Governing Law for Contracts

Practical Considerations and a Checklist

English law? New York law? French law? German law? Swiss law?  Many lawyers systematically
attempt to impose their home law as the governing law for contracts.  This can lead to lengthy and
dogmatic negotiations on the subject.  However, the choice of law should only rarely be a “deal-
breaker”.  We address some key considerations below.

One legal system is generally not better than another.

The main differences between the Common Law and Civil Law systems are well known.  Each has
advantages and disadvantages, including:

 Discovery/Disclosure.  Discovery/Disclosure may be quite a time-consuming and expensive

exercise, but on the other hand, it may make subsequent litigation less likely, once both
sides have the same facts.  On the other hand, Civil Law proceedings tend to be much faster,
which allows both parties to reach closure and move on with their business.

 Certainty vs. Fairness.  Common Law systems pride themselves on near-total freedom of
contract and respect for the written word of the contract, whereas many Civil Law systems
allow the judge to take into account all the circumstances and reach a conclusion which may
be quite different from the expressed intention of the parties in the contract.

Each system, taken as a whole, delivers coherent and commercially acceptable outcomes for the
parties. This is reflected in the fact that Swiss and English law are the two most commonly chosen
laws to govern international commercial contracts, even though they come from entirely different
legal traditions. 

Home law advantage? Be careful what you wish for.

Generally speaking there should be no home advantage per se, because the law itself is neutral
(though some legal systems are more developed than others and some jurisdictions strike a different
balance than others, e.g. regarding protection of agents).

Insisting on your home law can turn out to be a bad idea.  For example, you enter into a contract
with a customer which is subject to Swiss law, and you enter into a subcontract with a critical
supplier which is subject to English law (your home country).  You have reflected the relevant terms
and terminology from the contract in the subcontract.  You are later held liable towards the
customer due to a delay or performance issue caused by the supplier.  The court, applying your
home country’s law to the same facts and contract language, arrives at a different legal conclusion,
and exonerates the supplier. 

On the other hand, in the case of a parent company guarantee, if you are the issuer, you may be
concerned that in case of attempted enforcement by the beneficiary, it should be subject to a
governing law that you know and trust.  If you are the beneficiary, it may also be in your interests for
the governing law to be the law of the place where the parent company is located, to make
enforcement easier and cheaper.

With some customers it is clear from the outset that they will never agree to a different applicable
law, e.g. some state-owned companies, banks and insurance companies.  In such cases, it is useful to
take a step back and assess the practical risks.  For example, many state-owned customers have no
history of making aggressive claims against suppliers.  On the other hand, faced with a difficult
economic environment, some customers may not be reliable payers, but the best way to address
payment may be by insisting on delivery terms which avoid a negative cashflow or obtaining
payment security, rather than trying to enforce a foreign court judgement or arbitration Award.

If you have specific concerns, you can obtain some comfort by obtaining a local legal opinion, e.g.
regarding enforceability of liability limitations.  However, for smaller contracts, the costs which
would be incurred in obtaining legal advice in the foreign jurisdiction would be disproportionate.  For
product supply contracts, the United Nations Convention on Contracts for the International Sale of
Goods (CISG) may be a mitigating factor.  The CISG applies to contracts for sales of goods between
parties who are located in different ratifying states.  Some lawyers reflexively exclude the CISG
because it is different from their local law or because they are simply unfamiliar with its provisions. 
However, the CISG does provide a coherent set of rules which may be preferable to the local law.
Many Civil Law countries are parties, as is the US (but not the UK).
 
The dispute resolution mechanism is more important than the governing law.
In commercial transactions, it is generally good practice for the parties to regulate any matters of
importance to them in the contract, rather than relying on the general law to fill in the gaps.  This
means that there is normally no need to look beyond the contract to the chosen system of law
(though it will still govern matters such as the rules of interpretation).  This means that the choice of
dispute resolution mechanism is in practice much more important than the governing law.  For
international transactions, if there is a concern regarding the impartiality of local judges or that they
would not have the specific expertise necessary to decide complex commercial disputes, then
arbitration in accordance with the rules of a reputable institution can be a better option (in addition
to offering privacy and a certain degree of procedural flexibility).
 
Beware situations in which the governing law and the competent court are different.
If the parties choose courts over arbitration, they may anticipate non-exclusive jurisdiction, i.e. that
a local court would have to apply a foreign governing law.  Local courts will respect the contracting
parties’ free choice of foreign governing law in most circumstances (e.g. excluding areas of
mandatory law and public policy).  However, taking the example of Switzerland, a judge may insist
that all documents be translated by a court-certified translator, which can have a huge additional
cost.  The judge will then try to establish what are the relevant requirements of the foreign law or
may require the parties to do so (and if the judge does not reach a conclusion, then Swiss law will
apply).  It is obviously going to be more efficient to have the judge decide cases based on the local
law with which he/she is familiar. 
 
If you take account of the considerations outlined above, you are likely to find that your Company is
able to significantly reduce contract negotiation time (e.g. by giving the flexibility to your commercial
teams to accept the customer’s local law when you are a supplier) without harming your own
Company’s position (because you still have an acceptable dispute resolution mechanism in case of a
serious dispute).
 
Checklist
What types of contract dispute could most likely arise (payment, technical performance, etc.)?  Are
you most likely to be a plaintiff or a defendant?
1.  Are you in a customer-contractor-subcontractor chain?  If so, consider choosing the same
governing law for each contract.

2. Do you have experience of the law proposed by the other party?

3. Which dispute resolution-governing law combination offers the best chance of fast and cost-
effective enforcement against the other party? (Alternatively, if you are likely to be the
defendant, you may prefer a combination which has the least chance of successful
enforcement).

4. Are the parties from states which have ratified the UN Convention on Contracts for the
International Sale of Goods?  If so, think twice before excluding it.