Contractual Choice-of-Law Provisions

The scope and enforcement of commercial contracts can pose challenges for the contracting parties in many ways. One potential area of uncertainty is when courts are called upon to interpret and enforce a contract’s terms, especially where the parties and the contract have a connection to more than one state. Variables in how the parties’ respective obligations, duties and remedies may be enforced in different jurisdictions create the potential for inconsistency in how the terms of the agreement may be applied to resolve disputes. 

Laws differently interpreted  

Our federal system is structured so that state law (as opposed to federal law) usually applies to determine the existence, performance and remedies for breach of contracts. The specific language used and the object or purpose of the contract may be interpreted differently from state to state based on how each state’s jurisprudence has developed. Individual states may also have enacted laws that pertain to how specific types of contracts may be enforced, such as employment contracts and restrictive covenants like non-compete clauses. This effect of our federal system may lead to unintended results. In the U.S. legal system, contracting parties developed contractual choice-of-law provisions to create consistency as to which rules will apply to a contract. 

In very general terms, choice-of-law provisions are written agreements between contracting parties to have one state’s laws apply to control the interpretation and enforcement of the contract. This “choice” provides the parties with reasonable assurance that their respective obligations and rights will be interpreted in a court of law as they intend. 

When a contract has no choice-of-law provision and litigation ensues, the judge, not the parties, decides which state’s law will apply. In making this decision, the court may look to see how the object of the contract and its performance relate to the state within which the litigation was brought. Or the court may conclude that the state law where the contract was made applies. 

This “place of contracting” analysis is unclear when the parties are from different states. The court could decide that if the state wherein the litigation is brought (the forum state) is also where the performance of the contract is to take place, the forum state’s law should apply because the consequences of performance or breach of the contract are important to the interests of the state and its citizens. This court-based analysis is called a “conflicts of laws” analysis, and the potential risks and inconsistencies posed by letting the court decide is why parties may lean toward a choice-of-law provision, which decides for the court. 

Most courts are willing to enforce choice-of-law provisions, so their use helps reduce potential risks of inconsistency and uncertainty. However, because choice-of-law provisions are contract terms, they are also subject to judicial interpretation, which may vary by state. 

Choice-of-law provisions basics 

Once a decision is made to include a choice-of-law provision, the question becomes: “Which state’s law should apply?” If company A is located in one state and company B is located in another, each may perceive a performance or contract enforcement advantage in having its home state’s laws apply to a dispute. However, without analyzing how those laws relate to the formation, purpose, performance and enforcement of the contract, that assumption could create more problems than advantages. 

Choice-of-law provisions may be ignored under specific circumstances when applying the chosen state’s law causes a waiver of substantive rights protected by the forum state’s laws. For instance, states have enacted statutes that specifically provide that a choice of another state’s law, which would “vary a statute, administrative rule or regulation that may not be varied by agreements under the [forum state’s] law,” is unenforceable. Laws regarding required financial disclosures and certain consumer protection statutes are the types of laws that may invalidate a choice of law provision if it would cause a waiver of those protections. 

In choosing state A’s law in the contract, parties should be aware that some courts may construe law to include only the substantive law of state A and not its procedural law. This distinction may become important in determining which state’s statute of limitations applies to a claim. The majority of states in the U.S. regard statutes of limitation as procedural. Specific language may be required to confirm the intent that state A’s statutes of limitation apply. 

Another consideration relates to the scope of the choice-of-law provision. If the provision is drafted with reference only to the contract, e.g., “…this contract shall be governed by the laws of state A…” is the scope limited to the law of contract-based claims only, or does it include non-contractual but related claims, such as tort (negligence, etc.) or claims based in statutory law?

Suppose the choice-of-law provision controls only contract-based claims. In that case, the forum court may undertake a conflicts of law analysis to determine whether the forum’s laws or another state’s law applies to those non-contractual claims brought within the same action as the contract claim. The parties should consider the intended scope before deciding on the language to use. 

Choice-of-law provisions are intended to create clarity and consistency in the legal interpretation and enforcement of contracts. However, choice-of-law provisions themselves are subject to potentially varied interpretations and enforcement. Their use likely reduces the potential for unintended and unforeseeable interpretations and enforcement of contracts. Given that unintended consequences may also result from their use, those entering into choice-of-law provisions should thoroughly analyze the potential impact of the chosen law and whether there are potential legal barriers to their enforcement.