Chapter 5

THE LAW APPLICABLE TO

CONTRACTUAL
OBLIGATIONS

PROFESSOR
DR. ABDUL GHAFUR HAMID
 5.1 Introduction

 The general principle is that every

international contract has a governing law
– known at common law as the ‘proper
law’ and the Rome convention (now Rome
I Regulation) as the ‘applicable law’ – by
reference to which most of the significant
issues arising out of the contract are to be
determined.
 Party autonomy: freedom of
choice by the parties
 Subject to certain limitations, parties to a
contract are free to choose the proper law
(applicable law).
 If the parties fail to make a choice, the
governing law is the law of the country
with which the contract is most closely
connected.
Choice of law in contract
 5.2 Choice of law under the
Common Law
 The common law principles are still applied in
England for those contracts not covered by the
Rome Convention (or Rome I Regulation).
 For those common law countries which are not
parties to the Rome Convention (or Rome I
Regulation), they primarily apply the common
law principle of the doctrine of “proper law of
the contract in relation to contracts involving a
foreign element.
 Proper law of the contract

 Under the common law, a contract involving a foreign

element is governed by the proper law of the contract.
 The doctrine of the proper law of the contract reflects
the doctrine of party autonomy, the underlying basis of
English contract law itself.
 The influence of the common law doctrine of the proper
law of the contract is considerable and has been
recognized and followed in practically overwhelming
majority of jurisdictions.

 Meaning of the proper law of the contract

Lord Wright in Mount Albert Borough

Council [1938] AC 224:
“ The proper law of the contract means that
law which the court is to apply in
determining the obligations under the
contract….
 Party autonomy and examining the proper law
 On the basis of the doctrine of ‘party autonomy’,
parties are free to choose the law governing their
contractual relationship.
 In Bonythorn v Common Wealth of Australia,
[1951] AC 201, 219, Lord Simons ruled that if
the parties have not expressly chosen the
governing law, the proper law of the contract is
“the system of law by reference to which the
contract was made or that with which the
transaction has its closest and most real
connection.”
 Tripartite hierarchy of rules for determining the
proper law of a contract

(1) Where the parties have made an

express choice of the proper law;
(2) Where there is no express choice but the
court may imply a choice of law from the
nature of the contract; and
(3) Where there is no express or implied
choice of the proper law.
 (1) Where there is an express choice of
the proper law
 Express choice here means the inclusion of a
choice of law (governing law) clause in the
contract.
 Parties are free to stipulate in their contract the
system of law which is to be applied to it.
 Vita Food Products Inc. v Unus Shipping Co Ltd
[1939] AC 277 at 290, the Privy Council upheld a
choice of English law even though all the
relevant factors were connected with either
Canada or the United States and there was no
connection at all with England.
Vita Food Products Inc. v Unus Shipping Co
Ltd
 In this case herrings were shipped from
Newfoundland to New York, using bills of lading
under a contract which provided that it “shall be
governed by English Law’.
 Arriving in a damaged conditions, the shippers
claimed damages against the ship owners.
 It was held that the case must be decided by
English law which was chosen by the parties.
Vita Food Products Inc. v Unus Shipping Co
Ltd
 Lord Wright, ruled that: “The courts will
normally enforce a choice of law clause provided
that the intention expressed is bona fide and
legal, and that there is no reason for avoiding
the choice on grounds of ‘public policy’.
 The parties choice is in general conclusive.
 It may be set aside by the court only in a rare
case, e.g. when it is made to avoid a
“mandatory rule” of the forum or contrary to
“public policy.”
Express choice may be set aside if it is made to
avoid a mandatory rule of the forum
The Hollandia [1983] 1 AC 565
 Machinery was shipped on a Dutch vessel
bound to Amsterdam.
 The bill of lading incorporated a term that the
law of the Netherlands was to apply to the
contract of carriage.
 The machinery was damaged and the owners
sued the carriers in UK.
 At that time, The Netherlands had not acceded
to the Hague-Visby Rules and still applied the
Hague Rules, under which the maximum
liability of the carrier was lower.
 The HL held:

 The Hague-Visby Rules were binding in English

law by virtue of COGSA 1971.
 Art. III r. 8 of the Rules prohibited reduction by
contract of the carrier’s liability.
 Since the effect of the choice of law clause
would be to reduce that liability (under a
mandatory rule of the forum) by means of a
contractual term, the clause was invalid and
should be ignored.
 (2) Where there is no express choice but
an implied choice is available
 Where there is no express choice of law, Lord
Diplock stated in Amin Rasheed case that “if it is
apparent from the terms of the contract itself
that the parties intend it to be interpreted by a
particular system of law their intention will
prevail…”
 Thus, the intention to choose a particular law
may be implied by the contract.
 The most obvious implications will be the use of
a particular standard form contract (Amin
Implied choice: use of standard form contract; an
inclusion of a jurisdiction or arbitration clause

