By Ben Hicks
The “fine print” in a contract is often ignored, and often at the peril of business owners and executives. A few months ago, we launched a new blog series titled “Know Your Boilerplate,” where we outline what is commonly known as “the boilerplate” in contracts.
In the business world, contracts provide the framework for the daily relationships necessary for a business to operate — with vendors, employees, contractors, service providers, and strategic partners — as well as transformational events in the life of a business such as the purchase or sale of real estate, equipment, other assets, or the business itself.
Too often, business owners focus solely on the high-level business terms in a contract that structure the overall business relationship between the parties. In a perfect world, training one’s sights on these parts of a contract would be fine, but in the real world, transactions and relationships inevitably sour from time to time. When the high-level business terms in a contract come into question, it is the boilerplate that determines how well or poorly positioned a business is to defend its interests.
In our first installment, we looked at notice provisions that govern timeframes and methods for making changes to or ending a contractual agreement. Last time we reviewed anti-assignment and change of control provisions, where problems often arise during the sale of a business (and subsequent transfer of its contracts).
Today, let’s discuss choice-of-law provisions, an often-overlooked or, even worse, omitted section of contract boilerplate that can come back to haunt entrepreneurs and executives.
While federal law holds sway over certain interstate commerce and intellectual property matters, general contract law principles for business dealings live and breathe at the state level, through state-specific laws and court rulings. As such, parties to a contract should take to care to specify which state’s laws will govern the relationship between the parties by inclusion of a choice-of-law provision similar to the following:
“This Agreement, and all claims or causes of action (whether in contract, tort, or statute) that may be based upon, arise out of, or relate to this Agreement, shall be governed by and construed in accordance with the laws of the State of North Carolina, without regard to its conflict of laws principles.”
If a contract does not include some flavor of choice-of-law provision, then the parties will end up relying on courts to determine which governing law should apply, done by the court’s application of “conflict of laws principles” that are established in the jurisdiction where the court sits. In some instances that decision is predictable – if two North Carolina companies enter into a contract involving performance entirely within the state of North Carolina, there is little (albeit some) risk that the law of any state other than North Carolina would apply.
Failing to include a choice-of-law provision can cause headaches, however, when a party to a contract is formed or has operations in another state, or where the respective contract involves performance outside of the state of North Carolina. A court’s application of conflict of laws principles and determination of which state’s laws should apply can be unpredictable (indeed, law schools have entire classes on the sole subject of the application conflict of law principles), which complicates the process of litigating contract disputes. The choice of which state’s law to apply may significantly impact the rights and remedies that are available; a party to a contract may find that its ability to be successful in litigation depends entirely on the specific state’s law that is applied.
It bears mentioning that parties to a contract are somewhat restricted in their ability to select a state’s laws to apply – there must be at least some rational relationship between the state and the relationship between the parties. If two North Carolina companies with no operations in the state of Delaware decide that Delaware law is particularly favorable and include a choice-of-law provision that elects for Delaware law to apply, a North Carolina court is likely to disregard that provision and apply North Carolina law instead. Courts may also determine that public policy or some prevailing interest may require the application of the law of a different state than what the parties included in their choice-of-law provision.
Take a careful look at the sample choice-of-law provision included above and you may notice that it includes claims based on more than just contract law principles. This is important because courts can apply the laws of different states to a single relationship between two parties, depending on the nature of the claim being pursued. A court could find that contract claims between parties to the relevant contract will be governed by North Carolina contract law, but that the laws of another state would more appropriately apply to other types of claims, such as tort claims, between those same parties, even if each claim arises from the same set of facts.
Absent a carefully drafted choice-of-law provision, a party to a contract may find itself in the unenviable position of going before a court to resolve a dispute related to that contract without feeling confident about which state’s law will apply or what claims are available.
I have committed much of my practice through the years to drafting, negotiating, and reviewing all elements of contracts. Contact me at the Forrest Firm if you are interested to hear more about how I can help you draft or review your business’s contracts.
In our next installment in this series, we will review integration clauses and their impact on contracts.