Choice of Law Provisions in Contracts

Before you sign a business contract, you'll need to review its terms and conditions to make sure you agree with your obligations under the contract. The more obvious terms to review include what each party is exchanging—usually goods or services for money. But at the end of the agreement, you'll find a set of clauses (typically called "boilerplate" or "miscellaneous" provisions) that are included in virtually every contract.

Among these boilerplate provisions is the choice of law clause, also called the "choice of law provision" or the "governing law clause." Sometimes overlooked, the choice of law clause determines how a contract is interpreted. Without a choice of law clause, your agreement will probably be governed by the state where you file the lawsuit.

What Is a Choice of Law Clause?

A "choice of law clause" is a contract provision that declares which state's laws will be used to interpret the agreement. This clause can also be referred to as the "governing law provision" because it specifies which state law will govern or control if there's a dispute.

The laws of the state you choose in your choice of law provision will apply to both:

• the terms and conditions of your contract, and
• any conflicts that arise from your agreement.

The parties to a contract can agree to have one state interpret the agreement even if one or both sides live or do business in another state. For example, many big corporations choose Delaware law in their contracts' choice of law provisions, because that state's laws often favor corporations and offer some predictability when it comes to disputes.

Why Are Choice of Law Clauses Important?

When negotiating a deal, you might feel that the choice of law provision is a low priority. For some parties, this clause is a point of contention. For others, it's hardly discussed because both sides are on the same page or don't deem it important.

But just like any part of a contract, you should never overlook a choice of law clause. Laws vary across states, and some of these variations can be meaningful.

For example, suppose you run a company connecting suppliers to businesses. You hire a tech company to build a platform for your business, where companies can find and vet suppliers. The platform is the backbone of your company, and your profit depends on its functionality. You don't have much experience with computer programming, so you want to make sure that you're protected if something goes wrong in the near or distant future.

In the agreement that the tech company has provided, you see that the choice of law provision lists Delaware as the governing state. But you know that the statute of limitations for breach of contract claims in Delaware is three years for written contracts from the time the breach occurs, regardless of when you find out about the breach.

Because you're not familiar with computer code, you know that there's a possibility you might not discover an important bug in the code until much later. To protect yourself from a scenario where you run out of time to sue, you want a longer statute of limitations. You negotiate for a more favorable governing law provision that puts Illinois—a state with a 10-year statute of limitations—as the chosen jurisdiction.

Will Your Choice of Law Be Honored?

In contract law, the parties usually have the freedom to choose their own terms and conditions. Courts won't override what the parties have already agreed to unless there's an important reason to do so. For instance, the court will intervene if a contract clause undermines public policy, as we'll discuss later.

In general, courts enforce choice of law clauses in contracts unless an exception applies. Many courts will generally use the rule under Restatement (Second) of Conflicts of Laws § 187 or a close variation of it to determine a choice of law clause's validity. Under §187, the courts will enforce a choice of law provision in a contract unless either:

1. the chosen state has no substantial relationship to the contracting parties, and there's no reasonable basis for the parties' choice, or
2. the chosen state's laws conflict with a fundamental policy of the forum state, and the forum state has a materially greater interest than the chosen state in resolving the current issue.

Here, "forum state" means the state where the party files the lawsuit.

Let's look at these two exceptions in more detail.

Substantial Relationship to or Reasonable Basis for Chosen State

Courts will typically honor a choice of law clause when a meaningful connection exists between the chosen state and the parties or conflict. In general, courts will consider a "substantial relationship" to exist if any of the following are true:

• one of the parties lives, does business in, or is registered in the chosen state (for example, one company is incorporated in the chosen state)
• the parties negotiated or signed the contract in the chosen state
• the subject matter of the contract is located in the chosen state (for instance, the contract is about property that's located in the chosen state), or
• the contract is performed in the chosen state (the parties, say, travel to the chosen state to perform the contracted services).

If one of these situations applies to your case, then the court will almost certainly enforce your contract's choice of law provision unless it's against public policy to do so.

If none of these reasons are applicable, but you have a reasonable basis for selecting the chosen state, then the court will also likely enforce this governing provision. The courts don't have a standard test to determine what a "reasonable basis" is. But in the past, courts have identified some helpful parameters for selecting a governing jurisdiction. Accordingly, courts would likely view these factors as providing a "reasonable basis" for the parties' choice of law.

Parties might choose a state because it has a developed set of laws relevant to their industry. For example, Delaware is known for its sophisticated corporate law. If you pick Delaware, you can expect consistency and predictability in the courts on business law matters. If your contract is for entertainment-based services, you might choose California or New York as your choice of law. Some states are known for specific industries or areas of law. So, it's common for particular contracts to default to these states.

Conflict of Fundamental Policy and Materially Greater Interest

Even if the courts have determined that a substantial relationship or reasonable basis exists, they still might not honor a choice of law clause. Under Restatement (Second) of Conflicts of Laws § 187, courts won't enforce a choice of law clause if:

1. the chosen state's laws conflict with a fundamental policy of the forum state, and
2. the forum state has a materially greater interest than the chosen state in resolving the disputed issue.

