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Wood, Philip R., Governing Law Risks in International Business Transactions, 2022

Wood, Philip R., Governing Law Risks in International Business Transactions, 2022
Table of Contents




Governing Law of Contracts

Free choice of governing law

4.4 It is now well settled in almost all jurisdictions that the parties have freedom to choose the governing law of their agreement, notwithstanding that there is no connection between the agreement and the jurisdiction concerned. This is sometimes called party autonomy.

4.5 For example, a German bank can agree to make loan in US dollars to a corporation in France under a loan agreement expressly governed by English law, and all three countries, plus New York, will recognise the choice of law as being English law. It is irrelevant that neither the German bank nor the French borrower has any business in England, that the currency of the loan is not sterling, and that dollar payments are made in New York.

4.6 Freedom of choice appeared finally in England by 1865 in relation to a ship charterparty between parties who had nothing to do with England: see P & O Navigation Co v Shand (1865) 3 Moo PC (NS) 272. Freedom of choice without requiring any connection between the contract and the chosen jurisdiction was accepted in Germany in the 1880s, in France in 1910, and finally in Switzerland in 1952. Jurisdictions in the US were slow to confirm complete freedom of choice and even now the question of whether there must be a reasonable relationship is not clearly established in some states. To set the matter at rest, in 1984 the New York General Obligations Law was amended to enable parties to choose New York law for transactions of more than US$250,000, whether or not there is a reasonable relationship to New York in the contract: see the New York General Obligations Law. However, the Uniform Commercial Code requires ‘reasonable relationship’ in transactions covered by the Code.

4.7This freedom of choice is codified in the EU by a regulation of 2008 on the law applicable to contractual obligations—usually called Rome I. Rome I applies in the UK notwithstanding that the UK is no longer a member of the EU, subject to amendments not relevant here. For the Swiss position, see the Swiss Act on Private International Law of 1987. There are conflicts codifications in many other states, such as Japan, as well as the Bustamante Code applying in a number of Latin American states.

4.8Jurisdictions in which the free choice of law is considered doubtful include Laos, Oman, Saudi Arabia, Turkmenistan, and Vietnam. None of these jurisdictions would generally be considered suitable for large international contracts for other reasons.

4.9In the EU and the UK, the effect of article 3 of Rome 1 is that if all of the elements of the contracts are located in a country other than the country whose law has been chosen, then the choice cannot prejudice mandatory provisions of law in that other country. This is to prevent evasion of a mandatory rule of law which would have applied to the contract which is otherwise purely local and domestic.

4.10The law must be that of a jurisdiction. You cannot choose, say, the law merchant, or (as in one case in 2004) ‘the principles of the Glorious Sharia’a. You can choose public international law, and indeed there are many cases in which the general principles of law have been implied, at least by arbitral tribunals, into agreements to which one of the parties is a government. The World Bank, for example, applies the general principles of law in its loan contracts. The choice of public international law would be rare in other contracts, usually on the grounds that the rules of public international law on treaties which are the equivalent of contracts or insufficiently developed for the types of situation contemplated by most business contracts.

4.11 A choice of law which is to be made by the court at the time of the hearing is not a valid choice of law since there is no chosen law up to the time of a court decision. However, it is perfectly possible under Rome I to vary the choice of law: see article 3(2), and this is probably the case practically everywhere.

Governing law in the absence of express choice

4.12If the parties do not expressly choose the governing law, then most jurisdictions will apply various centre of gravity tests to discover the governing law, such as a choice implied by the choice of courts, or tests based on substantial connection, dominant contacts, or the law of having the most significant relationship, and sometimes rigid presumptions in a hierarchy such as common residence, or the law of place of contracting or performance. There is a hierarchy of contacts in the case of Rome I. In the US, the tests are basically centre of gravity: see the US Restatement of Conflicts of Law, especially section 188. There are special rules for various classes of contracts in sections 189-197, eg contracts for transfers of interests in land and various insurance contracts. Similarly, in Rome I there are special rules for such items as employment, consumer, and insurance contracts, all of which are generally outside our scope.

