A contract is a legally binding document that recognises and governs the rights and obligations of the parties to the agreement. Where both parties are located in a particular state, it makes sense that the laws that apply to that state govern the contract. It gets more complicated where one party is located in a different jurisdiction, whether that be another state or country, as each jurisdiction has different laws. This article looks at what governing laws are and how to select the right law for your contract.

What Is the “Governing Law” of a Contract?

The “governing law” in a contract is the law that applies to whatever it is that the contract covers.

For example, your contract is for the supply of goods. Here, the governing law would apply to the contract as a whole, including that supply.

It is important to note that every contract has a governing law. This even includes where one has not been specified in the contract.

My Contract Doesn’t Specify a Governing Law – What Applies?

Where the governing law has not been specified, a Court will need to determine which governing law applies. This is why it is always a good idea to agree to the governing law upfront. You should always aim to specify it in your contract.

There are generally two considerations:

  1. a Court will consider whether the parties have intended that a particular governing law should apply. Where neither party has expressed the intent, the Court will need to look at other factors. These factors include the circumstances surrounding the parties entering into the contract; and
  2. if there is no evidence that a particular governing law was intended to apply, a Court will need to objectively determine which law has the closest connection to the contract.

In determining this, the Court might look at a number of things, including: 

  • where each party is located and operates;
  • the place or places where you negotiated and entered into the contract;
  • where performance under the contract has taken or will take place;
  • the kind of contract and what it covers; and
  • the parties’ relationship, particularly at the time you entered into the contract.

How Do I Pick Which Governing Law Should Apply?

There are a number of factors to consider when determining which governing law should apply.

Context

Sometimes what your contract relates to might benefit from a particular law applying.

For example, not every jurisdiction recognises the concept of a trust. So, if this is relevant to what you are hoping to achieve, you will need to pick a governing law that recognises trusts.

Examples of other areas of law which differ significantly across jurisdictions include:

  • health safety laws;
  • employment laws;
  • business and tax laws;
  • consumer protection laws; and 
  • environmental laws.

If you want to hold the parties to a particular standard, you should pick the law based on this.

Relevance

It might be tempting to pick a governing law so that a particular law applies. However, what you select must also be relevant. In other words, the law has to connect to the contract in a meaningful way.

If this connection is not there and the governing law is called into question, your selection of a particular governing law may be overruled by a Court. This is significantly more likely where you made the selection deliberately to ensure a law does not apply that otherwise would (and arguably should) have applied.

Familiarity

Ideally, you want the governing law to be something that you are comfortable with. As such, we recommend selecting the governing law that applies to the majority of your business operations.

For example, if most of your business takes place in New South Wales, you will have a good idea what to expect operating under those laws and how to make sure that you are compliant.

It is important to keep in mind that laws vary across jurisdictions, even from one state to the next. If you are thinking about commencing operations in a new jurisdiction, or are considering agreeing to a governing law that you are not familiar with, you should seek legal advice. This way, you know what to expect and can adjust your operations and secure any additional licences that you might need.

Dispute Resolution

The question of governing law is different from but related to the question of what forum disputes are resolved in.

For example, you could pick New South Wales law as the governing law but have your disputes determined by arbitration and have the seat of the arbitration as Auckland. 

In some cases, where disputes are resolved is of more significance to the other party than what the governing law is. Ideally, you want to avoid having the dispute resolved in a way or by someone who has no familiarity with the governing law. This, and improved enforceability, are two reasons why arbitration may be a good dispute resolution option.

Cost

Cost is also a factor when selecting the governing law. This is because there may be additional fees in becoming compliant. It can also be costly to obtain jurisdiction-specific advice if something does not work out as planned.

Preferences

If you are contracting with a party in another jurisdiction (particularly one that is overseas) and their business is predominantly in that jurisdiction, they may have strong feelings about choosing that law as the governing law.

While this may be less familiar to you, it could end up costing you more and might not be where you ideally want to be resolving disputes. Agreeing to such a request might be a commercial decision that you are willing to make in the circumstances. 

For example, if you know it is important to the other party, you might want to consider conceding the governing law point to get other things that you want, such as a better price.     

Key Takeaways

Governing laws are often misunderstood, and there can be a lot of value in being selective about which governing law you choose. Determining the governing law in a contract can have a large impact on the way you conduct your business relationships with international clients. If you have any questions or would like to know more about how governing laws work, get in touch with LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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