Drafting Choice of Law and Choice of Forum Provisions for U.S. Agreements
Fully elaborated commercial contracts typically identify the governing law and specify the forum that would hear any dispute. They may also provide that disputes will be resolved by arbitration instead of judicial litigation.
Contract provisions specifying the choice of law that will govern and choice of forum to resolve disputes range from simple to elaborate, but do not always get the care they deserve. As with other contract provisions often tucked away at the end of the agreement in a section titled "miscellaneous," they can be easy to ignore once the substantive decisions are made — and agreement reached — on what law applies and what forum will be used. But nuances of drafting can have more of an impact on the outcome than many lawyers, including many U.S. lawyers, realize. Thus, lawyers who draft commercial agreements with connections to the U.S. should be aware of some recurring issues that complicate what may seem to be straightforward matters. This article explores some of the more common issues that arise in this context.
In the United States, contracts are governed by state law: with rare exceptions (such as certain contracts to which the federal government is a party), there is no such thing as U.S. contract law. However, the laws of the 50 U.S. states — as well as those of the handful of U.S. territories — are generally consistent in applying a "freedom of contract" approach to commercial agreements between sophisticated (or presumed to be sophisticated) parties. Accordingly, choice of law and choice of forum provisions in commercial agreements are generally enforced in accordance with the contract language.
The Need for Choice of Law Provisions, and How a U.S. Court Determines Foreign Law
In part because the U.S. court system is highly fragmented — with each state and territory having its own court system in addition to the federal courts — both state and federal courts routinely apply the substantive law of a different jurisdiction. For example, a suit for breach of contract between a New York company and a New Jersey company might be brought in either state, but the location of the court does not itself control which law applies. Either way, the court in which the case is filed will have to determine whether to apply its own law or the law of the other state.
The same principle applies to international cross-border disputes, e.g., a U.S. court hearing a contract dispute between a U.S. company and a Canadian company will have to determine whether to apply domestic contract law or Canadian contract law (which itself can vary from province to province). When the issue comes up, the litigants may expressly or tacitly agree which law governs, or will agree that the choice of law does not matter because the governing principles are largely the same under each possible choice. In these cases, the court will generally rely on the contract law of the state in which it sits.
Oftentimes, however, the litigants are unable to reach agreement on which law applies, with each perceiving that its preferred choice will result in a better outcome. When this occurs in the absence of a choice of law provision in the contract under dispute, the court will apply its own choice of law rules, which themselves vary from state to state, to select what jurisdiction's substantive law governs. (As to procedural matters, the court will apply its own laws and rules.) If the case is being heard in a federal court, it will apply the choice of law rules of the state in which it is located. The outcome of this determination can be unpredictable.
As noted above, U.S. courts routinely apply laws of other jurisdictions. When the other jurisdiction is a different U.S. state, doing so is straightforward: the court will read the statutes and caselaw of the other state that are cited to it by the parties' respective attorneys, just as it would read its domestic statutes and cases in applying its own law. Nor is it usually challenging for a U.S. court to apply the contract law of a common law jurisdiction such as England and Wales, given that the source material will be in English and the legal principles will be familiar.
Things get harder when the governing contract law is that of a non-English speaking, non-common law jurisdiction. In such cases, the court will rely on treatises and translations cited to it by the parties, supplemented by its own research if necessary, and on the testimony (usually written, but on occasion oral) of expert witnesses hired by the parties to opine on the laws of the jurisdiction at issue. For example, a federal trial court in New York was called on in Wultz v. Bank of China Ltd., 979 F. Supp. 479 (S.D.N.Y. 2013), to determine the scope of attorney-client privilege under Chinese law. To do so, it relied on affidavits submitted by the parties from a law professor and Chinese lawyer, as well as the conclusions reached by other U.S. courts.
For purposes of increased predictability and reduced expense in the case of a dispute, it is desirable for commercial contracts to specify what law governs.
Breadth of Choice of Law Provisions
Once a decision is made to include a choice of law provision in a commercial contract — and the parties have agreed what law this should be — the issue becomes one of drafting. The drafting attorney should be aware of certain nuances that may not be entirely obvious to one who has not encountered them.