Matters decided by the governing law

4.13The governing law primarily governs the existence and validity of the contract, whether it complies with formal requirements, how the courts interpret the contract, how the contract is to be performed, the consequence of breaches such as damages or specific performance, and the extinction of obligations, such as by prescription and limitation, that is, rules limiting the time within which claims must be brought so that they do not become stale.

Matters Not Decided by the Governing Law

Narrowing of scope of governing law

4.14Some crucial matters in our context are not decided by the governing law but rather by a different law, Others are mandatory, compulsory laws, or rules of basic morality—sometimes called public policy—and override the governing law: these will be applied by the court hearing the matter. The effect is that freedom of choice does not apply in these cases. Some of these cases are hugely significant: their effect is to erode and restrict the free scope of the law. The governing law gives freedom with one hand and takes it back with the other.

4.15The main lesson which the practitioner should take from the list below is that each item represents the threat to the chosen governing law and courts. The practitioner who is seeking to protect her position and to reduce her risks should therefore choose a law and courts which have the most liberal and proportionate views on each of these items, having regard to the circumstances of the case and the location of the counterparty. Otherwise, there is not really a free choice of governing law because the free region of the scope of the governing law is no longer a grand open plain, but a narrow strip of rock and scrub.


Doctrine of Good Faith in Contract

Good faith doctrine generally

5.30The deepest and widest chasm in contract law between English and New York law on the one hand, and France and Germany on the other, and therefore to a greater or lesser degree the members of their respective families of law, is the approach to what is called the doctrine of good faith in contracts. This doctrine is not general under English law. The English courts do not intervene to overrule the express terms of contracts between business parties on the grounds of an imposed view of fairness. In principle, the English courts do not believe that it is just that they should overrule and ignore what responsible parties have agreed, whereas the courts of France are interventionist and are prepared to remodel contracts if the court thinks the outcome would otherwise be unfair.

5.31The English courts in effect take the view that it is unjust and bad faith for a parties in a business setting to seek to change an agreement after they have agreed to it under cover of the cloak of altruism and morality.

5.32See generally the literature on this subject cited in the Sources and References under this chapter. For France, see especially the lucid text by Solene Rowan, The New French Law of Contract (OUP 2022) which also contains comparisons with English law.

Good faith generally in England

5.33English law has a strong business orientation and considers it just and fair in wholesale markets, particularly financial markets, that the parties should have freedom of contract to decide the terms of their contracts and to allocate their risks without subsequent court interference. English law considers that contract predictability is essential in view of the large amounts at stake, and the often systemic interdependence and links between parties and markets which have high concentrations of risk.

5.34The result is that in the English courts under English law the parties get what they agreed and are regarded as being responsible for their own agreements if between business parties, whereas that is not normally so in the civil families of law. In various cases in France and some other (but not all) jurisdictions in the Napoleonic and Roman-Germanic groups, the court can reform the contract which the parties thought they had negotiated between themselves. In that case the court decides the risk after the contract was entered into and the parties have less freedom to determine with predictability what their risks are in advance. Instead, it is decided for them.

Good faith generally in France

5.35In France, the courts may override express terms agreed by the parties on the grounds of non-compliance with their view of justice. Hence, French law is less predictable. This interventionist approach may originally have been based upon the view that contracts in commerce are a battle between the strong and the weak, the overmighty bank or corporation against the innocent farmer, the predatory capitalist against the ordinary citizen. This view now seems obsolete and out-of-date in relation to business transactions in the modern world where most of the population have a business or work in a business and consumers are protected by consumer laws.

Examples of good faith laws

5.36The first step is to describe the general declarations about good faith in the main jurisdictions, but noting that jurisdictions mean very different things when they refer to a duty of good faith.

5.37The idea of good faith when employed in English statutes refers to honesty, not what is considered commercially fair in a particular case. English case law consistently makes it clear that the courts do not generally adopt a universal good faith doctrine for contracts, except in specific cases.

