Introduction: why the concern?

You are about to enter into a contract – experience tells you that you need to deal with (a) the law that will apply to any disputes arising under the contract, and (b) where such disputes are to be heard e.g. Courts of a particular place or arbitration before a particular organisation. These might already be covered by your standard GTCs. However, what about disputes arising out of non-contractual obligations between the parties known as "Torts"?

Take the situation where a buyer has taken possession of goods but does not own them because title passes on payment. If the buyer refuses to pay, the seller is entitled to demand the return of the goods. If the buyer then refuses to return the goods, he will have committed the tort of "wrongful interference" and the seller can seek an order for redelivery. If the buyer no longer possess the goods, because he resold and delivered the goods to a third party, the buyer will have committed the tort of "conversion" and would be liable to the seller in damages.1 Would these torts also be covered by the applicable law and jurisdiction provisions that have been agreed to govern contractual claims? 

In so far as the applicable law is concerned, the answer is – probably not. Indeed, as the law now stands, you may end up with an applicable law that no-one expected or wants. As regards jurisdiction, the answer is yes – probably, although the situation regarding arbitrations can be unclear. We look at why that is and what can be done to make things clearer from the outset.

Rome II: New Rules for the law applicable to torts

Where a defendant resides in an EU state, the question as to the courts of which country has jurisdiction to hear a dispute (whether contractual or in tort) is governed by the Brussels Regulation. Proceedings may be commenced in the courts of the country where the defendant resides or the country where the tort or damage occurred.2 Any agreement between the parties as to which court should have jurisdiction to hear claims in tort (which may fall under a generally drafted jurisdiction clause in a contract) are also recognised.

Since 11 January 2009, where a court of an EU member state3 has jurisdiction to hear a claim in tort, it will apply the Rome II Regulation4 to work out which law to apply to determine the dispute.

Before Rome II, the position under English law was that the applicable law was that of the place where the tort was committed.

Under Rome II, unless the parties agree otherwise, the general rule is that the applicable law will be the law of the place in which damage occurs, wherever that might be. That is regardless of the country in which the event giving rise to the damage occurred and irrespective of where the indirect consequences of that event occurred. That is also so, even if it means that the application of those rules results in the law of a non-member state being applied to the dispute because that is where the damage occurred.

However, and again, unless the parties otherwise agree another law, where the parties have their habitual residence in the same country when the damage occurs, the law of that country will apply; and where the tort is manifestly more closely connected with the law of another country, the law of that other country will apply.5

Freedom to choose applicable law

The extent to which the English Courts would take into account an express choice of law applicable to a tort has previously been unclear. Importantly, Rome II allows parties to agree contractually to the application of a law of their choice: (a) Where commercial parties are involved - by an agreement which has been freely negotiated before the event giving rise to the damage occurred; or (b) By agreement entered into after the tort occurred, regardless of any commercial activity.

However, the parties do not have carte blanche. The parties' choice is subject in particular to: (a) Any mandatory law of a country which is solely connected to the dispute at the time when the tort occurs; (b) Any mandatory EC laws of a member state whose tribunal is determining the dispute; (c) Any mandatory laws of the place hearing the dispute irrespective of the law that applies to the tort;6 (d) The application of a provision of law of the country that applies to the tort may be refused if it is manifestly incompatible with the public policy of the place hearing the dispute.

Scope of applicable law and damages

The applicable law under Rome II will govern not only the basis and extent of liability, but also grounds for exemptions and limitations of liability. Crucially, it will also determine the existence, nature and assessment of damages and the remedy claimed. That is a particularly important development from an English law point of view, which regards the quantification of damages as a procedural matter for the law of the country in which the dispute is being heard. Whilst it might not seem wrong to apply the chosen law to that exercise, in practice, it can have a significant impact on issues concerning damages. Take for example a foreign law that requires a minimum level of award above the level available under English law. Punitive damages is another example which is common in some jurisdictions but not in others. It can also lead to additional costs and uncertainty, as a court will have to hear expert evidence as to how damages should be calculated under the governing law, and may find it applying unfamiliar concepts to reach a judgment.7

Arbitration

There is some argument that Rome II does not seem to apply to arbitrations at all. Thus, where a jurisdiction clause provides for disputes to be resolved by arbitration, the arbitrators may not be bound to apply Rome II in order to determine what the law should apply to the dispute. Instead, the tribunal will have to look to the pre Rome II position.

Having said that, under English law, section 46 of the Arbitration Act 1996, provides without distinguishing between contractual and non-contractual obligations that the arbitral tribunal shall decide the dispute (a) in accordance with the law chosen by the parties applicable to the substance, or (b) if the parties so agree, in accordance with such other considerations as are agreed between them or determined by the tribunal, or (c) if or to the extent that there is no such choice or agreement, by applying the law determined by the conflict of laws rules which it considers appropriate.

