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Choice of Law by the Parties to the Contract

Written by: Vaishali B - Studying in National Law Institute University Bhopal
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In this era of globalization where a contract contains one or more foreign elements, the difficult and complicated question in proceeding that arises is that of ascertaining its applicable law. Such difficulty stems from the multiplicity and diversity of connecting factors and each of them may arise in a different jurisdiction for instance the place where the contract was made; the place of performance; the place of business of the parties; the place of payment; the currency of payment; domicile or nationality o the parties and so on. So to avoid this situation parties are granted with the freedom to select the law to govern their contract under the provisions of Rome convention. The inclusion of a choice of law clause is such an everyday matter in international contracts that its absence would be to ignore commercial realities.

Party Autonomy

Article 3 embodies the principle of “party autonomy”, giving the parties freedom to select the law, which is to govern the contract. Although very frequently the chosen law has some connection with the transaction, it often happens that commercial contracts contain a choice of law, which has no connection, or no apparent connection, with the transaction.[1] The Rome convention allows the choice of the law, which has no connection with the contract. By Art 1(1) of the convention, its rules apply to contractual obligations “in any situation involving a choice between the laws of different countries”. And Article 3(1) states that the law chosen by the parties governs a contract. The combined effect of these articles is, however, that parties who are in one country, and whose transaction is connected only with that country, may choose the law of another country, and the courts of contracting states must, subject to mandatory rules, give effect to that choice. It is apparent from the Art. 3(3) that the convention contemplates that the choice of a foreign law may be made even if all the relevant elements are connected with one country only.

This shows that there is no requirement that the chosen law has a connection with the transaction. The choice of the parties must be ‘express or demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case’.

Express Choice

A choice of law is express when the contract contains a provision, which specifies the law, which it is to be governed*. Privy council in Vita Food Product Inc v Unus Shipping Co.Ltd. held that the parties were free to select any governing law they wished, irrespective of any connection with the contract, provided that the choice was bonafide, legal and not contrary to English public policy. Where the parties have identified the applicable law there is no difficulty in giving effect to the choice of the party. But where the parties selects the applicable law indirectly the effectiveness of the alleged choice depends on interpretation of the clause in question.

In Companie Tunisienne de Navigation SA v Companie d’ Armament Maritime SA[2] a contract was made in Paris between D, French Company and P, a Tunisian company, for the carriage of the consignment of oil. Parties adopted a charterparty, clause 13 of which provided that the charterparty was governed by the law of the flag of the vessel carrying on the goods. At the time of the conclusion of the contract the parties seemed to have assumed that D would be using its own ship, which flew the flag. Before performance of the contract a war broke out and relying on the French law as the governing law frustration of contract was alleged. The question before the court was whether clause 13 was an effective choice of French law, in view of the fact that forth first six voyages the defendant had employed ships flying five different flags. The court answered the question affirmatively and held that the parties have envisaged that D would use French vessels in performing the contract and it was reasonable to conclude that the parties had chosen French law as the governing law, even though the parties’ assumption at the time of the contracting were erroneous.

Choice Demonstrated With Reasonable Certainty

The convention does not require choice to be express in order to be effective. It is sufficient if a choice can be ‘demonstrated with reasonable certainty’ by the ‘terms of the contract or the circumstances’ of the case.[3] Convention gives no such guidance as to how such an inference may be determined. However Guiliano Lagarde Report provides example for certain factors which may be of assistance to the court’s attempt to infer a choice of law. Such factors may be: a choice of jurisdiction or arbitration clause[4]; previous dealings of the parties[5]; a connected transaction[6]; the use of a standard form[7] and so forth. Thus in Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd[8] the judge said that the reinsurance contract was placed in London on the London market, the terms of the slip and the claims co-operation clause pointed to an implied choice of English law ‘demonstrated with reasonable certainty by the terms of the contract/the circumstances of the case’

Limitation On Choice

Mandatory Rule

Every choice of law in a contract that is genuinely international inevitably avoids the operation of the laws of other connected system. Sometimes the evasion is not incidental but intentional i.e. the parties consciously choose one system in order to avoid another. Such evasions are controlled by the use of the concept of the mandatory rule. A mandatory rule is a rule of the law of the country, which cannot be derogated from by contract. The provision of Art 3(3) states that, where all the other elements relevant to the situation at the time of the choice are connected with one country only, a choice of a foreign law, whether or not accompanied by a foreign jurisdiction clause, will not prejudice the application of the mandatory rules of the solely connected system[9]. The Rome convention 1980 applies only to contracts, which involve a choice between the laws of different countries, and the situation envisaged here is not such a case as, on the facts, all the connections are with a single country. What brings it within the Rome convention is the selection by the parties of a governing legal system which is factually unconnected with the contract.

