Choice of law that applies to certain non-contractual disputes to be decided between the parties of commercial contracts.
A recent European Union Regulation (EU Council Regulation (EC) No. 864/2007, known as Rome II) allows parties to commercial contracts to choose the law that will apply to certain non-contractual disputes between them. In a fundamental change to the way in which most EU member states resolve non-contractual conflict of law issues, if no choice of law is made, the applicable law to most non-contractual disputes is now that of the country in which the damage occurs, rather than where the act was committed.
“Non-contractual obligations” can include tortious claims, such as negligence, misrepresentation and pre-contractual deceit or claims in respect of restitution or unjust enrichment. As a result, parties conducting cross-border business with a number of counterparties risk the possibility that an act committed in one country causing damage in a number of jurisdictions may give rise to multiple claims governed by a number of different applicable laws, with an attendant increase in litigation complexity and cost. A further risk is that, as the new Regulation has “universal application”, it is possible for the applicable law to be the law of a non-EU member state, e.g., UK courts could apply Nigerian law to a non-contractual dispute if the damage occurs in Nigeria. This could result in companies finding that they have breached non-contractual obligations which do not exist in their home countries.
However, the advantage of such universal application is that non-EU contracting parties have the opportunity to choose a governing law with which they are familiar to apply to certain of their non-contractual obligations. This should increase legal certainty for contracting parties and ensure consistency in the laws to which they are subject.
Accordingly, companies and financial institutions engaged in cross-border transactions where an EU court could have an ability to exercise jurisdiction should familiarise themselves with the new rules and, when entering into new contracts, should negotiate a choice of law clause in relation to non-contractual as well as contractual obligations. If the event giving rise to the damage has already occurred, it is possible under the new rules for the parties subsequently to choose the law applicable to the dispute, provided they are able to reach agreement. Given that the new Regulation provides that the applicable law also governs factors such as burden of proof and the nature and extent of compensation available for any loss incurred (a significant departure from the previous position), contracting parties should consider such choice of clauses with great care.
Application and Objectives
Rome II does not affect the question of which country’s courts have jurisdiction over a particular claim but rather which country’s laws should be applied by the presiding court in relation to a non-contractual claim. Rome II does not have any impact on the applicable law in contractual disputes.
Rome II applies to events giving rise to damage which occur after 20 August 2007 (the date it came into force), provided that any claim in respect of such damage is brought on or after 11 January 2009. It applies throughout the whole of the European Union, except Denmark. The main objective of Rome II is to harmonise the rules by which the law applicable to non-contractual disputes is determined, so that all EU member states (except Denmark) will apply the same rules to conflict of law issues in relation to non-contractual obligations. This should increase legal certainty for parties doing cross-border business in the European Union and is intended to prevent “forum shopping” by parties to a non-contractual dispute.
The general rule under Rome II
Article 4(1) of Rome II provides that the applicable law is that of the country “in which the damage occurs irrespective of the country in which the event giving rise to the damage occurred”. The relevant damage is only the direct damage and not the indirect consequences of the event. One of the potential uncertainties caused by this rule is that it may be very difficult to decide where such damage occurred. For example, it would not be clear whether damage occurred in the country where a misrepresentation was relied upon when making financial investments or in the country where financial loss was later suffered.
There are a number of exceptions to the general rule (see below). In addition, different rules apply to non-contractual obligations relating to intellectual property, unfair competition, product liability, environmental damage and industrial action.
Exceptions to the general rule
The general rule does not apply in the following circumstances:
- Where both parties have their habitual residence in the same country at the time when the damage occurs. In such a case the law of the country of residence shall apply (Article 4(2)).
- Where it is clear from all the circumstances of the case that the tort is “manifestly more closely connected” with a country other than the country specified by Articles 4(1) or 4(2). Such manifestly closer connection might be based, for example, on a pre-existing relationship between the parties that is closely connected with the relevant tort (Article 4(3)).
- If the parties have expressly agreed on which country’s laws are to govern their non-contractual obligations (Article 14). This is discussed in more detail below.
- Where there are mandatory rules of the forum which override the law otherwise applicable to the non-contractual obligation.
- If the application of any law determined to be the applicable law would be “manifestly incompatible” with the public policy of the forum.
Express choice of law
Subject to a few exceptions, Article 14 allows the parties to a contract to agree on the law which will govern their future non-contractual agreement, provided that such choice is expressed “with reasonable certainty by the circumstances of the case and shall not prejudice the rights of third parties”.
Such a choice of law will only be effective if all the parties to the contract are pursuing “commercial activities” (not defined) and the contract is “freely negotiated”. The concept of a “freely negotiated” agreement has not yet been considered by the courts and it is likely that a choice of law clause contained in a party’s standard terms and conditions will not be upheld. It remains to be seen whether the courts will consider standard form contracts (e.g. ISDA agreements) to be freely negotiated or how the courts will treat contracts between parties with unequal bargaining power.
If the choice of law is agreed after the event causing damage, there is no requirement for the parties to be engaged in “commercial activities” or for the agreement to be “freely negotiated”.
The parties’ express choice of law will not apply if such choice is contrary to the application of any European Community law (Article 14.2) or where “all elements relevant to the situation” at the time of the damage are in a different country to that chosen (Article 14.3).
Parties to any sort of cross-border pre-contractual negotiations should be aware that they may now be unexpectedly bound by the law of that contract in any non-contractual dispute, even if the contract is never entered into (Article 12). This is a significant change from the general position in English law, in which pre-contractual negotiations are usually not binding. Parties to such negotiations could find themselves bound by duties to negotiate in “good faith” and other obligations which do not exist in English law. To avoid this kind of risk, express agreement should be made at the start of any negotiations regarding the applicable law governing non-contractual obligations.
- Rome II could pose a number of risks for parties engaged in cross-border business, such as the risk of unexpectedly breaching non-contractual obligations of unfamiliar jurisdictions or increased litigation complexity and cost.
- However, Rome II provides companies and financial institutions doing cross-border work with an opportunity to choose the law applicable to their non-contractual obligations, which has not previously been possible. It is also now possible for the parties to agree that a non-EU law should apply to their non-contractual obligations.
- Businesses engaged in cross-border transactions should review the choice of law provisions in existing contracts to ensure that any non-contractual claims are covered and should include such clauses in any new contracts entered into. The choice of law should be considered very carefully, taking into account factors such as the availability of certain causes of action and defences, the burden of proof and the way in which damages are calculated.