The interpretation of a contract will be dictated by which country’s law governs it. Parties to an agreement can agree which law applies and, generally, this will be expressed in the governing law clause. A contract does not need to include a governing law clause to be effective, but including one achieves an element of certainty for the parties, as they will know what law applies when determining their rights and obligations.
If the contract does not include a governing law clause, there are complex rules that determine what law applies. Generally, these rules take into consideration issues such as the place of performance of the contract, where the parties are located and other relevant issues. Determining the governing law in this way can be a difficult task and often leads to costly arguments at the outset of any dispute as the parties try to determine which law governs.
It is important that the parties make clear the scope of the governing law clause when drafting their contract. For example, parties will often want the governing law clause to apply not only to claims for breach of the contract, but also to all other claims which arise in connection with the performance of the contract; for example, claims that the other party has been negligent in performing its obligations. If parties do not make clear the scope of the governing law clause, they may find that certain disputes could be governed by the laws of another country.
The governing law clause does not state how disputes will be resolved (e.g. what courts will have jurisdiction to determine disputes or whether the parties must submit disputes to alternative dispute resolution methods such as arbitration). Instead, this issue is dealt with in a jurisdiction clause. To find out more about jurisdiction clauses, see our blog discussion for ‘J: Jurisdiction’ (coming soon). It is common, but not always the case, that parties will choose to be consistent in their approach to governing law and jurisdiction clauses (e.g. if the contract is governed by English law the parties will often agree that disputes relating to that contract will be submitted to the English courts).
For more information please contact Gary Parnell or any member of the commercial contracts team.