Governing Law Clauses

Governing Law Clauses

    This guide highlights the relevant law and key considerations that should be borne in mind when drafting or considering the effect of a governing law clause.

    What is a governing law clause?

    A commercial contract sets out the terms on which the contracting parties will conduct business. The interpretation and effect of those terms may, however, vary significantly depending upon which country's laws govern them. The purpose of a governing law clause is to express the parties' choice as to what that law should be.

    Why is a governing law clause important?

    The parties' choice of governing law will usually be upheld by courts in countries with developed legal systems.1 It follows that, by inserting a governing law clause, parties achieve certainty: they know what law is likely to be applied to determine questions regarding their rights and obligations under the contract. This, in turn, allows them to analyse their legal position with confidence.

    It is rare for commercial parties not to agree a governing law clause. Where they omit to do so complex rules exist to determine what the governing law of the contract should be. Where parties are located, or obligations are to be performed, in different jurisdictions, determining the governing law of the contract may be difficult. This may lead not only to uncertainty but also to time and cost being spent arguing at the outset of any dispute over what law should be applied.

    The problems which can arise in this regard are highlighted by the comments of Mr Justice Mann in the case of Apple Corps Ltd v Apple Computer Inc.2 In that case a dispute arose in relation to an agreement which did not contain a governing law or jurisdiction clause. Mr Justice Mann noted that: 

    "The evidence before me showed that each of the parties was overtly adamant that it did not wish to accept the other's jurisdiction or governing law, and could reach no agreement on any other jurisdiction or governing law. As a result, [the relevant agreement] contains no governing law clause and no jurisdiction clause. In addition, neither party wanted to give the other an advantage in terms of where the agreement was finalised. If their intention in doing so was to create obscurity and difficulty for lawyers to debate in future years, they have succeeded handsomely."

    What factors should you consider when choosing the governing law? 

    Parties to a contract are free to choose their governing law: it need not have any connection with the location of the contracting parties or the subject matter of the contract.3

    In practice the parties' choice of law may often be straightforward, based on market practice or the law that they are familiar with. We have, however, set out below a few points to consider when choosing the governing law:

    • Parties will usually want consistency between their governing law clause and jurisdiction clause. So, for example, if disputes are to be resolved in the English courts, it makes sense to choose English law. But if, for example, the parties agree that their contract is to be governed by French law but disputes are to be resolved by the English courts, the parties will have to produce expert evidence on French law in order for the English court to determine the relevant issues. This increases the cost of litigation and there is a risk that the court will incorrectly apply the foreign law. Another thing to consider is that where English law is chosen but the jurisdiction of a different court selected for dispute resolution, if outside the EU, there is no guarantee that the particular court chosen will recognise an express choice of law clause.
    • In certain circumstances the parties' choice of law for the contract may also determine the law which applies to any issues arising out of the parties pre-contractual dealings. This may represent a good reason for choosing English law which, unlike some civil law regimes, does not incorporate a developed body of law imposing a duty of good faith in pre-contractual negotiations.
    • There may be technical reasons why a particular law should be chosen. For example, one of the reasons for choosing English or New York law in finance transactions is that they both recognise the concept of a trust.
    • Make sure that you accurately describe the particular legal system that you intend to apply (e.g. refer to "New York law" rather than "US law").
    • Finally (and perhaps obviously), ensure that you choose a legal system which the courts will give effect to. The Rome I Regulation (which continues to apply in the UK as assimilated law) requires the law of a "country" to be chosen, as illustrated by the following cases:
      • In Beximco Pharmaceuticals Ltd v Shamil Bank of Bahrain EC,4 the governing law clause provided that "Subject to the principles of the Glorious Sharia'a, this Agreement shall be governed by and construed in accordance with the laws of England". The Court of Appeal held that the only relevant governing law was the law of England.
      • In Halpern v Halpern,5 there was no express choice of law, but one of the parties argued that the agreement was governed by Jewish law. The Court of Appeal rejected this submission: the law of a country was needed.

