Choice of law

What Is Choice of Law?

Choice of law, a concept within private international law, determines which legal system governs a contract or dispute when multiple jurisdictions could apply. This is particularly relevant in international transactions, where parties from different countries enter into agreements, or when a transaction crosses state or national borders. The primary goal of a choice of law clause is to provide legal certainty and predictability by establishing beforehand which set of laws will be used to interpret the agreement and resolve any disputes that may arise. Without a clear choice of law, the applicable legal framework could be ambiguous, leading to protracted and costly litigation to determine the governing rules.

History and Origin

The roots of modern choice of law principles can be traced back to medieval commercial laws, specifically lex mercatoria (the law for merchants on land) and lex maritima (the law for merchants at sea), which emerged to govern cross-border trade and provide a consistent legal framework for merchants²⁸. As international trade grew, so did the need for more formalized rules to address conflicts between different legal systems.

A significant development in the modern era was the establishment of the Hague Conference on Private International Law (HCCH) in 1893, initiated by Tobias Asser. The HCCH is an intergovernmental organization that works toward the "progressive unification of the rules of private international law" through the creation of international conventions and instruments²⁴, ²⁵, ²⁶, ²⁷. This initiative recognized the growing complexity of international interactions and the need for clear and uniform rules for resolving conflicts of laws²², ²³.

The formal inclusion of choice-of-law clauses in contracts saw a "breakthrough" moment in the early 1960s, though they had been used in specific industries in the years following the American Civil War²¹. These clauses became a critical tool for contracting parties to predetermine the legal landscape for their agreements, influencing how courts developed interpretive rules for such provisions²⁰.

Key Takeaways

• Choice of law is a provision in a contract specifying which jurisdiction's laws will govern the agreement.
• It provides legal certainty and predictability in cross-border transactions and disputes.
• The absence of a clear choice of law can lead to complex and costly legal battles.
• International organizations like the Hague Conference on Private International Law work to harmonize choice of law rules globally.

Formula and Calculation

Choice of law does not involve a mathematical formula or calculation. Instead, it is a contractual term or a legal principle applied by courts to determine the applicable law in a dispute involving multiple jurisdictions. The determination is based on the wording of the contract, established legal precedents, or conflict-of-laws rules if no choice is specified. While it doesn't involve quantitative data analysis, its impact on potential legal costs and outcomes can be significant.

Interpreting the Choice of Law

Interpreting a choice of law clause involves understanding its scope and effect on various types of claims. A generic choice of law clause, which states that "the contract" will be "governed by" or "subject to" the chosen law, is often interpreted by courts as applying to contractual claims only¹⁹. This means that extra-contractual claims, such as those arising from tort law or statutory law, might still be subject to a separate conflict of laws analysis by a court¹⁸.

The interpretation can also depend on whether there is an express choice of law or if it is implied. In the absence of an express choice, courts may infer the parties' intent, often by considering the law of the place where the contract was formed or the law with the "closest and most real connection" to the agreement¹⁶, ¹⁷. This emphasis on clarity highlights the importance of precise contract drafting.

Hypothetical Example

Imagine a technology startup based in Delaware, United States, enters into a software development agreement with a company in Berlin, Germany. To avoid potential legal ambiguities should a dispute arise, they include a choice of law clause in their contract:

"This Agreement and any disputes or claims arising out of or in connection with it or its subject matter or formation (including non-contractual disputes or claims) shall be governed by and construed in accordance with the laws of the State of Delaware, United States, without regard to its conflict of laws principles."

In this scenario, if the German company later claims a breach of contract regarding the software's functionality, a court or arbitrator would apply Delaware state law to interpret the terms of the agreement and resolve the dispute. This preempts the need to argue whether German law or a combination of laws should apply, streamlining the dispute resolution process.

Practical Applications

Choice of law clauses are ubiquitous in various financial and commercial agreements, playing a critical role in providing legal stability for cross-border transactions.

