What is a governing law clause?

“Governing law” clauses are widely used in commercial-based, legal agreements to specify the rules and laws that will govern the dispute resolution process in the event of a legal dispute. It is clear that governing law must be carefully considered when reviewing a contract.

As contracts are negotiated, parties will stipulate how business is conducted. However, these clauses may have different meanings and effects depending on the country’s law on which the contract is based. Therefore, depending on the parties involved, governing law clauses seek to clarify and express which country’s law applies to the contract, which is a point of interest for parties not familiar with the laws of that jurisdiction. For example, contract law in England and Commonwealth countries may significantly change the requirements for a contract to be valid or introduce unwanted exceptions or elements to existing clauses such as force majeure. 

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Why governing law is important?

Governing law is a crucial clause in any commercial agreement because it allows parties to the contract to understand the context in which the agreed terms were constructed. This understanding allows all parties to comprehend how the law will apply and interpret the contractual clauses. Besides, governing law clauses and the resulting clarity on each party’s rights and responsibilities within the commercial agreement also allows the parties to save time and resources on possible. Hence, it is important to understand the pros and cons of a governing law when reviewing a contract.

 

In the cases where no governing law clause has been stipulated, the contract may be governed according to the jurisdiction that has the strongest connection to the contract. Factors that may be considered in this scenario may include the parties’ residence and the location in which the contract takes place.

 

Why choose English governing law?

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English governing law is commonly used for cross-border commercial agreements and other associated non-contractual claims due to the fact that it is highly predictable. The use of English law allows parties a high level of certainty due to the fact that the agreement will be enforced as set out in the expressed intentions of the party without the invention of codified rules of law.

The good reputation of English law is due to the fact that the city of London has very high standards when it comes to commerciality, predictability, and judicial precedent. London has established itself as a highly stable and leading financial center for many companies to conduct business, and it is also home to the London Court of International Arbitration (LCIA), which is a highly prestigious arbitration option. This international institution is known for offering flexible and efficient arbitration for the resolution of commercial disputes. About 80% of the cases the LCIA process are international cases, which may demonstrate that it is an impartial body and makes it an attractive option for the arbitration of commercial agreements.

Governing law when a contract is silent or does not include governing law?

 

If the contract is silent regarding what governing law should be applied to the contract, a court may be tasked with determining it. This process will be determined according to a series of principles and regulations depending on whether the dispute concerns EU member states or non-EU member states. If the contract proceedings started in the EU and it was signed after the 17th of December 2009, the provisions of Regulation (EC) 593/2008 will likely apply. This provision, commonly known as the ‘Rome I’, recognizes the express mention and choice of a governing law within the contract. However, in the absence of this, Article 4 of ‘Rome I’, which determines the governing law according to the type of contract, will apply.

Article 4 of ‘Rome I’ outlines clear guidelines for establishing the governing law, in the absence of an express mention of this. Article 4 outlines in the absence of a governing law clause, the governing law may be where the habitual residence of the seller or buyer is. Article 4 also will apply to specific contracts such as those relating to the sale of goods or the supply of services.  On the other hand, construction and engineering contracts are not expressly mentioned within ‘Rome I’, meaning they are not covered by a specific rule.

The process to determine governing law may vary. In instances where contracts do not express which specific rules apply or where more than one rule does, general guidelines within ‘Rome I’ dictate that the applicable governing law will be the law of the place where the ‘characteristic performance’ has its habitual residence. The governing law will be a presumption in instances such as these unless it can be shown that the contract is shown to have a closer connection with another country. Another exception may occur when another court applies in another jurisdiction from where ‘Rome I’ does not apply.

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What Jurisdiction applies when the contract is silent?

In the event of a contract not containing a jurisdiction clause, the framework for deciding which jurisdiction will apply may vary. In cases when the parties or the commercial dealings are located in the EU, matters regarding the jurisdiction within contracts will be governed by the Brussels Regulation 2015. These detailed provisions have set out the framework to determine which courts have jurisdiction over any given commercial agreement in the cases where a jurisdiction has not been set out. The general rule is that the party that is the defendant in the dispute will be heard in a court of their country’s law. The following are considerations that may be an exception to this rule: 

• If the matter falls within one of the categories of exclusive jurisdiction, such as real property, intellectual property, or concerning the constitution of a company. These issues will primarily be heard where the dispute is located.

• If the defendant has already made an appearance before the court of a member state. In those cases, the jurisdiction will be of that member state and that court. 

• If the parties to the dispute can come to an agreement relating to the member state and jurisdiction.

 

Which governing law and jurisdiction to choose?

 

A governing law clause may expressly mention which country’s laws apply to the commercial agreement, but this does not mean that it expressly outlines what to do when disputes arise, or which tribunals will have jurisdiction over the matter. In such cases, it is common practice to also include a jurisdiction clause alongside the governing law clause to clarify and avoid possible disputes over jurisdiction. Jurisdiction clauses may come in the form of three categories: exclusive, non-exclusive, or one-sided. 

• Exclusive categories are where each party cannot bring a claim against another party in a court of law other than the court agreed to in the contract. 

• Non-exclusive categories are where each party can bring a claim against another party in either chosen country of governing law or a court in which the country’s law has jurisdiction over the dispute. 

• One-sided categories are where only one party has the power to sue another party in any component jurisdiction and in effect, limits the other party to only one jurisdiction when bringing possible proceedings.

 

What governing law to choose?

 

During the drafting and negotiation of contracts, parties will have the ability to nominate and express which governing law they want their contract to be upheld. The courts of the governing country’s law, as a result, will determine the dispute between parties. However, in some instances, different jurisdictions may have overriding laws that prevent parties from choosing a governing law. General guidelines for what governing law and jurisdiction to choose are that they should match. As an example, English law and English courts are noteworthy as they are known for being well versed in dealing with foreign disputes involving various different legal systems. In any case, it is recommended that before the signing and finalization of a contract, a governing law should be chosen as this will prevent complex and costly proceedings relating to disputes as to what governing law should apply. 

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What jurisdiction to choose?

 

Jurisdiction clauses usually go hand in hand with governing law clauses as jurisdiction clauses will stipulate where contract disputes will be heard. Drafting this jurisdiction clause will be crucial to providing clarity about which courts will hear the dispute, how the courts will resolve the issue, and what the costs that will be associated with dispute resolution are. Not including in what jurisdiction possible disputes will be heard will likely result in more costly and lengthy dispute processes that also involve the disputes as to which court should hear the matter. When choosing a jurisdiction, a number of factors should be considered such as the subject matter of the contract, the performance of the contract, the location of the parties, the quality of the courts, the language of the court, and the costs associated. Other factors may include the enforceability of the court and how easily the damages can be recouped. Considering these factors, parties may conclude that, in the event of a dispute arising, choosing one or more jurisdictions may be appropriate.