    Where parties want their relationship to be governed by a law other than the law of a country, they should include provision for arbitration. In particular, section 46 of the Arbitration Act expressly recognises that arbitral tribunals can and should decide disputes in accordance with the law chosen by the parties "or if the parties so agree, in accordance with such other considerations as are agreed by them or determined by the tribunals".

    The scope of a governing law clause: what should it cover?

    When commercial parties reach an agreement, a written agreement will usually set out their "contractual" obligations. The parties may, however, also have obligations which arise out of general law and which are not contained in the terms of the contract. These "non-contractual" obligations could arise in relation to both:  

    • the period before the contract is entered into; for example, claims for negligent and innocent misrepresentation or in the tort of deceit may arise out of statements made in pre-contractual negotiations; and
    • the period after the contract has been entered into; for example, in addition to any contractual obligations, one party may owe the other a duty of care in tort to take (or not take) certain steps.

    Therefore, when drafting the governing law clause, thought should be given to whether to limit it to the agreement itself or to extend it so that any other non-contractual obligations related to the contract are also covered.6 There is currently no clear authority as to whether, under English law, such a clause would be effective to determine the law governing the parties' non-contractual obligations. In light of Rome II that position has now changed.

    The scope of a governing law clause: impact of Rome II 

    Rome II is an EC regulation7 which sets out the regime that will govern the law applicable to non-contractual obligations in "civil and commercial matters". The Regulation came into force on 11 January 2009 and will be applied by courts in all Member States except Denmark. Although the UK has now left the EU, Rome II continues to apply in the UK as assimilated law. 

    The general rule under Rome II is that the law applicable to non-contractual obligations will be the law of the country in which the relevant damage/loss occurs. There are a number of circumstances in which this general rule will be disapplied.8 The most relevant situation, in the context of governing law clauses, is that, by virtue of Article 14 of Rome II, parties may agree to "submit their non-contractual obligations to the law of their choice".

    The following points should be noted about the right to make this choice:

    • Where, as will usually be the case, the governing law is agreed before the event giving rise to the damage has occurred, the parties' choice of law will only be effective under Article 14 if the parties are pursuing a commercial activity and the agreement has been "freely negotiated". Unfortunately, the meaning of "freely negotiated" has not been defined in Rome II. This requirement would, however, appear to cast doubt on whether governing law clauses in standard terms will take effect under Article 14.
    • Article 6 provides for the law applicable to non-contractual obligations arising out of unfair competition and Article 8 deals with the law applicable to infringement of intellectual property rights. In both cases the applicable law cannot be changed by the parties' agreement.

    Drafting considerations: widening the scope of the governing law clause 

    Rome II offers commercial parties an opportunity to achieve greater commercial certainty by allowing them to contractually agree a governing law clause which covers both the parties' contractual and non-contractual obligations. In terms of drafting requirements Article 14 does not impose any specific formalities to follow. It simply provides that the parties' choice as to the law governing their non-contractual obligations "shall be expressed or demonstrated with reasonable certainty by the circumstances of the case".

    An example of a clause which seeks to do this is as follows:

    "This agreement, and any dispute, controversy, proceedings or claim of whatever nature arising out of or in any way relating to this agreement or its formation (including any non-contractual disputes or claims), shall be governed by and construed in accordance with English law."

    For a number of reasons a clause in these terms will not guarantee that any non-contractual claims between the parties are always governed by English law. For example:

    • The subject matter of the claim may take the contract outside Rome II.9
    • Rome II may apply but, as explained above, a clause may not take effect under Article 14.
    • If proceedings are commenced in a court outside the UK or the EU the courts will apply their local laws which may not permit parties to contractually agree in advance the law governing non-contractual obligations.

    As a general proposition, however, adopting a clause in the terms set out above can only increase the prospect of parties' non-contractual obligations being governed by the law identified in the governing law clause. This, in turn, will allow parties to analyse their legal relationships with greater certainty and, it is hoped, avoid the risk that time and cost is spent arguing over what law applies.

