A governing law clause generally fulfils two functions. Firstly, it allows parties to specify the system of law which will apply to a contract. This will have an affect on how the contract is interpreted should any disputes arise under it; different jurisdictions have different rules of contractual interpretation and certain terms and phrases have distinct meanings in certain jurisdictions. It is therefore important, to understand your contract, to know which law will govern its interpretation. The second function of the clause is to specify a jurisdiction to which disputes will be submitted to.
In the European Union, if parties do not specify a governing law or jurisdiction for disputes the basic rules are that (i) the governing law will be that of the country with which the contract is most closely connected, and (ii) claims will be brought against individuals in the court of his/her domicile and against companies in the court of its principal place of business. There are exceptions to these general rules, however, which can give rise to complicated issues which in turn can lead to expensive litigation. Most of these inter-jurisdictional issues can be avoided by including an express governing law clause in a contract.
The rules outwith the EU are different and, as such, local advice would be required. However, most jurisdictions recognise the parties' right to elect a governing law and jurisdiction to apply to the contract and it is usually safe to proceed on this basis.
Accepting an Alternative Governing Law Clause
If accepting an alternative to your standard governing law clause, this needs to be considered carefully as:
| I. | the interpretation of the contract under the proposed governing law may be unfavourable; |
| II. | raising or defending claims in a foreign court may be complex, expensive, and inconvenient; and |
| III. | obtaining local legal advice from lawyers in the relevant jurisdiction may incur additional expense |
In certain situations a party may accept an alternative governing law clause, for instance where:
| I. | the partner is unable/unwilling to attend, for example, a Scottish court and the partner's jurisdiction does not recognise Scottish judgements, and so there would be little or no chance of enforcing a Scottish judgment against them; |
| II. | the contract is being performed substantially in a different jurisdiction; or |
| III. | a 'friendly' jurisdiction is proposed which is acceptable to both parties. |
Additional Factors
In addition to the considerations above, there are some other factors to keep in mind when considering the governing law clause to apply in a contract.
Mandatory laws:
If the contract has a close connection to a country which has not been specified in the governing law clause, it is important to check (and obtain local legal advice if necessary) whether mandatory rules in that county may modify the governing law and jurisdiction expressed in the clause. For example, local law may give a party rights in another jurisdiction irrespective of what is agreed in the contract. One example of this is that sometimes local laws can give agents rights to a payment on termination of their agency, irrespective of what the parties may have agreed by contract. Again, local legal advice should be sought.
Related contracts:
It is important to consider whether there are any related contracts with conflicting governing law clauses. If there are any disputes which could potentially involve both contracts, it may be preferable to have one set of proceedings.
Exclusive/non-exclusive jurisdiction:
The parties may elect for exclusive or non-exclusive jurisdiction. If exclusive jurisdiction is elected, disputes can go to no other courts other than in the country set out in the contract. If non-exclusive jurisdiction is chosen, disputes can go to the court in the chosen country or in the court of an alternative country which has, under its own jurisdictional rules, jurisdiction over the dispute.
The advantage of non-exclusive jurisdiction is that it is flexible; however, it does not provide parties with any certainty and there is the risk that parties may end up raising or defending claims in an unfavourable jurisdiction.
If a governing law clause is being considered which provides exclusive jurisdiction from the perspective of one party and non-exclusive jurisdiction from the perspective of the other, advice should be sought from lawyers in the relevant jurisdictions on the validity of the clause. Whilst such clauses are generally considered enforceable, they can raise issues as they are particularly one sided.
Separate governing law and jurisdiction:
It is generally possible to separate the governing law and the jurisdiction. Thus, for example, it would be possible to elect for English law to govern the contract but for the courts of Scotland to hear any dispute. It is likely that splitting governing law and jurisdiction in this way will be expensive and complicated as the court may be deciding on issues arising under a different legal system with which it is not familiar and, in any event, expert evidence would need to be led as to what the law is (so, in our example, it may be necessary to lead evidence as to what the English legal position is on a particular point before the Scottish court). Certain courts, however, such as the English court, are experienced in applying foreign laws to disputes. However, there will still be additional cost and complication.
It is also possible to specify alternative jurisdictions (but not governing law) for each party. However the risks highlighted above, in relation to accepting an alternative governing law clause, should be taken into consideration.
The doctrine of sovereign immunity:
The rules of state immunity concern the protection which a state is given from being sued in the courts of other states. Immunity can extend to legal proceedings against the state itself or its organs, enterprises and agents. If entering into a contract with such a body, this may have an effect on the ability to bring proceedings against that party under the chosen jurisdiction unless the body specifically waives its right to immunity in the contract. If contracting with a body of the state, legal advice should always be sought.
Alternatives dispute resolution:
Alternative dispute resolution (ADR) procedures, such as mediation and arbitration, may also be considered. However, these can often be time consuming and expensive. In addition, such alternatives do not provide for the same remedies as those that are available in the courts and in certain situations such remedies will be required; an example of this is the remedy of interdict to prevent an anticipated breach of confidentiality or to prevent or stop an intellectual property breach. Again, if the counter-party wishes to provide for ADR instead of recourse through the courts, legal advice should be sought.
Escalation procedures:
It is generally in neither party's interest to take a dispute to court; disputes are better resolved between the parties. It is therefore not uncommon to include escalation processes within a contract to help resolve disputes before they reach court. These clauses usually provide a tiered escalation approach with unresolved disputes being referred to increasingly senior people within each party for resolution within defined timescales. It is important to remember though that there are cases, such as the case of interdict noted above, where escalation is not appropriate and immediate recourse to the courts may be required. Any escalation clause therefore needs to provide for this.
The extent of the governing law clause:
Ideally a governing law and jurisdiction clause should extend not just to disputes which may arise under the contract itself (i.e. claims for breach of contract) but also to extra-contractual claims that might arise under other areas of the law (such as under the law of negligence) but which still relate to the subject matter of the contract. This is to avoid the position that a common law claim (such as a claim under the laws of negligence) could be raised under a different legal regime than that which governs the contract.