Overriding Statute

The second limitation applies whether the governing law is determined by choice under Article 3 or by the close connection test under Article 4.
Article 7(2) provides that is nothing in the Rome Convention is to restrict the application of the rule of the law of the forum in a situation where they are mandatory irrespective of the law otherwise applicable to the contract. This provision makes it clear that the effect of an express choice of foreign law may be nullified[10] or limited by the terms of the statute of the forum e.g. English legislation. Where an overriding statute applies regardless of the governing law, the effect of an express choice by the parties of a foreign law to govern their contract is limited to the extent required by the statute.

Consumer And Employment Contracts

The third and fourth limitation relates to the consumer and employment contract. Article5 (2) and 6(1) provides that a choice of law made by the parties does not have the effect of depriving an employee or consumer of the protection of certain mandatory rules, in case of consumer under the law of their habitual residence, and in the case of employees under the law which would be applicable in the absence of choice of law.

Public Policy

A choice of foreign law will not prevent the court from disregarding it if the application of rule of foreign law would be manifestly incompatible with public policy[11].

Splitting of Applicable Law [12]

The parties are free to select the law to govern the whole of their contract or a part of it only, or, indeed, to have a series of choices for different parts. A multifaceted international contract requiring performances in various countries might be one reason for the parties wishing to split up the whole into component parts or the parties might wish to select one law to interpret the contract and another to implement the terms so interpreted.

Variation of Choice
The convention enable the parties at any time to alter the applicable law, whether they are revising an earlier choice, have discovered the benefits of choice after the contract is underway or have decided that they don’t wish to be subjected to the law, which the convention would impose on them. The new or revised choice may apply to the contract as a whole or to any severable part of it.

While the convention permits changes to be made at any time, the effect of any agreement between the parties, which is made after the dispute has come to litigation, will depend on the attitude of the forum and its rules about amending pleadings. There are four potential dangers in respect of a change of applicable law:
(a) the new law might contain requirement for formal validity not present under the prior law;
(b) the right of third parties might be effected;
(c) attempt might be made to avoid mandatory rules arising under the prior applicable law; and
(d) under the newly chosen law, the contract might be invalid.

Thus, no change in the applicable law can adversely affect the formal validity of the contract or operate to the prejudice of third party rights acquired under the former applicable law. The object of the qualification concerning formal validity is to avoid a situation whereby the agreement to vary the governing law may create doubts as to the validity of the contract during the period preceding the agreement between the parties; the preservation of third parties who have acquired rights is to protect the rights of third parties who have acquired rights under the contract during the period it was governed by a law which permits the acquisition of rights by third parties under a contract.

Reference And Incorporation
Under the Rome Convention, there is a clear distinction between reference to a foreign law as a choice of that law to govern the contract on the one hand and incorporation of some provisions of a foreign law as a term or terms of a contract on the other hand[13]. The distinction between incorporation of foreign law and an express choice of the applicable law is seen most clearly if there is a change in the law between the time of making and contract and its performance. The applicable law is a living law and must be applied as it is when the contract is to be performed and not as it was when the contract was made[14]. Thus legislation passed in the country of applicable law may have the effect of modifying or discharging the contractual obligation, e.g. by reducing the rate of interest[15] or declaring a gold value clause invalid[16]. On the other hand where a foreign statute is incorporated in a contract, although as a statute it may have been amended or repealed.

Based on the aforesaid analysis, it is submitted that though the convention allow the parties to make the choice of the law to govern their contract but the basic principle of the party autonomy is demonstrated by the convention when its provisions enables the parties at any time to alter the applicable law. Since absolute power corrupts absolutely, this choice of law and the variation of choice of law are subject to the limitations as the mandatory rules may serve many purposes. They may relate to socio economic policies of states, e.g. in the field of anti trust law or exchange control designed to protect the national economy or its currency. Or they may seek to regulate the content of private contract, requiring the inclusion of certain types of terms, or prohibiting exclusions or exemption clauses etc. they may be designed to protect the interest of those seen as economically weak such as workers (with rules as to health and safety at work and to safeguard from unfair dismissal) or consumers (with rules designed to help them in the dispute with suppliers of goods and services. the main argument against depecage or severability was that , it might be used to avoid mandatory rules. But the courts and Article 7 of the Rome convention has made it clear that the doctrine is only to be applied where severability does not lead to inconsistency. So a kind of balance is maintained.

