Choice of Law Clause: Everything You Need to Know
A choice of law clause in a contract lets the parties agree on which state's laws will be applied to their contractual relationship.4 min read
A choice of law clause in a contract lets the parties agree on which state's laws will be applied to their contractual relationship. That may or may not be the state where the parties live, and it does not have to be the state where the contract is signed. For example, many large companies specify that Delaware law governs their contracts because of that state's corporation-friendly environment.
Benefits of a Choice of Law Clause
Choice of law clauses are part of the standard language of contracts in most fields today, and they offer multiple benefits.
- When a contract includes a choice of law clause, all the parties are clear about which state's laws govern the agreement and any conflicts that arise from it.
- A choice of law clause can substantially reduce the length of time it takes to resolve a dispute, saving the parties money.
- Familiarity with the laws of the state of your choice gives you more certainty of how a dispute will be handled. The statutes in different states, or even countries, have a significant impact on how the case turns out. Working within the bounds of state law you are familiar with gives you more confidence in the outcome.
Barriers to Using a Choice of Law Clause
In specific circumstances, you may run into conflicts between the provisions of a choice of law clause and other state and federal regulations. However, these conflicts don't usually cause a problem in negotiations.
- In some states, insurance contracts cannot include a choice of law clause. Those states, like Massachusetts for example, want to be sure that their own consumer protection laws are applied.
- Conflicts sometimes arise between choice of law clauses and other provisions in a contract, like those involving secured transactions and/or the Uniform Commercial Code (UCC).
- Contracts related to the governance of corporate behavior are usually required to be determined by the laws of the state of incorporation.
The Importance of the Language
Often deal-makers and their lawyers don't give the choice of law clause enough attention. If the wrong language is used, the provision may not have the desired outcome. Besides the careful choice of the governing state, those working with contracts should make sure the wording is thorough and detailed.
While the specific language may vary some by industry, there is a generally accepted form for choice of law clauses as in this example.
"This contract shall be governed and construed in accordance with the laws of (agreed upon state), excluding that State's choice of law principles, and all claims relating to or arising out of this contract, or the breach thereof, whether sounding in contract, tort or otherwise, shall likewise be governed by the laws of (agreed upon state), excluding that State's choice-of-law principles."
If you are involved in writing contracts, you need an in-depth understanding of how different courts interpret choice of law clauses. It's unwise to rely on boilerplate language that may not be read the same everywhere. A carefully modified version of the standard language can extend the provisions to cover other types of claims that may develop within the relationship between the parties.
Choice of Law Versus Jurisdiction
Though sometimes used interchangeably and often grouped together in the contract language, choice of law is not the same as jurisdiction. A choice of law clause specifies which state's laws will apply to interpret the contract. Jurisdiction is the specific court where a lawsuit can be filed. That means that a court in one state or country may have to apply the laws of another state or country to the case at hand.
In technical terms, this is the difference between the applied procedural law (enforcement of rights) and the applied substantive law (creation of those rights). Statutes of limitations, for example, are matters of procedural law. Choice of law clauses determine the substantive law, rather than the procedural.
For example, the choice of law provision in a contract specifies that California law applies, but a New York federal court has jurisdiction. The proceedings will take place in New York, but the court will apply the California law. However, it is possible for the language in the choice of law clause to be crafted in such a way that both the procedural and substantive law of New York apply.
As a practical matter, the state selected through the choice of law clause doesn't make much difference. However, the state of jurisdiction can be very important because the parties have to travel there for the proceedings.
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