Perhaps the most important point to remember is that a U.S. court may apply different law to different issues presented in the same case. In commercial disputes, one circumstance involves claims that arise under the contract in combination with extra-contractual claims. For example, a defendant may argue both that it did not breach the terms of the contract, and that the plaintiff intentionally misrepresented certain material facts in the course of negotiations. The former defense (no breach) is contractual, while the latter defense (fraud) is extra-contractual. Thus, if the contract's choice of law provision states simply that "This Agreement shall be construed in accordance with the law of the State of California," but the alleged fraud occurred while the parties were negotiating the contract in New York, a New York court is likely to apply California law to the defense of "no breach," but New York law to the fraud claim. See, e.g., Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996) ("Under New York law, a choice-of-law provision indicating that the contract will be governed by a certain body of law does not dispositively determine that law which will govern a claim of fraud arising incident to the contract.") (emphasis in original). Other states require less exacting language than New York in order to conclude that the simple choice of law example given above was intended by the parties to apply to all aspects of their relationship, but at the drafting stage there is no reason to leave room for dispute if this is the intent.
Thus, if the drafting attorney intends that his or her preferred law is to govern all aspects of the parties' relationship and not just the limited question of contractual rights and obligations, a broader choice of law provision is desirable. For example, one might provide that:
This Agreement, and all claims or defenses based on, arising out of, or related to this Agreement of the relationship of the Parties created hereby, including without limitation those arising from or related to the negotiation, execution, performance, or breach of this Agreement, whether sounding in contract, tort, law, equity, or otherwise, shall be governed by, and enforced in accordance with, the internal laws of the State of _____ including its statute of limitations, without reference to its choice of law rules or any principle calling for application of the law of any other jurisdiction.
An attorney who views this degree of elaboration as unnecessary or provocative, but who wishes to have a provision that is still likely to apply to extra-contractual claims, may prefer a choice of law provision along the lines of the following:
Any disputes arising out of or related to this Agreement, or the Parties' relationship created hereby, shall be governed by the internal law of the State of ________.
Of course, the drafter may in certain cases prefer not to have an all-encompassing choice of law provision. For example, if the counter-party insists on its preferred choice of law and there is no room to negotiate this, the narrow provision given as an example above ("This Agreement shall be construed in accordance with the law of the State of ______") may give some latitude to argue for application of different law to extra-contractual claims.
Excluding the UN Convention on Contracts for the International Sale of Goods
The U.S. is a party to the United Nations Convention on Contracts for the International Sale of Goods (CISG), which by its terms applies to commercial agreements for the sale of goods entered into between nationals of contracting states. As a matter of U.S. law, because the CISG has been adopted at the national level, it is automatically part of domestic law of all U.S. states and territories.
At the same time, each U.S. state and territory also has its own state-level law governing contracts for the sale of goods. In virtually all of them, this is Article 2 of the Uniform Commercial Code (UCC), sometimes verbatim and sometimes with modest variations. Because federal law preempts any conflicting state law under the "supremacy clause" of the U.S. constitution, the CISG will by default supersede the UCC in the case of any agreement which by the terms of the CISG falls within its ambit.
However, consistent with the "freedom of contract" approach that prevails in the U.S., parties to a commercial contract that would by default be governed by the CISG are permitted to opt out of the CISG, in which case the applicable provisions of the pertinent state's adoption of the UCC would apply.
The desirability of opting out of the CISG is beyond the scope of this article, but lawyers drafting a contract to which the CISG may apply should take this into account when considering the choice of law provision. Because the CISG is part of the domestic law of all U.S. states and territories, a choice of law provision that specifies the law of a U.S. or territory without reference to the CISG includes the CISG by default. If the intent is to exclude the CISG and apply only the state's version of the UCC, a phrase such as "but excluding the UN Convention on Contracts for the International Sale of Goods" should be added after the name of the state whose law is chosen.
