court with jurisdiction.
Conflict of Laws:
When drafting agreements with US laws, it is important to consider the principles of conflict of laws. This refers to situations where the laws of different states or jurisdictions may come into conflict. For example, if a contract is entered into in one state but performed in another, there may be a conflict of laws issue. The choice of law provision in the agreement can help resolve these conflicts by specifying which state's laws will govern the agreement.
Federal and State Courts:
It is worth noting that the US legal system has both federal and state courts. If an agreement is to be construed with federal law, it will fall under the jurisdiction of federal courts. However, if the agreement specifies a particular state's laws, the state courts of that jurisdiction will have authority. Federal courts apply the choice of law rules of the state in which they are located when determining the applicable law in a case.
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Frequently asked questions
A governing law clause is a clause used in legal agreements that specifies which rules and laws will apply in the event of a legal dispute.
The Choice of Law determines the Governing Law of the relationship detailed in the contract, which is to say what location’s law will govern any dispute between the parties if the contract is broken.
Contract provisions specifying the choice of law range from simple to elaborate but do not always get the care they deserve. As with other contract provisions, they can be easy to ignore once the substantive decisions are made. However, nuances of drafting can have more of an impact on the outcome than many lawyers realize.
If a conflict arises concerning an agreement that lacks a governing law or jurisdiction clause, the contract will be governed by the law of the jurisdiction with the strongest ties to the contract. To determine which jurisdiction law is best suited for a fair trial, the court will consider factors such as the parties' residence and the location of the contract.
