Beware of Choice of Law Provisions and Forum Selection Clauses!

Most parties negotiating contracts focus upon the big 3 contract terms – scope, price, and schedule. Such a focus makes sense, given those are material terms required for contract formation. After establishing those terms, most contracting parties turn to negotiate other important terms defining payment, indemnification, claims, changes, and dispute resolution. Seldom do the parties focus upon terms governing choice of law or forum selection, with respect to domestic contracts. Although these latter clauses are procedural in nature, they often dictate the substantive issues governing formation, administration, and enforcement of all other terms upon which the parties placed their principal focus.

Parties should be mindful of the laws governing their contractual relationship for a variety of reasons. There are often material differences between the laws of various States and jurisdictions having a relationship to the contract or negotiations that led to its execution. Clauses enforceable under the laws of a State in which one contracting party resides, may be void and unenforceable under the laws of the State where the other party resides, or the contract was executed. Absent a choice of law provision dictating which States law governs the contract, the choice of law is undecided causing uncertainty over the enforceability - or lack thereof - of negotiated contract terms.  The primary purpose of a choice of law provision is to remove the uncertainty that may apply if disputes subsequently arise under the contracts. Hence, many contracts contain a standard choice of law provision intended to eliminate such uncertainty perhaps reading like this: “This Contract shall be governed by the laws of the State of “New York.”

However, even this standard type of choice of law clause (recited above) does not eliminate all uncertainty proving even the best of intentions may go astray. Many Courts interpreting this standard choice of law clause, find it only dictates the substantive laws governing a contract – not the procedural laws. This is a critical distinction because substantive laws govern “formation” of a contract, whereas procedural laws govern “enforceability,” including statutes of limitation or SOL’s.  Parties could agree the State laws with a six (6) year SOL would govern their contract, only to find their contract was rendered unenforceable sooner than intended if the claims were filed in a State with a three (3) year SOL.  [See e.g. “The Tortured Relationship Between Statutes of Limitations and Statutes of Repose! ” posted 10/18/23].

Other Courts interpret a standard choice of law clause (example recited above) to govern breach of contract claims, but not claims based upon torts or statutory violations. These courts hold that although the substantive laws of the State selected by the parties governs “formation” of the Contract, the laws of that State would not necessarily apply to elements of a tort or statutory claim arising out of that same contract. Parties could agree the laws of a State allowing tort claims surrounding a contract were allowable, only to find their tort claims are rendered unenforceable, by the laws of the State where the claims were filed.

Parties must likewise be mindful of the forum selection in which claims arising from or relating to their contractual relationship may be filed. Simply because parties have agreed upon the laws of a State to govern their contract, has no bearing whatsoever upon forum selection, or where such claims might be filed. Absent a forum selection clause either party could choose to file claims in any court (State or Federal) that could exercise jurisdiction over the claims and parties.  A party could file claims in a State that allows or prohibits tort or statutory claims otherwise prohibited by the State laws agreed upon to govern the contract. Alternatively, a party could file a claim in a State with a shorter SOL thereby rendering contract claim parties unenforceable even if such claims would be enforceable if filed in the State the parties agreed would govern their contract.

Similarly, an agreement to submit all or some claims to an arbitration forum, could impact enforceability of the negotiated terms of the contract as well as the scope of claims to be arbitrated. Some courts interpret narrowly drawn forum selection clauses dictating arbitration, to be limited to contract claims only, resulting in the possibility of “claim splitting” between court and arbitration. Some arbitrators seek to impose equitable resolutions upon the parties, saving them from the agreement to express contract terms which may appear onerous after the claims arise and disputes are filed. Moreover, as the costs and time associated with arbitration become longer and longer, the benefits of arbitration are being called into question.

Contracting parties should make a conscious and informed decision as to the choice of law governing the contract provisions, they are so careful to negotiate. Likewise, they must do the same with respect to the forum selection in which claims arising from or relating to their contract must be filed, as these too can impact enforceability of the negotiated terms. Parties must be aware that seemingly inconsequential procedural terms, may have enormous impact upon the substantive terms they spend all their time negotiating.