The Need for Choice of Forum Provisions
At the risk of stating the obvious, no article on drafting choice of law provisions would be complete without noting that choice of law does not necessarily control choice of forum. Even though these provisions are usually in the same section of an agreement, and are sometimes included in a single sentence, they are in U.S. jurisdictions legally distinct. Thus, while all of the examples of choice of law provisions given above — from simplest to most elaborate — may suggest that the parties contemplated the possibility of litigating in the specified state, none of them require a lawsuit to be brought or heard in that state.
The drafting attorney should also keep in mind that the choice of forum may have a greater impact on the outcome of a dispute than the choice of law. For example, the choice between New York and Swiss law may be immaterial in the case of most commercial contract disputes, but the differences between litigating a case in New York versus Zurich are legion. Procedural differences such as the availability of fulsome pretrial discovery and the mode of taking evidence could well be outcome determinative. The choice of forum takes on even greater significance if there is a concern about the competence or fairness of the courts in a potential jurisdiction. Even if such concerns are unfounded, a client that believes that it cannot get a fair hearing in a certain jurisdiction will be disadvantaged in negotiating a fair settlement in the event of a dispute. On the flip side, a client or counter-party who believes that he or she "can't lose" in a certain jurisdiction may be intransigent during settlement discussions without regard to the accuracy of that belief.
Drafting Choice of Forum Provisions
Once a decision is made to specify the choice of forum and agreement is reached on what that forum will be, the drafting itself is relatively straightforward. Still, care should be taken to consider a few issues that can be problematic.
First, the issue of breadth or scope of the choice of forum provision is similar to that discussed above with respect to choice of law provisions. Usually, the intent will be for any dispute to be heard in the chosen forum.
Second, care should be taken to make the selected provision mandatory or exclusive. A provision stating that disputes "may" be heard in a specified court does not require the dispute to be heard only in that court. Unless the intent is to leave other options open, the verb "shall" should be employed instead of "may" or "will." The mandatory nature of the selected forum can be made even clearer by starting that disputes "shall be heard only" in that court "to the exclusion of all other courts and fora." Commonly added is a consent to jurisdiction and a waiver of defense or objections, so the final provision is along the lines of the following:
Any disputes arising out of or related to this Agreement or any other aspect of the Parties' relationship shall be heard only in the courts of ________ to the exclusion of all other courts and fora. The Parties irrevocably consent to the jurisdiction of, and venue in, such courts and waive any objection that such courts are an inconvenient forum.
Third, when choosing courts in the U.S., it is best to avoid limiting the choice to a federal court. In the U.S., the state courts are courts of general jurisdiction versus the federal courts that have limited jurisdiction. In brief, a federal court has jurisdiction in civil cases only if the claims arise under federal law, or are between parties of completely diverse citizenship. Ordinary contract claims do arise under federal law, and diversity jurisdiction is not always available. If an agreement's choice of forum provision is limited to federal court but the resulting dispute is not within the federal court's limited jurisdiction, the provision may be treated by other courts as a nullity, with the result that the agreement is deemed to have no choice of forum provision at all. It is best to avoid this risk by specifying the state or federal courts in the given U.S. jurisdiction, or providing the state courts as a fallback to the federal court, for example:
Any disputes arising out of or related to this Agreement or any other aspect of the Parties' relationship shall be heard only in the state or federal courts located in the State of Delaware, to the exclusion of all other courts and fora.
Any disputes arising out of or related to this Agreement or any other aspect of the Parties' relationship shall be heard only in the U.S. District Court for the District of Delaware if federal subject matter jurisdiction exists, or if not only in the state courts of the State of Delaware, in each case to the exclusion of all other courts and fora.
Fourth, keep in mind that many U.S. states have more than one federal court, and virtually all have more than one state court. New York has four different federal trial courts; New York City alone has two federal trial courts and five different state courts that hear general commercial cases. Thus, if the intent is to choose the courts located in Manhattan (which is New York County), one should specify the "federal or state courts located in New York County, New York" and not simply the "federal or state courts located in New York."
Fifth, what if the parties negotiating a contract cannot agree on a choice of forum? One option is to omit a choice of forum provision, with the hope and expectation that a dispute leading to litigation is unlikely to occur. This is an entirely reasonable approach. Another compromise is to select a "neutral" forum that is foreign to both parties but considered by each to be fair. For non-U.S. companies, New York is a popular choice, especially if the agreement is also governed by New York law.
