Drafting Choice of Law Clauses

Submitted by bmurray on Thu, 04/08/2010 - 22:09.

 By Timothy Murray

JUDICIAL RESPECT FOR THE PARTIES’ CONTRACTUAL CHOICE OF LAW

Courts generally respect the choice of law agreed to by the parties in their contract. Section 187 of the Restatement (Second) of the Conflicts of Laws is widely followed and provides that a court will follow the law of the state chosen by the parties “to govern their contractual rights and duties . . . unless either (a) the chosen state has no substantial relationship to the parties or to the transaction or there is no other reasonable basis for the parties' choice; or (b) application of the law of the chosen state would be contrary to fundamental policy of a state which has a materially greater interest than the chosen state in the determination of a particular issue and which . . . would be the state of applicable law in the absence of an effective choice of law by the parties."

While the Restatement speaks only to the parties’ autonomy to choose the law of a state relating to their contractual rights and duties, and although there has long been tension as to whether parties ought to be permitted to choose the law governing extra-contractual matters, the prevailing view in the United States is that parties generally do possess the right to contractually agree on the law that will govern extra-contractual matters, as well as their contractual rights and duties. “. . . [C]ourts tend to scrutinize clauses that purport to encompass tort-like issues much more closely than clauses confined to purely contractual issues.” S. Symeonides, “Oregon’s Choice of Law Codification for Contract Conflicts: An Exegesis,” 44 Willamette L. Rev. 205 (Winter 2007).

SCOPE OF CHOICE OF LAW CLAUSE DETERMINES ITS APPLICABILITY TO A PARTICULAR DISPUTE

The prevailing view in the United States is that whether the choice of law provision encompasses extra-contractual claims depends on its wording; specifically, whether it is a narrow or broad choice of law clause.

As with all other parts of a contract, courts will neither rewrite the choice of law clause nor construe it to be broader than its express wording allows. Care in drafting the choice of law clause is critical for at least two reasons: (1) because commercial litigation often entails both contractual and extra-contractual claims (examples of the latter include alleged tortious misconduct, including fraud and interference with contract), and (2) generally in the commercial setting, when parties choose the law of particular forum to govern disputes that might arise, they intend for that law to govern all disputes between the parties that in any way relate to the contractual relationship, including claims couched in extra-contractual claims.

Too often, however, parties inadvertently draft their choice of law provisions in a manner that excludes extra-contractual disputes from their ambit. In drafting choice of law provisions, prudent parties need to consider, and agree on, the extent to which they want their choice of law provision to apply to disputes that might arise.

In order to draft a choice of law provision properly, it is important to understand how courts construe them. The first point to understand is that when courts decide whether a particular dispute falls within the scope of a contractual choice of law clause, they generally look not to the law of the state chosen by the parties in the choice of law provision but to the law of the forum state. See, e.g., Caton v. Leach Corporation, 896 F.2d 939 (5th Cir. 1990). The court will apply the law of the forum state to discern whether the clause is a “narrow” or a “broad” clause. That will determine whether the dispute is within the scope of the choice of law provision.

NARROW CLAUSES

In Caton v. Leach Corporation, 896 F.2d 939 (5th Cir. 1990), the court held that a choice of law clause stating that “[this] Agreement shall be construed under the laws of the state of California” was a narrow clause that did not encompass the entirety of the parties’ relationship. The court explained: “In contrast to broad clauses, which choose a particular state's law to ‘govern, construe and enforce all of the rights and duties of the parties arising from or relating in any way to the subject matter of this contract,’ the instant clause denotes only that California law will be applied to ‘construe’ the contract.” Id. at 942 n.3. The court explained that claims arising in tort do not arise out of the contract. Thus, to decide which states’ law applied to the tort claims asserted in the litigation between the parties, the court looked to the conflicts of laws rules of the forum state, Texas, which held that "the law of the state with the most significant relationship to the particular substantive issue will be applied to resolve that issue." Id.

In Benchmark Elecs., Inc. v. J.M. Huber Corp., 343 F.3d 719 (5th Cir. 2003), the court held that a clause providing that the "Agreement shall be governed by, and construed in accordance with, the internal laws of the State of New York . . . ." does not address the parties’ entire relationship and therefore claims for fraud and negligent misrepresentation were not encompassed by it. “The provision at hand is narrow,” the court concluded, “because it deals only with the construction and interpretation of the contract.” Id. at 726. See, e.g., Green Leaf Nursery v. E.I. Dupont de Nemours and Company, 341 F.3d 1292, 1300 (11th Cir. 2003)(choice of law clause providing that "[t]his release shall be governed and construed in accordance with the laws of the State of Delaware” held to be narrow since “it does not refer to related tort claims or to any and all claims or disputes . . . arising out of the relationship of the parties.”); Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996) (choice of law provision stating that document "shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts" did not apply to claim for fraudulent misrepresentation).

Even language that would otherwise be construed as “narrow” is sometimes held to encompass a tort claim if the tort claim is closely related to contractual performance. In Fla. State Bd. of Admin. v. Law Eng'g & Envtl. Servs., 262 F. Supp. 2d 1004 (D.Minn. 2003), the court held that the choice of law clause was narrow: “[T]his Agreement shall be governed by and construed in accordance with the laws of the State of Florida." Nevertheless, because the negligence claim at issue was based on the defendant’s alleged deficient performance of the contract at issue, the court held that the tort claim was so intertwined with the performance of the contract that the tort claim was within the ambit of the choice of law clause.

BROAD CLAUSES

The court in Caton v. Leach Corporation, 896 F.2d 939, 942 n.3 (5th Cir. 1990) provided an example of broad language: The law of [fill in the blank] state shall govern, construe and enforce all of the rights and duties of the parties arising from or relating in any way to the subject matter of this contract.”