Rasheed Shipping Co v Kuwait Insurance Co), or

the inclusion of a choice of forum (jurisdiction)
clause (The Kominos S) or an arbitration clause
(James Miller v Witworth Street Estates).
 If the parties agree in the contract that an
arbitral tribunal or a court in a particular country
shall decide any dispute arising from the
contract, there may be an implication that they
also intend the law of that country to be the
proper law of their contract.
The Komninos S [1991] 1 Lloyd’s Rep. 370

 A cargo belonging to P was shipped on a vessel

owned by D. P started proceedings in England
for damages due to lost of cargo during the
voyage.
 Although neither the contract nor the parties
had any connection with England, the bill of
lading provided that any dispute should be
referred to ‘British courts’.
 Court of first instance held that the parties had
not made a choice of law and that Greek law
 The Komninos S

must govern the contract because it was the law

with which the contract had most real
connection.
 On appeal, P argued that the jurisdiction clause
in favour of ‘British courts” was an implied
choice of English law.
 The CA upheld P’s argument and held that the
choice of British courts was to be interpreted as
a choice of English law.
 (3) Where there is no express or implied
choice of law by the parties
Inferring the proper law of the contract by the
court
 Where the parties have not expressed or clearly
implied their intention as to which law should be
applied to their contract, that intention will have
to be inferred by the court from the contract and
from all the circumstances connected with it.
 The general principle is that the proper law of the
contract in this situation is the system of law with
which the transaction has its closest and most
real connection. (most close connection test)
 The close connection test:
connecting factors
 The court normally identifies the ‘connecting
factors’ (factors that indicate the connection with
the law of a particular country).
 Examples of the connecting factors:
(i) the place where the contract was made;
(ii) the place of performance of the contract;
(ii) the nationality of the ship that carried the
goods;
(iv) the currency used in making the payment;
and so on.
 Off Shore international SA v Banco Central
SA [1976] 3 All ER 749

 A Spanish Co contracted to build an oil drilling

rig for a company registered in Panama.
 A deposit of $ 3 Million was paid to the
constructors and its repayment in the event of
cancellation was to be by a irrevocable letter of
credit issued by a Spanish bank through a
correspondent bank in New York.
 The letter of credit did not contain any express
term as to the governing law.
 Off Shore international SA v Banco Central
SA [Cont.]
 A dispute arose as to whether the law of New
York or that of Spain was the proper law of the
contract of payment (LC).
 The court looked for connecting factors:
 There was only one factor connected with Spain
(issuing bank).
 There were three with New York: the payment
(1) in American dollars, was (2) to be made
through a New York bank (CB) against (3)
documents to be presented in New York.
 The law of New York thus had the closest and
most real connection with the contract.
 The Assunzione [1954] 1 All ER 278

 While the principle is clear, The Assunzione case

indicates that it is not always easy to put into
practice (especially when the number of
connecting factors are almost the same).
 A cargo of wheat was to be carried from
Belgium to Italy on an Italian ship chartered by
French charterers. The charter party was
entered into in France, on a standard form
English contract.
 The Assunzione [Cont.]
 In this case, the connection factors with Italian
law and French law are almost equal.
 French law: (1) Charter party made in France;
(2) French charterers.
 Italian law: (1) Italian ship;
(2) to be performed in Italy.
 However, the Court of Appeal held that the
closest and most real connection was with
Italian law, largely because the performance of
the contract was to take place in Italy (the place
of performance carries more weight).
5.3 From the Rome Convention to the
Rome I Regulation
 The common law rules outlined above remain in
force in many Common Wealth countries
(including Malaysia) but in England they almost
wholly gave way to first the Rome Convention
on the Law Applicable to Contractual Obligations
1980, given effect by the Contracts (Applicable
Law) Act 1990, and now to those of the Rome I
Regulation 2008.
 From the Rome Convention to the
Rome I Regulation [Cont]
 The Rome Convention on the Law Applicable to
Contractual Obligations 1980 entered into force on April
1, 1991.
 The objective of the Rome Convention is to harmonize
the choice of law rules in contract.
 The rules of the Rome Convention are not entirely
different from those of the common law but there are a
number of changes and developments.
 One of the basic changes is the replacement of the term
‘proper law’ with ‘applicable law’.
 5.4 The Rome I Regulation 2008

 After six years and many rounds of consultations

and political debates, the Rome Convention on
the Law Applicable to Contractual Obligations
has been finally converted into a Community
instrument: the Rome I Regulation.
 This Regulation entered into force on July 24,
2008.
 It is a relatively modest modernization of pre-
existing choice of law rules designating the
applicable law to contractual obligations.
5.4.1 Determining the applicable
law
 Article 3: The Principle of Party
Autonomy
1.   A contract shall be governed by the law chosen by the
parties. The choice shall be made expressly or clearly
demonstrated by the terms of the contract or the
circumstances of the case….