[1] A contact for the construction of a plant by a German company in Poland may provide for the application of English law or Swedish law, because the Polish party is not prepared to accept the application of German law and the German party is not prepared to accept the application of Polish law.
* Choice of non-national system of law (such as Sharia law) this choice does not constitute a choice of law for the purpose of the Article 3. Shamil Bank of Bharain EC v Beximco Pharmaceutical Ltd [2004] 1 WLR 1784
[2] [1971] AC 572
[3] Notwithstanding the use of the word ‘or’ in Art3 (1), an implied choice can be based on the combined effect of ‘the terms of the contract’ and ‘the circumstances of the case’: Aikens J in Marubeni hong kong and South China Ltd v Mangolian Government [2002] All ER (Comm.) 873 at 885
[4] In Egon Oldendorff v Liberia Corpn [1995] 2 LR 64 the plaintiff, a German company, secured leave to serve a writ on the defendant, a Japanese company, on the basis that the contract was governed by English law, having regard to inclusion of a clause providing for arbitration in England.
[5] ‘A previous course of dealing between the parties under contracts containing an express choice of law may leave the court in no doubt that the contract in question is to be governed by the law previously chosen where the choice of law clause has been omitted in circumstances which do not indicate a deliberate change of policy by the parties’ .OJ 1980C282/17.
[6] In Broken Hill ProperietryCo. Ltd v Xenakis [1982] 2 LR 304 where a contract between A and B contains an express choice of English law, it is implied the choice of English law where C undertook to guarantee the obligation of A.
[7] In Amin Rasheed Shipping Corporation v Kuwait Insurance Co [1984] AC 50 the use of a Lloyd’s SG form of policy modeled on that contained in a schedule to the Marine Insurance Act 1906 persuaded the House of lords that English law was the impliedly chosen law by the parties.
[8] [1999] IL Pr 729
[9] Suppose parties who were Italian made a contract, to be performed in Italy and all other relevant contacts were with Italy. Suppose, further, that the parties chose German law and consented to the jurisdiction of the German courts. Article 3(3) requires the German court to apply the mandatory rules of Italian law. In such a situation, the probability is that he parties only chose German law to avoid such mandatory rules. While the law of Germany will be the governing law, it will only be applied to the extent that it does not violate the mandatory rules of Italian law.
[10] In The Hollandia [1983] 1A.C. 565 a bill of lading contained an express choice of Dutch law and a submission to the exclusive jurisdiction of the Dutch Court . it was common ground that the Dutch Courts would have applied Dutch law, under which Hague Rule would have been applicable, with the consequence that the carrier’s limit of liability would have been lower than that under Hague- Visby Rules. It was held that the Hague Visby Rules Scheduled to the Carriage of Goods by Sea Act, 1971 applied so as to render the choice of dutch law and jurisdiction had the effect of lessening the liability of the carriers otherwise than as provided in Hague Visbu Rule.
[11] Art 16. Privy council in Vita Food Product Inc v Unus Shipping Co.Ltd.[1939]AC 277
[12] McLachlan (1990) 51 BYIL 311
[13] Amin Rasheed Shipping Corporation v Kuwait Insurance Co [1984] AC 50. In this case there was evidence that the definition used in the Marine Insurance Act 1906, to which the standard Lloyd’s policy was scheduled, were used as a source of law in this sense by continental courts.
[14] Rassano v Manufacturers Life Insurance Co.[1963] 2 Q.B. 352
[15] Barcelo v Electrolytic Zinc Co. of Australia Ltd 919320 48 C.L.R. 391
[16] R v International Trustee for the protection of Bondholders A/G [1937] A.C.

Copyright Useful links on Contract laws in India:
# Tax on Works Contract
Pre-incorporation contracts
Statutory transaction and contract of sale
Indemnity in a contract
Void & Voidable Agreements
Extension of Time in Service Contracts
Choice of Law by the Parties to the Contract

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