Governing Law in a Contract
The governing law clause determines what state laws will be used to interpret the contract and which jurisdiction will oversee the enforcement of its terms.3 min read
What is Governing Law?
The governing law clause, sometimes called choice of law clause, determines what state laws will be used to interpret the contract and which jurisdiction will oversee the enforcement of its terms.
Governing law can be important because a dispute may hinge on differences in local laws. However, the parties in a contract are not necessarily bound to where they live or where the contract is signed. A governing law provision allows the parties to agree to use a particular state's laws to interpret the agreement. Delaware has laws that benefit corporations, for example, so many large corporations interpret their agreements based on Delaware state law.
Courts generally respect the selection by the parties.
Though it can be an important part of a contract, the choice of law provision is usually brief. For example: “This Agreement shall be governed by the laws of the Commonwealth of Massachusetts.”
To avoid surprises, parties agreeing to a contract become familiar with the laws of the state that will be used to interpret the contract or hire local counsel to assist in drafting it.
Governing Law Provisions in Contracts
The governing law clause regulates the local law that will govern the interpretation of the contract the parties agreed to.
As a result, the parties often select a lawyer to draw up the contract who is from or familiar with the state or local law that the parties choose.
Contract law varies between states, and the differences can be important.
Choosing which state's laws by which interpret a contract doesn't mean that a dispute has to be settled there. The parties can often also select a jurisdiction. You could have a governing law clause that chooses to use California law but requests disputes to be decided by a court in New York.
Jurisdiction selection can be crucial. If there's a dispute, it will have to be resolved in the state of jurisdiction. This is often a strategic decision, but sometimes, attorneys take a more practical approach. If you're on the East Coast and the court is in California, that can be an expensive and inconvenient contract dispute to settle.
Exceptions to Governing Law Clause
Some laws cannot be modified by contract and are enforceable despite the governing law clause. For example:
- Insurance contracts - Some states require that their consumer protection laws relating to insurance are applied in their states.
- Connection required - Courts also may want to make sure there is a connection between the state chosen for the governing law clause and the parties or type of transaction, such as the contract being signed in the state or one of the parties operating a business in the state.
- Corporate contracts - Contracts governing corporate behavior usually must be decided by the law of the state of incorporation. However, differences in state law are not great enough to make it a major negotiating issue for most parties.
- Portions of contracts - Some laws cannot be modified by contract and are enforceable despite the choice of law clause. However, the governing law clause can make certain the parts of contract law that can be assigned in the contract are assigned to the preferred state and jurisdiction.
Choice of Venue
The parties in a contract also may choose a venue where legal proceedings would be held, if necessary. It also determines the site of mediation or arbitration proceedings.
A court case's venue is the location and court where the matter will be heard. Having a local venue can be to your advantage in a dispute as well as give your lawyer, who is familiar with local laws and courts, a type of home-field advantage.
For these reasons, venue clauses can be hotly contested. Some contracts contain a “dual” venue clause that allows for more than one location at the plaintiff's option.
To sum up, the governing law can be important. State laws are not the same, and one may be more favorable for your agreement. Choice of venue matters because it may be more expensive and time-consuming to go to a court across the country.
Contracts should contain governing law clauses to clear away confusion on where disputes must be filed and what law will govern.
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