5.38 In France, article 1104 of the new Civil Code on contracts provides that contracts must be ‘negotiated, formed and performed in good faith. This is described as ‘a matter of public policy’ and therefore is mandatory and cannot be departed from by agreement. The 1804 code stated that contracts should be performed in good faith, but now in the 2016 codification of case law the principle is extended to cover pre-contract negotiations and the stage of the formation of the contract at the beginning. The new code does not contain a definition of good faith, but case law prior to the new code in 2016 is expected to remain relevant. Good faith has been held, amongst other things, to mean that the parties have a duty of loyalty, cooperation, and a duty to be ‘coherent’ France has also expanded its doctrine of the abuse of rights. The meaning of the duty of good faith was deliberately left open so that the judge could control the loyalty of contracting parties and their good faith. The result appears to be that the parties themselves cannot define good faith and that essential elements of the contract can be unpredictable. The doctrines of good faith and abuse of rights were significantly enlarged by case law mainly from the 1980s onwards.

5.39Many of the French principles are adopted in international contract law instruments which are intended to be non-binding models which reforming states can introduce if they want, in particular the UNIDROIT Principles of International Commercial Contracts and the Principles of European Contract Law. These instruments on the whole are products of academics.

5.40In Germany, the principle has achieved a very high degree of penetration, often more than is the case in other members of the Roman-Germanic group. Section 242 of the BGB, which is the German Civil Code, states generally that, on the one hand, everyone must perform his contract in the manner required by good faith and fair dealing, taking into consideration the general practice in commerce. Based on this, the German courts have created numerous obligations of loyal performance of a contract, such as duty to cooperate, to protect each other's interests, to give information, and to submit accounts. On the other hand, it is said that the courts are reluctant to impose terms overriding the express terms agreed between the parties on the grounds only that the court believes the imposed terms to be fairer and more equitable.

5.41Provisions laying down a principle of good faith in the performance of the contract are found in article 1134 of the Civil Codes in Belgium and Luxembourg (based on the old French code), in article 288 of the Civil Code in Greece, in article 1175 of the Civil Code in Italy (see also articles 1337, 1366, and 1375), in articles 6.2 and 248 of the Netherlands Civil Code, in article 762(2) of the Portuguese Civil Code, in article 1258 of the Spanish Civil Code and in article 57 of its Commercial Code. In Denmark, the principle is said to be recognised by the courts and legal writers. In the Netherlands, for example, the doctrine as expressed in article 6:2 and 6:248(2) allows the courts to change the contract so as to comply with a form which the court believes to be more fair and equitable. See Ole Lando and Hugh Beale, Principles of European Contract Law (Martinus Nijhoff 1995).

5.42The principle is a mandatory in at least Germany, France, Belgium, Luxembourg, Greece, Italy, the Netherlands, Portugal, and Spain in the Napoleonic group, in Germany and the Netherlands in the Roman-Germanic group, and therefore probably in a great many other countries in those groups. That means that the doctrine is espoused with such fierce intensity that the parties lose the right to contract out of the doctrine so that the doctrine overrides so as to change the terms of the contract the parties have agreed. In order to give more teeth to this, Rome I on contract applicable law requires in article 3(3) that, in effect, in a domestic contract the parties cannot choose a foreign governing law to avoid these mandatory provisions, thereby making an inroad on the freedom of choice of governing law.

5.43The idea of good faith is also found in the codes of Switzerland, Japan, Poland, and South Korea, all of which are civil code systems in this respect. In China, the Contract Law provides in article 6 that in exercising their rights and performing their obligations, the parties shall observe the principles of honesty and good faith. We can therefore assume with some confidence that the concept is probably almost universal, or at least very common, in the Napoleonic and Roman-Germanic jurisdictions, as well as other civil systems outside the American and English common law groups. We cannot assume that the outcome is the same in all civil code jurisdictions, especially in such cautious jurisdictions as Sweden, Switzerland, and Japan.

Referring Principles
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