In English Mt. Spring Water Co. v. AIDCO Int'l, Inc., 2008 U.S. Dist. LEXIS 43478 (E.D. Tenn. 2008), the court held that a choice of law clause that stated "Resolution of disputes shall be conducted in accordance with the laws of the State of Michigan” was a broad provision that covered the entirety of the parties’ dispute and not just the construction of the contract itself.

Use of the words “arising out of or relating to” are indicative of a broad choice of law clause. In Gloucester Holding Corp. v. U.S. Tape & Sticky Prods., LLC, 832 A.2d 116, 124 (Del. Ch. 2003), the court explained that the absence of words of this nature precluded a finding that the clause was a broad one: “The choice of law clause . . . does not claim to cover litigation that arises out of or relates to the Asset Purchase Agreement. Rather, the clause merely provides that Delaware law applies to the ‘rights of the parties’ derived from the contract. This clause is simply not sufficiently broad enough to cover tort claims such as fraud in the inducement.”

While words such as “construed” and “interpreted” are widely held to be insufficient to encompass extra-contractual claims, some courts hold that tacking on the word “govern” to a choice of law clause serves to broaden the clause, but other courts disagree. In Lincoln Gen. Ins. Co. v. Access Claims Adm'rs, Inc., 2007 U.S. Dist. LEXIS 67172 (E.D.Cal. 2007) at **17-18, the court explained:

When contracting parties wish that all disputes arising from their relationship be subject to a particular state's law, they must use language indicating as much. In [Nedlloyd Lines B.V. v. Superior Ct., 3 Cal. 4th 459, 466, 11 Cal. Rptr. 2d 330, 834 P.2d 1148 (1992)], the California Supreme Court noted that "[t]he phrase 'governed by' is a broad one signifying a relationship of absolute direction, control, and restraint. Thus, the clause reflects the parties' clear contemplation that 'the agreement' is to be completely and absolutely controlled by [the foreign jurisdiction's] law." Nedlloyd, 3 Cal. 4th at 469. See also Boat Town U.S.A., Inc. v. Mercury Marine Division of Brunswick, 364 So. 2d 15, 17 (Fla. App. 1978) ("The difference between 'interpretation' and 'govern' is more than a technical distinction. It goes to the very heart of the purpose underlying a contract."). Here, however, those critical words were missing from the choice of law provision.

Nevertheless, not all courts have come to the same conclusion . . . . The Sixth Circuit in particular has rejected the view that there is a distinction between "interpreted and construed" on the one hand and "governed by" on the other. See Boatland, Inc. v. Brunswick Corp., 558 F.2d 818, 821-22 (6th Cir. 1977) (describing distinction between "interpreted and construed" and "governed by" as strained and narrow); Kipin Industries, Inc. v. Van Deilen Int'l. Inc., 182 F.3d 490, 494 (6th Cir. 1999) (citing Boatland with approval). See also Hammel v. Ziegler Financing Corp., 113 Wis. 2d 73, 76, 334 N.W.2d 913 (1983) (describing distinction as "a trick interpretation or twist on one word").

Likewise, in Finance One Public Co. Ltd. v. Lehman Bros. Special Financing, Inc., 414 F.3d 325, 335 (2d Cir. 2005), the Second Circuit construed a choice-of-law provision to be “narrow” despite the use of the word “governed.” The provision read: "This Agreement will be governed by and construed in accordance with the laws of the State of New York."

TORT CLAIMS THAT ATTACK VALIDITY OF CONTRACT

When a claim is stated as a tort but is really a challenge to the validity of the contract, courts sometimes hold that the tort claim falls within the ambit of the choice of law provision even if the provision is a narrow one. In Moses v. Business Card Express, Inc., 929 F.2d 1131 (6th Cir. 1991), plaintiffs sought to avoid enforcement of a contract on a fraud theory and claimed that a choice of law clause stating "This Franchise and License Agreement and the construction thereof shall be governed by the laws of the state of Michigan” applied only to construction of the contract itself and not to the fraud claim. The court disagreed, and found the dispute to be within the scope of the clause: “The plaintiffs are not asserting a non-contractual claim or one that arose incidentally out of the contractual relationship. Rather, they are seeking to avoid enforcement of the contract itself. They put the validity of the contract in issue, and such a claim would appear to be encompassed by the language . . . .”

In addition: “Clearly, the clause refers to more than construction of the agreement; otherwise the first six words would be surplusage. If the clause provided merely that its construction would be governed by the law of Michigan, the plaintiffs would have support for their argument that it does not apply more generally.” See also, Nw. Airlines, Inc. v. Astraea Aviation Servs., Inc., 111 F.3d 1386, 1392-93 (8th Cir. 1997) (even a narrow choice of law provision, providing that the contract "shall be deemed entered into within and shall be governed by and interpreted in accordance with the laws of" a particular state, "can govern tort claims arising out of the parties' performance under the contract or closely related to the interpretation of the contract, including claims of fraud in the inducement or misrepresentation").

DRAFTING CHOICE OF LAW CLAUSES THAT ENCOMPASS EXTRA-CONTRACTUAL DISPUTES

Given the vagaries of the judicial decisions on this subject, to assure the application of the law the parties desire to govern extra-contractual disputes, care must be taken in drafting the choice of law clause. A broad choice of law clause might read as follows:

Any and all matters in dispute between the parties to this agreement, whether arising from or relating to the agreement itself, or arising from alleged extra-contractual facts prior to, during, or subsequent to the agreement, including, without limitation, fraud, misrepresentation, negligence or any other alleged tort or violation of the contract, shall be governed by, construed, and enforced in accordance with the laws of [fill in the blank for name of state], regardless of the legal theory upon which such matter is asserted.