Practical steps

Parties need to assess whether to go with Rome II or take matters into their own hands in order to avoid the uncertainties that might exist. We set out below some of the issues that will need to be borne in mind.

Agree in advance

Even with the exceptions to the general rule under Rome II, there is no certainty either before or after a dispute has arisen as to the law that will apply. It is not even clear what is meant by "damage" for the purpose of the rule. It may also be unclear where damage has occurred,8 especially where the damage suffered is only financial in nature.9 Given the ability to agree in advance the law that is to apply to torts, it would seem sensible to do so, if it is possible to reach such agreement.

Of course, a possible downside is the risk that if and when a dispute does arise, it may turn out that the law of the country where the damage occurred might in fact be more favourable.10 The alternative is to agree an applicable law after the tort has occurred. However, that is only likely to occur if the law which would ordinarily apply is disadvantageous to the parties. It is therefore a less likely and less satisfactory option to rely on.

Choice of law

Carefully consider the law that you want applied before agreeing the governing law clause. That is especially important as the amount of damages will be determined by the applicable law. The availability of particular causes of action may also be a relevant consideration.

Aligning the choice of law and jurisdiction clauses is usually preferable and can avoid difficulties discussed above, particularly in relation to the assessment of damages. Thus, the jurisdiction clause should be sufficiently widely drafted to allow the chosen courts to hear non-contractual, as well as contractual disputes.

There is the risk of the application of a foreign law of a third party (outside the EU). However, forum shopping is not unusual and one would expect there to be some good reason for the parties to make such a choice.11 In the context of the English Courts, it is possible for a court to have jurisdiction to hear a dispute but apply the law of another country, if that is the law selected by the parties.

Restrictions on choice

It may not be worthwhile negotiating and agreeing an applicable law clause if it is clear from the outset that it would not be upheld by a court. Remember that the parties' choice is subject to constraints set out above, particularly the mandatory laws of the place hearing the dispute. It would therefore be advisable to consider and take into account the mandatory laws of any jurisdictions already agreed.

Sufficiently certain

Rome II requires that the choice of applicable law should be "expressed or demonstrated with reasonable certainty" by the circumstances of the case. Under English law, it is possible to imply a choice of law for example from previous dealings. However, the safer option would be to expressly say so in words rather than to leave matters to chance.

Scope of jurisdiction clause

As stated above, even if Rome II does not apply to arbitrations, parties should be able to rely on section 46 of the Arbitration Act 1996 to agree a choice of law applicable to torts. However, agreeing a law applicable to torts will be of little use if it turns out that the Court intended to hear the dispute has no jurisdiction. Issues relating to the scope of jurisdiction clauses have arisen particularly in the context of arbitration agreements. That is especially important given that arbitration is more often than not the preferred forum for the resolution of disputes in the commodities trade.

Certain types of arbitration clauses (e.g. referring to disputes "under" a contract) have been said to be too narrow to allow a tribunal to hear non-contractual/tort claims. Wider clauses such as "any" disputes "relating to or in connection with" a contract are arguably required. Some clarity has recently been provided by the House of Lords12 which has stated that the starting point for interpreting such clauses is to assume that parties are likely to have intended any dispute arising out of the relationship into which they have entered be decided by the same tribunal, unless it is clear that certain matters were intended to be excluded.

It is however better to be safe than sorry and the safer course (whether drafting a jurisdiction clause or arbitration agreement) would be to ensure that such clauses are drafted in the widest possible terms to expressly include both contractual and non-contractual disputes.

Example clause

A possible choice of law clause, based on English law, could look like this:

"This Contract, and the whole of the relationship between the parties to it, is governed by English Law. The parties agree that all disputes relating to or in connection with it, or with the negotiation, validity or enforcement of this Contract, and the relationship between the parties, and whether or not the same shall be regarded as contractual claims or not (and therefore including all non-contractual claims in tort, for breach of statute or regulation, or otherwise), shall be exclusively governed and determined in accordance with English Law."

A possible arbitration agreement could start off on the following lines: "Any and all disputes (whether or not the same shall be regarded as contractual claims or not and therefore including all non-contractual claims in tort, for breach of statute or regulation, or otherwise) relating to and in connection with this contract shall be determined by arbitration. ..."

Conclusion

The law applicable to torts has traditionally been ignored in the negotiating process and in GTCs. That needs to change in order to avoid the default position under Rome II, which can leave parties stuck with a law that they did not want.

Exceptions have been carved out of Rome II to give some flexibility. However, that still does not provide any comfort. Instead, parties should take advantage of the fact that Rome II allows parties to manage their own risk and choose the law that will govern their non contractual obligations.

The most sensible place is in the choice of law and jurisdiction clause. Most GTCs will invariably already have a carefully thought out choice of law and jurisdiction clause. Equally careful thought needs to be given the incorporating agreement for the choice of law applicable to non-contractual obligations.