    Impact of Brexit

    Both Rome I and II will continue to apply in the UK post Brexit (subject to minor amendments) as a result of The European Union (Withdrawal) Act 2018.  

    Therefore, the English courts will continue to apply the rules currently contained in the Rome I and Rome II Regulations when deciding whether to uphold a choice of law, or in the absence of a choice of law clause, in determining the applicable law of contractual and non-contractual obligations. Likewise, the rest of the EU should continue to give effect to English governing law clauses because the Rome I Regulation requires Member States to give effect to the governing law chosen by the contracting parties, irrespective of whether it is the law of a Member State or not, or whether the parties are from outside the EU.

    1. For example, Regulation (EC) 593/2008 on the Law Applicable to Contractual Obligations (otherwise known as "Rome I" or "The Rome I Regulation") provides that an express choice of law should be respected by the courts of all EU states (except Denmark). On its exit from the EU, Rome I was converted into UK law as assimilated law and as amended by legislation that came into force at the end of the transition period that ensures Rome I will operate effectively in domestic law. The Rome Convention (incorporated into English law by the Contracts (Applicable Law) Act 1990) will apply to all contracts entered into prior to 17 December 2009.
    2. [2004] EWHC 768 (Ch).
    3. Note, however, that Rome I will not allow parties to circumvent certain rules of law by choosing the governing law of another country. In particular, it makes provision for the "overriding mandatory provisions" and "public policy" of a relevant state to be applied over and above the law chosen by the parties. The distinction between the two is not easy to draw but, generally, overriding mandatory provisions will require terms to be written into the contract (e.g. employee rights), while public policy will prevent the application of elements of the foreign governing law (e.g. where the performance of an act in a foreign state is illegal under that state's law).
    4. [2004] EWCA Civ 19; [2004] 2 Lloyd's Rep 1.
    5. [2007] EWCA Civ 291; [2007] 2 Lloyd's Rep 56.
    6. The risks in not attempting to do this are illustrated by the New York Federal Court case of Telemedia Partners Worldwide Ltd. v Hamelin Limited 95 Civ. 2452. In that case, a claim was brought under the Racketeer Influenced and Corrupt Organisations Act (RICO) as a result of Hamelin's alleged fraudulent representations prior to the execution of the agreement. RICO claims give rise to treble damages, a concept not recognised by English law. In Telemedia, the clause in issue stated as follows: "This agreement shall be governed by and construed in accordance with English law and both [Telemedia] and [Hamelin] hereby submit to the non-exclusive jurisdiction of English courts." Telemedia brought its claim in the New York Courts, as permitted by the non-exclusive jurisdiction clause. In answer to Telemedia's claim under RICO, Hamelin argued that the agreement, by virtue of the governing law clause, should "be governed by and construed in accordance with English Law" so that the RICO claim was precluded. The New York Court did not agree. It stated "[t]he plain language of the clause reveals an intent for English law to apply only to issues relating to the construction and enforcement of the agreement". Thus the RICO claim was valid as it was based on allegations of fraud preceding the existence of the contract.
    7. Regulation EC No 864/2007 on the Law Applicable to Non-Contractual Obligations.
    8. The general rule will be superseded (or may be limited in its application) where the non-contractual obligation arises out of, among other things, unfair competition, product liability and IP infringement claims. Special provisions apply in these circumstances and are set out in Articles 5, 6 and 8.
    9. There are certain subject matters in respect of which Rome II does not apply. These include in respect of obligations arising out of the relations between the settlors, trustees and beneficiaries of a voluntary trust. So, for example, if a bank was sued in the courts of an EU Member State by a bondholder in respect of its work as a trustee, those courts would have to apply their existing choice of law rules, rather than Rome II, to answer any relevant questions as to the governing law of non-contractual claims.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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