This is the first in a series of bulletins highlighting practical strategies for dealing with common issues in international business transactions and disputes. This bulletin is about choice of contractual governing law – a key risk management tool in international business transactions

What Is the Contractual Governing Law?

It's the law that governs the interpretation of the contract. The parties can expressly choose it themselves. If they don't, a court or other tribunal considering the contract will choose it for them. But,  as a matter of law, every contract has a governing law.

Why Is It Important?

Because it governs the contract. It determines how the parties, and any tribunal, interpret the contractual language, and therefore what the contract means. Not much could be more important than that. Particularly in international transactions, where the parties may come from jurisdictions with different legal traditions.

Obviously, until the contractual governing law is chosen there is uncertainty about what the contract means. That uncertainty creates a risk of disputes about that meaning. So, the key point is to manage that risk by expressly choosing a governing law and so minimizing that uncertainty.

And it's important to make that choice as early as possible in the negotiation process. Think about it. The governing law determines how the contract is interpreted, the meaning of all the detailed language which will be the product of the negotiations. Surely it makes most sense to agree on the governing law, and so set the interpretation parameters, before going to the effort of negotiating the detailed language. After all, that language could be interpreted one way under one governing law and completely differently under another.

If the parties don't choose a contractual governing law, they create uncertainty. If a dispute arises about the meaning of the contract, they will have no interpretive parameters to help resolve it. If they can't resolve the dispute some other way, they'll have to ask a tribunal to do it for them. The first thing that tribunal will do will be to impose on the parties its own choice of governing law. The tribunal will say it is looking all the circumstances of the transaction to divine the parties' own implicit choice. But the reality is that the parties didn't choose, expressly or implicitly, and the tribunal will impose its choice on them instead.

In doing so, the tribunal will look at all kinds of factors, such as, where the parties carry on business, where the transaction was to be performed, where products were to be delivered, services provided or money paid, and even the language and format of the contract and the currency of payments. Who knows what jurisdiction those factors might lead the tribunal to choose? One thing for certain, the parties' contract will be interpreted, and their legal rights and obligations determined, under a governing law they didn't chose – not a good situation.

One Final Point: Just Choose One Governing Law

Why? Here's a real life answer: Apparently the contract for the construction of the Chunnel provided that it would be governed by "the principles common to both English law and French law and, in the absence   of such common principles, by such general principles of international trade law as have been applied by national and international tribunals." Think about that for a minute. England is a common-law country. France is a civil law country. I don't imagine their contractual laws have much in common. And what the heck are the general principles of international trade law, at least in the context of a construction contract? Legal lore has it that the resolution of the dispute over how that contract was to be interpreted financed construction booms in Mallorca and the Algarve as City silks thrashed out the issue and commissioned vacation homes with the resulting legal fees. (Presumably the construction contracts for those homes were governed by only one law.)

No need to go there. Manage the risk. Reduce the uncertainty. Just choose a contractual governing law at the outset.