Key Takeaways

  • A choice of law clause allows contract parties to agree on which state’s laws will govern their contract.
  • It provides clarity, reduces legal uncertainty, and can help lower dispute resolution costs.
  • Enforceability of such clauses depends on a reasonable relationship between the state chosen and the parties or the transaction.
  • There are exceptions where these clauses may not be honored, particularly in insurance contracts, secured transactions, and corporate governance issues.
  • Language precision is critical; vague or boilerplate clauses may not be enforceable.
  • Choice of law is distinct from jurisdiction — a court in one state may apply the laws of another.
  • Courts generally uphold a choice of law clause unless doing so would violate public policy or statutory protections.

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.

What Makes a Choice of Law Clause Enforceable

For a choice of law clause to be legally enforceable, courts typically require that:

  • The chosen law bears a reasonable relationship to the contract. For example, the state may be where one party is based or where the contract was executed.
  • The clause is not contrary to public policy. Courts may strike down clauses that attempt to avoid consumer protections or statutory requirements.
  • The clause was freely negotiated. Especially in consumer or employment contracts, courts may scrutinize whether one party had unfair leverage or lacked real bargaining power.

Courts are more likely to uphold a clause in a business-to-business (B2B) context, particularly when both parties had equal opportunity to negotiate terms.

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.

Common Situations Where Choice of Law Clauses Fail

Despite their general enforceability, choice of law clauses may be invalid in certain scenarios, such as:

  • Insurance contracts: Some states prohibit out-of-state laws from applying to insurance agreements, preferring to protect local consumers.
  • Franchise and employment contracts: Courts may reject clauses that bypass stronger worker protections in the employee’s home state.
  • Consumer protection violations: If the chosen law would circumvent a state’s protective consumer laws, a court might override the clause.
  • No substantial connection: If neither party has ties to the selected jurisdiction, courts might deem the clause unreasonable.

Additionally, courts can invalidate a clause if it was hidden in fine print or not clearly explained during the contract formation.

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.

Sample Choice of Law Clause Variations

Here are a few example formats of choice of law clauses:

  • Basic Format:
    “This Agreement shall be governed by the laws of the State of [X].”
  • Expanded Format (with exclusions):
    “This Agreement shall be governed by the laws of the State of [X], without regard to its conflict of law principles.”
  • Including federal law considerations:
    “Except to the extent federal law applies, this Agreement shall be governed by the laws of the State of [X], excluding its choice of law rules.”

Tailoring the language ensures the clause applies as intended, especially in contracts involving tort claims or statutory violations.

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.

Choice of Law and the Uniform Commercial Code (UCC)

In commercial contracts governed by the UCC — such as sales of goods — state-specific interpretations can still apply even when the UCC provides a unified framework. A choice of law clause helps determine which state's version of the UCC is used. However, for secured transactions, Article 9 of the UCC has its own choice of law provisions, often prioritizing the debtor’s location.

When drafting contracts involving the sale of goods, licensing, or credit agreements, consult the relevant UCC provisions in both the chosen and default states to ensure alignment.

Frequently Asked Questions

  • What is a choice of law clause?
    A choice of law clause allows contracting parties to designate which state’s laws will govern the interpretation and enforcement of the contract.
  • Can any state’s law be chosen in a contract?
    Generally yes, but there must be a reasonable relationship to the parties or transaction, and the chosen law cannot violate public policy.
  • How does a choice of law clause differ from jurisdiction?
    Choice of law dictates which state's laws apply; jurisdiction determines where legal disputes will be heard.
  • Can courts ignore a choice of law clause?
    Yes, especially if the clause is unfair, not clearly disclosed, or conflicts with state statutes or consumer protection laws.
  • Should I use standard language for a choice of law clause?
    It’s safer to customize the clause based on the contract's context. Boilerplate language may not account for torts, statutory claims, or procedural nuances.

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