A different approach seen on occasion is one that conditions the choice of forum on the identity of the party that sues, i.e., a party may bring suit only in the other party's home jurisdiction. One perceived virtue of this approach — that is discourages the parties from suing in the first place — is also a potential drawback if the result is that an aggrieved party that in all fairness should bring suit feels constrained from doing so. It can also lead to gamesmanship with each party trying to provoke the other into suing first. As the reader can tell, the author generally dislikes this approach, but offers it as an alternative to silence in the right circumstances.
Finally, lawyers will sometimes include a jury waiver in the section of a commercial contract that includes choice of law and choice of forum provisions. Most states will enforce jury waivers in commercial contracts. A notable exception is California, which holds that parties may waive their right to a jury trial only after a lawsuit has been filed. There is also some concern that a California court may not honor the choice of law provision in a contract that includes a jury waiver if the outcome would be that a dispute with a meaningful California connection would be heard in a different state that recognizes the validity of jury waivers. Assuming that the possibility of litigation in California is largely off the table because the agreement has no meaningful connection to California, a lawyer who wants to include a jury waiver in the agreement may consider language such as the following:
EACH PARTY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY SUIT, ACTION, OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.
EACH PARTY HEREBY WAIVES ITS RESPECTIVE RIGHTS, IF ANY, TO A JURY TRIAL OF ANY CLAIM, CONTROVERSY, OR CAUSE OF ACTION BASED ON OR ARISING OUT OF THIS AGREEMENT OR ANY OF THE TRANSACTIONS CONTEMPLATED HEREBY. EACH PARTY REPRESENTS THAT IT HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL.
These examples are provided in capital letters because some states require that a jury waiver must be conspicuous in order to be enforceable. For this reason, lawyers may include the jury waiver as the last provision of the agreement so that it appears on the same page as the signatures, or have the parties separately sign or initial the jury waiver to minimize any argument that it was overlooked.
As with other provisions discussed above, a court may find that the jury waiver in a contract does not extend to extra-contractual claims such as fraudulent inducement. This potential exception should not, however, be a reason to omit a jury waiver if the drafting attorney otherwise believes that a jury waiver would be desirable.
Opting for Arbitration
When opting for arbitration as the chosen forum for disputes, some issues concerning the scope of the provision are similar to those concerning scope of choice of law and other choice of forum provisions, i.e., if only contractual claims subject to arbitration, or if extra-contractual claims are also subject to arbitration. An additional issue that is unique to arbitration is a dispute over arbitrability is to be resolved by the arbitrators or in court.
As a general proposition, U.S. courts hold that the threshold question of whether a dispute before a court should be resolved by the court or remitted to arbitration is for the court to decide. However, if the arbitration provision at issue is drafted broadly, the court may determine that the issue of whether the dispute is arbitrable is one for the arbitrators.
For example, in the recent case of Ashland Global Holdings, Inc. v. Speedway LLC, 2021 NY Slip Op. 31899(U) (June 4, 2021), the litigants disputed which of two agreements applied to their dispute. One agreement provided that disputes would be resolved in court in New York, the other provided for arbitration. The arbitration provision in the second agreement was very broadly drafted:
[A]ll controversies, claims or disputes that arise out of or relate to the Agreement or the construction, interpretation, performance, termination, enforceability or validity of the Agreement, or the commercial economic or other relationship of the parties thereto . . . shall be resolved [by arbitration].
Id. at 7 (emphasis added). Given what it characterized as "this very broad grant of power to the arbitrators," the court held that the question of which agreement governed the parties' dispute — the first one that provided for litigation in New York or the second one that provided for arbitration — was delegated to the arbitrators.
The relative desirability of arbitration to litigation is beyond the scope of this article. However, if the intent is to provide for a broad delegation of power to the arbitrators, including the power to make the threshold decision of whether the dispute is arbitrable in the first place, the provision excerpted above provides an adjudicated example.