• International Contracts: In global trade, contracts for the sale of goods, services, or licensing agreements routinely include choice of law clauses. This ensures that all parties understand the legal framework governing their obligations and rights, irrespective of their diverse national origins.
• Financial Instruments: Complex financial instruments, such as derivatives or syndicated loans involving multiple international lenders, rely on choice of law to define the governing legal principles. This is crucial for managing counterparty risk and ensuring enforceability.
• International Arbitration: Choice of law is fundamental in international arbitration, where parties often choose arbitration as an alternative to national court systems. The choice of law clause in the underlying agreement or the arbitration agreement itself dictates the substantive law applied by the arbitral tribunal¹⁴, ¹⁵. Organizations like the United Nations Commission on International Trade Law (UNCITRAL) develop model laws and rules for international commercial arbitration, further emphasizing the importance of predictable legal frameworks in global commerce⁹, ¹⁰, ¹¹, ¹², ¹³.

Limitations and Criticisms

While choice of law clauses are designed to provide certainty, they are not without limitations or criticisms. One significant area of debate concerns the scope of generic choice of law clauses, particularly whether they extend beyond contractual claims to encompass tort or statutory claims⁸. Courts in different jurisdictions may interpret such clauses differently, leading to unpredictable outcomes⁶, ⁷.

Another criticism revolves around the concept of "party autonomy," which allows parties to choose the governing law. While generally upheld, this autonomy may be limited by public policy considerations of a jurisdiction with a materially greater interest in the dispute⁵. For example, a choice of law clause might be invalidated if it attempts to circumvent fundamental policies or consumer protection laws of a relevant state⁴.

Academics have also critiqued the broader "choice-of-law problem," highlighting the complexities and inconsistencies that can arise when applying different rules to determine the applicable law³. The absence of a choice-of-law clause can itself lead to significant delays and costs as parties litigate the threshold issue of which law applies². Even when present, the specific wording of a choice of law clause can be subject to extensive litigation, with virtually every word potentially having a "hidden meaning" that leads to interpretive issues¹.

Choice of Law vs. Forum Selection Clause

Choice of law is often confused with a forum selection clause, but they serve distinct purposes.

While both clauses contribute to legal certainty, a choice of law clause specifies the legal framework, whereas a forum selection clause designates the physical or institutional venue for resolving disagreements. It is common for contracts, especially in international business, to include both a choice of law clause and a forum selection clause to provide comprehensive clarity on how and where disputes will be handled.

FAQs

Why is a choice of law clause important in international contracts?

A choice of law clause is crucial in international contracts because it provides legal certainty and predictability by pre-determining which country's or state's laws will govern the agreement. This helps parties understand their rights and obligations and reduces the risk of costly disputes over which legal system applies.

Can parties choose any law to govern their contract?

Generally, parties have significant autonomy to choose the law that governs their contract. However, this autonomy is not absolute. Courts may sometimes disregard a chosen law if it has no reasonable relationship to the parties or the transaction, or if applying it would violate a fundamental public policy of a state with a materially greater interest in the issue. This is especially true when dealing with areas like consumer protection or anti-trust law.

What happens if there is no choice of law clause in a contract?

If a contract lacks a choice of law clause, a court or arbitral tribunal will apply its own conflict of laws rules to determine which jurisdiction's laws should govern the dispute. This process can be complex, time-consuming, and lead to unpredictable outcomes, as different jurisdictions have different conflict of laws rules.

Does a choice of law clause cover all types of disputes arising from a contract?

Not always. While a broad choice of law clause might aim to cover all disputes, including non-contractual claims like torts, courts sometimes interpret generic clauses as applying only to contractual claims. For comprehensive coverage, it is advisable to draft the clause explicitly to include both contractual and non-contractual disputes, or to consider including a separate arbitration clause for dispute resolution.

How does choice of law relate to international arbitration?

In international arbitration, the choice of law clause in the underlying contract or the arbitration agreement determines the substantive law that the arbitral tribunal will apply to resolve the dispute. This is distinct from the lex arbitri, which is the procedural law of the seat of arbitration. The clarity provided by a choice of law clause is vital for the efficiency and enforceability of arbitral awards.