Again, here, "forum state" means the state where the party files the lawsuit.

What's considered a "fundamental policy" differs across states. For example, the Supreme Court of California has said that a "fundamental public policy" is one that:

1. can't be contractually waived
2. protects against otherwise inequitable results, and
3. promotes public interest.

Pitzer College v. Indian Harbor Ins. Co., 8 Cal. 5th 93, 103 (Cal. 2019).

Even if the chosen state's laws conflict with a fundamental policy, the court would also have to determine that the forum state has a materially greater interest in resolving the contractual dispute than the chosen state. Sometimes, courts will decide that the forum state is disinterested. In that case, the court will enforce the choice of law provision.

Governing Law vs. Governing Jurisdiction Clauses

Jurisdiction refers to where a dispute will be settled or resolved; governing law indicates which state's law will be used to decide the dispute. Accordingly, a governing law provision indicates which state's laws will govern or interpret the contract and issues that come out of that contract. A governing jurisdiction provision provides for where the parties can file a lawsuit.

It's possible, for example, for a contract to require lawsuits to be filed in California but to be decided under New York law. The selection of which state is used for the governing law isn't often a crucial negotiating issue. But the selection of the state for jurisdiction can be more important: If there's a dispute, that's where everyone will have to go to resolve it. Sometimes these two provisions are grouped into one paragraph.

How to Draft a Choice of Law Clause

A choice of law clause can be brief or fairly detailed. Sometimes, the clause doesn't fully capture what the parties intend. So, it's important to write a choice of law provision that covers any instance of ambiguity.

Governed vs. Interpreted or Construed

If you look at a choice of law provision in a contract, you'll come across the words "governed," "interpreted," or "construed." If you plugged any of these words into a thesaurus, you'd likely find the other two listed as synonyms. Indeed, only lawyers can find a way to distinguish these terms.

In a few cases, courts have ruled that choice of law clauses that use the words "interpreted" or "construed" and omit the word "governed" apply to only a subset of a state's laws. But in the vast majority of cases, courts have found these words to have the same effect. So while it probably won't matter if you use "construed" instead of "governed," it's best to include all three.

This portion of your choice of law clause should look something like this:

"This Agreement shall be governed, construed, and interpreted in accordance with the laws of the State of New York..."

Procedural Law vs. Substantive Law

A body of law can be divided into two main categories:

• Procedural law. "Procedural law" refers to the rules of the court. Examples of procedural law include time limits for when you must file complaints and answers and rules of evidence.
• Substantive law. "Substantive law" refers to the rights and obligations of everyone in the applicable jurisdiction. Examples of substantive law include the elements of a breach of contract claim, damages in a negligence claim, and definitions of crimes.

By default, if a choice of law clause doesn't explicitly state that the parties wish for the chosen state's procedural and substantive laws to apply, the court will usually assume that only the substantive laws of the chosen state will apply. It's not unreasonable to see why a court in Texas would want to use its own state's procedural laws to apply California's substantive law, for example.

In some cases, the parties don't mind using the forum state's procedural law to handle their claims. Usually, the parties are in disagreement about the interpretation of the contract or a material breach, both substantive issues. As a result, most choice of law provisions don't address this issue.

However, states differ on how they treat statute of limitations laws. Some view these laws as procedural and some as substantive. If you want to make sure a specific state's statute of limitations is enforced, then you should clarify the issue in your clause. Even if the forum state applies its own procedural law, it should apply your chosen state's statute of limitations as long as you specify this intention in your provision.

This portion of your choice of law clause should look something like this:

"...with the laws, both procedural and substantive, of the State of New York..."

Excluding Conflict-of-Laws Rules

A well-written choice of law clause should exclude conflict of laws principles. If you don't explicitly exclude these laws, the court will likely apply the whole law of the chosen state rather than the internal law. The whole law of a state includes its conflict of laws rules; the internal law doesn't. If you don't make this exclusion, the court can apply the rules of another state.

This portion of your choice of law clause should look something like this:

"...with the laws of the State of New York without regard to its conflict of law principles..."

Non-Contractual Claims

Finally, you'll need to address the question of whether you want the chosen state's laws to apply to non-contractual claims. A contractual claim would be a breach of contract, for instance. A non-contractual claim would be negligence or fraud. Most people want the chosen state's laws to apply to both contractual and non-contractual claims.

This portion of your choice of law clause should look something like this:

"This Agreement, and any action relating to or claims arising out of this Agreement..."

Choice of Law Clause Example

Now that we know the meaning of each part of a choice of law provision, let's put them together. Here's an example of a choice of law clause:

"This Agreement, and any action relating to or claims arising out of this Agreement, shall be governed, construed, and interpreted in accordance with the laws, both procedural and substantive, of the State of New York, without regard to its conflict of law principles."

Of course, you'll need to select which state's laws you want to apply to your agreement. Just replace your state's name with "New York" above.

When drafting or negotiating a contract, it's often a good idea to talk with a business or contract lawyer. They can make sure your contract is well-crafted and covers your best interests.

If you're looking for an A to Z guide to everything you need to know about contracts, check out our book Contracts: The Essential Business Desk Reference, by Richard Stim (Nolo).