Choice-of-Law Provisions in Contracts
Few contract provisions are as important and yet often overlooked as the choice-of-law provision. This provision determines which jurisdiction’s legal framework will govern the contract and shapes how disputes will be resolved and how legal rights will be interpreted. It is essentially the legal compass guiding the contractual relationship.
Making the right choice in this provision ensures clarity, predictability, and security for all parties involved. This post discusses this provision’s intricacies and potential pitfalls and explains why it truly matters.
The Common Mistake in Specifying Governing Laws
Many companies make a crucial mistake when it comes to specifying the governing law in their contracts. They often intend for one jurisdiction’s law to apply but inadvertently write their contracts to include a different set of rules. Cue: a lot of back and forth and potential motion practice before you even get into the issues of the case.
Domestic vs. International Governing Laws
In the United States, the Uniform Commercial Code (UCC), Section 2, typically governs domestic product sales, covering most goods-related transactions. Conversely, for international product sales contracts between companies from countries that have ratified it, the United Nations Convention on Contracts for the International Sale of Goods (CISG) is the prevailing framework. It’s worth noting that a vast majority of leading commercial nations are signatories to the CISG.
Where Companies Often Stumble
However, here’s where companies often stumble. American companies, in particular, sometimes specify in their contracts that they want U.S. law or the law of their particular state to be applicable. For instance, they might stipulate that New York law should govern the contract. The issue with this approach is that U.S. law recognizes the CISG as the default law for international sales. Therefore, if U.S. or New York law is specified in the contract, it will ultimately lead to the application of the CISG. (For legal experts, it’s acknowledged that this simplification may not capture the full nuance of “U.S. law,” but the general concept is understood.) If a New York choice-of-law provision is included in the contract, a court, most likely in New York, will apply New York law, which in turn triggers the application of the CISG. To prevent a U.S. (or state) court from applying the CISG, a contract should include a choice-of-law provision that explicitly states that the UCC of a specific state (e.g., New York’s UCC) should govern the contract, while expressly noting that the parties do not wish for the CISG to apply.
Similarities in International Contract Laws
Interestingly, the various laws governing international contracts are often more alike than different, and in most cases, the choice of law won’t significantly affect the outcome of a case. Many international dispute resolution cases involve similar substantive law, and the merits of the case are often unaffected.
The Costs of Ambiguity
However, a poorly drafted choice-of-law provision can have real-world consequences, primarily in terms of increased legal costs if a dispute arises. Ambiguous choice-of-law clauses necessitate additional attorney hours to determine the applicable substantive law and to explain the legal principles under two different legal frameworks to a judge or arbitration panel. In some instances, foreign lawyers may need to be brought in as paid experts to provide comprehensive explanations of their country’s legal systems.
It’s essential to emphasize that even when laws are “pretty much the same,” lawyers can produce extensive briefs to highlight seemingly insignificant distinctions in legal language, which can lead to aggressive litigation tactics and higher legal fees.
Conclusion: The Importance of Clarity
The central message is this: Rather than searching for the “perfect” law, it is usually more important that you focus on ensuring your contract clearly defines the law that will govern it.