Applicable Law in a Contract: Everything You Need to Know
In the applicable law in a contract dispute or “conflict of laws” case, a court must identify which jurisdiction’s law applies to a specific contract dispute. 3 min read
The applicable law in a contract dispute is an issue termed by the legal community as “conflict of laws.” In a conflict of laws case, a court must determine which jurisdiction’s law applies to the particular contract dispute. This element of law is one of the most confusing. A court must determine whether the location of the 1) making of the contract, 2) performance of the contract, or 3) another place related to the contract is most important/substantial in determining the jurisdiction’s law that should apply.
In determining what jurisdiction’s law should apply, courts should recognize that there may be a “false conflict.” In order to answer a conflict of law question, a court must first determine whether there is a difference, or “true conflict,” in the outcomes between the application of two jurisdiction’s laws. If the laws of two applicable jurisdictions would lead to the same result on an issue present in the case, then there is a “false conflict” and the court must apply the local law (aka it doesn’t matter which law they apply).
If a “true conflict” of laws exists, because it would result in different outcomes depending on which law was applied, a court must determine which state (or state v. federal) has the greater interest in applying its law. Under traditional conflict-of-law rules, the construction and validity of a contract is governed by the law of the jurisdiction in which the contract was formed.
Significant Relationship Test
Courts have moved past the traditional rules and instead adopted the significant relationship rule. This rule requires that the jurisdiction with the most significant relationship or substantial contacts with both the transaction and the parties should govern what law shall be applied.
This rule has other names as well:
- Choice influencing theory
- Center of gravity theory
- Substantial contacts theory
- Grouping of contacts theory
- Interest weighing theory
Under the most significant relationship test, courts look to the following factors to determine which state’s law applies:
- Location of contract formation
- Where the relationship of the parties is/was centered
- Location of contract negotiations
- Location of performance of either or both parties
- Subject matter (location if applicable)
- Incorporation state
- Location of parties (business)
These issues only arise in the absence of a valid choice of law provision. If your contract includes this provision, then the courts will apply that law, if possible, to a contract dispute. A court will honor the law negotiated and contracted by the parties. Parties to a contract have the right to negotiate and contract as to what state’s law will govern the contract as a whole.
There is no reason to prevent parties from deciding which laws they would like to govern the performance, validity, formation, execution, etc. of the parties, as long as the reasons for choosing said law are not against public policy.
In a transaction across state or country lines, laws from several jurisdictions could logically apply. Parties entering into an international transaction should decide on the law that shall be applied to the contract and include that decision in a provision within the written agreement in order to avoid court decision on that matter. Arbitral tribunals and international courts will respect the parties’ autonomy to make this decision.
Parties may choose a national or state law to govern the contract, but they may also choose other sets of rules such as transnational law, public international law, general principles of law or equitable principles to apply. The parties may also agree if they so choose that different parts of the contract will be governed by different sets of laws or principles if they would like. And this decision can be made any time, even if not made at the time of contract formation.
Applicable Law in Time
Once a court has determined which jurisdiction’s law it should apply, it must determine what law was applicable at the time of contract formation. The applicable law to a contract throughout its duration should be the one in force at the time of its signature.
However, there are situations where a new law may apply to an ongoing contract. The newly enacted law may provide for its immediate application through transitional legal provisions.
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