3.   Where all other elements relevant to the situation at the

time of the choice are located in a country other than the
country whose law has been chosen, the choice of the parties
shall not prejudice the application of provisions of the law of
that other country which cannot be derogated from by
agreement.
 A choice of court can be taken as an implicit
choice of the law
 In the absence of an express choice of law, a choice of court
could bring about an implicit choice for the law of the
country where the court has jurisdiction (the law of the
forum).
Egon Oldendorff v Libera Corp (No 2)
[1996]1 Lloyd’s Rep 380
 There was no choice of law clause in a contract between
German and Japanese companies.
 But their use of a well known English standard form of
charterparty and the presence of a clause specifying
arbitration in England was held to demonstrate the choice of
English law as the applicable law.
 Freedom of choice and “mandatory rules”

 There is no requirement that the chosen law need

have any real connection with the parties or the
subject matter of their contract.
 However, Art 3(3) qualifies the complete freedom
of choice.
 The chosen law must not be contrary to mandatory
rules of the country with which the contract has
most close connection (Art 3.3).
 What are the mandatory rules?
 Such (mandatory) rules serve many purposes.
They may relate to the socio-economic policies of
States, for example in the field of
- competition or anti-trust law;
- exchange control designed to protect the
national
economy or its currency.
 They may be designed to protect the interests of
those seen as economically weak, such as workers
or consumers.
 The effect of mandatory rules
 Article 3(3) envisages a situation in which all
elements of the factual situation are connected with
Country A, the law of which contains a relevant rule
which cannot be derogated from by agreement.
 The parties, for whatever reason, agree that the law
of the Country B is to govern their contract.
 They have that freedom of choice, and Art 3(3) does
not remove it; the law of Country B will indeed be
the governing law.
 However, the non-derogable rules of Country A will
also apply, and within their scope will override any
different rule on the law of Country B.
 Article 4: Applicable law in the
absence of choice
1.   To the extent that the law applicable to the contract has
not been chosen in accordance with Article 3… , the law
governing the contract shall be determined as follows:
(a)a contract for the sale of goods shall be governed by the
law of the country where the seller has his habitual
residence;
(b)a contract for the provision of services shall be governed
by the law of the country where the service provider has his
habitual residence;
Art 4: Applicable law in the absence of choice

(c) a contract relating to a right in rem in immovable

property or to a tenancy of immovable property shall be
governed by the law of the country where the property is
situated;
(d)…;
(e) a franchise contract shall be governed by the law of the
country where the franchisee has his habitual residence;
(f)…;
(g) …;
(h) ….
 Art 4: Applicable law in the absence of choice

2.   Where the contract is not covered by paragraph 1 or

where the elements of the contract would be covered by more
than one of points (a) to (h) of paragraph 1, the contract shall
be governed by the law of the country where the party
required to effect the characteristic performance of the
contract has his habitual residence.

* Characteristic performance means “performance which is

characteristic of the contract”, i.e., “performance which is
more crucial or important for the contract.”
Art 4: Applicable law in the absence of choice

3.   Where it is clear from all the circumstances of

the case that the contract is manifestly more closely
connected with a country other than that indicated
in paragraphs 1 or 2, the law of that other country
shall apply. (proper law in the common law sense)
4.   Where the law applicable cannot be determined
pursuant to paragraphs 1 or 2, the contract shall be
governed by the law of the country with which it is
most closely connected. (Proper law in the common
law sense)
 Article 9: Overriding mandatory
provisions
1.   Overriding mandatory provisions are provisions the
respect for which is regarded as crucial by a country for
safeguarding its public interests, such as its political, social or
economic organisation, to such an extent that they are
applicable to any situation falling within their scope,
irrespective of the law otherwise applicable to the contract
under this Regulation.
2.   Nothing in this Regulation shall restrict the application of
the overriding mandatory provisions of the law of the forum.
 5.4.2 Habitual residence
Article 19
1.   For the purposes of this Regulation, the
habitual residence of companies and other
bodies, corporate or unincorporated, shall be
the place of central administration.
The habitual residence of a natural person
acting in the course of his business activity
shall be his principal place of business.
 Article 19: Habitual residence [Cont.]

2.   Where the contract is concluded in the course of

the operations of a branch, agency or any other
establishment, or if, under the contract, performance
is the responsibility of such a branch, agency or
establishment, the place where the branch, agency
or any other establishment is located shall be treated
as the place of habitual residence.
3.   For the purposes of determining the habitual
residence, the relevant point in time shall be the
time of the conclusion of the contract.
 5.4.3 Exclusion of renvoi
Article 20

The application of the law of any country

specified by this Regulation means the
application of the rules of law in force in
that country other than its rules of private
international law, unless provided otherwise
in this Regulation.
 5.4.4 Public policy of the forum
Article 21
The application of a provision of the law of any
country specified by this Regulation may be refused
only if such application is manifestly incompatible with
the public policy (ordre public) of the forum.
Public policy: Principles and standards regarded by
the courts as being of fundamental concern to the
State and the whole of society.
Public policy has been characterized as a “last-ditch
weapon” wielded at the end of the forum’s choice of
law process to resist the application of the rule that
process has identified.
 Thank you
For
Your kind attention