Making Sure Your “Choice-of-Law” Clause Chooses all of the Laws of the Chosen Jurisdiction
By Weil Gotshal & Manges LLP - September 5, 2017
In a 2016 post to Weil’s Private Equity Insights blog it was suggested that deal professionals and their counsel should not only “choose governing law wisely, but also choose it thoroughly!”1 That suggestion was an effort to highlight the importance of the actual language used in the choice-of-law clauses found in the miscellaneous provisions at the back of most M&A-related agreements. And a recent ruling by Vice Chancellor Slights in the Delaware Court of Chancery provides yet another opportunity to reinforce that suggestion.2
There can sometimes be meaningful differences between the laws of various jurisdictions that might have some relationship to your agreement or the negotiations that lead to its eventual execution. And the primary purpose of a choice-of-law clause is to avoid uncertainty over the law that would govern any disputes that may arise out the relationship created as a result of that agreement. But many deal professionals and their counsel fail to give appropriate attention to the actual language used in a choice-of-law clause; and that failure can result in untoward consequences that threaten the certainty sought to be achieved by the choice of a particular jurisdiction in the choice-of-law clause.
The specific issue that was highlighted in the 2016 Insights post was the distinction between choosing the substantive law of the chosen jurisdiction versus choosing that jurisdiction’s procedural law—a distinction between the law governing the enforcement of a party’s rights (procedural law) and the law governing the creation of those rights (substantive law). Because statutes of limitations are generally held to constitute procedural rather than substantive law, many deal professionals and their counsel are often surprised to learn that the standard choice-of-law clause only chooses the substantive, not the procedural law of the chosen jurisdiction. As a result, substantive rights available under New York law with a six-year statute of limitations may be subject to a three-year statute of limitations in an action brought in Delaware to enforce rights created by an agreement with a standard New York choice-of-law clause. By focusing on the actual language used in the choice-of-law clause, however, both the procedural and substantive law of New York can be effectively chosen in a manner that will be honored even in a forum other than New York.
The recent ruling by Vice Chancellor Slights focused on a different aspect of the “choose wisely but thoroughly” suggestion regarding choice-of-law clauses—the issue of ensuring that all claims that might arise out of the relationship created by or related to the parties’ agreement will be governed by the same law. When a dispute arises respecting an M&A-related agreement, it is not uncommon for both contract-based and tort-based claims to be made respecting that dispute—i.e., in addition to allegations that one party or the other breached the agreement, there may also be claims for fraudulent or negligent misrepresentations, conversion, breach of fiduciary duty, tortious interference, and similar claims based not upon the breach of duties imposed by the contract itself, but upon duties imposed by the common law of a particular jurisdiction with some connection to the transactions contemplated by the agreement.
If the purpose of a choice-of-law clause is to provide certainty as to the applicable governing law in the case of a subsequent dispute, it only makes sense that the parties would have wanted the chosen law to cover both tort and contract claims arising out of the agreement in which that choice-of-law clause is contained. But that is not the way many courts interpret the standard choice-of-law clause. For example, in Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996), the court noted that:
Under New York law, in order for a choice-of-law provision to apply to claims for tort arising incident to the contract, the express language of the provision must be “sufficiently broad” as to encompass the entire relationship between the contracting parties.
The standard-variety choice-of-law clause tends not to be “sufficiently broad” and therefore does not expressly include tort claims within its ambit. Indeed, the standard-variety choice-of-law clause tends to be a fairly simplistic provision that reads (similar to the clause at issue in the Krock case) as follows:
This Agreement shall be governed by, and construed in accordance with, the law of the State of [ ].
Delaware courts have traditionally had a more liberal view of the standard-variety choice-of-law clause than many other courts, generally holding that a standard-variety clause was sufficient to encompass claims founded in tort that were related to contract, and was not limited to contract claims alone. The Delaware courts’ reasoning is illustrated by then Vice Chancellor Strine’s holding in Abry Partners V, LP v. F&W Acquisition LLC, 891 A.2d 1032, 1048 (Del Ch. 2006), where a standard-variety choice-of-law clause similar to the one set forth above was found sufficient to cover both tort and contract claims arising out of a disputed acquisition agreement. According to then Vice Chancellor Strine:
Parties operating in interstate and international commerce seek, by a choice of law provision, certainty as to the rules that govern their relationship. To hold that their choice is only effective as to the determination of contract claims, but not as to tort claims seeking to rescind the contract on grounds of misrepresentation, would create uncertainty of precisely the kind that the parties’ choice of law provision sought to avoid. In this regard, it is also notable that the relationship between contract and tort law regarding the avoidance of contracts on grounds of misrepresentation is an exceedingly complex and unwieldy one, even within the law of single jurisdictions. To layer the tort law of one state on the contract law of another state compounds that complexity and makes the outcome of disputes less predictable, the type of eventuality that a sound commercial law should not seek to promote.
But this liberal approach by the Delaware courts is no guarantee that a choice-of-law clause lacking adequate breadth to clearly cover tort, as well as contract-based, claims will in fact do so, even in Delaware. Indeed, in the recent ruling in Reid v. Siniscalchi, C.A. No. 2874-VCS, tr. ruling (Del. Ch. May 3, 2017; filed July 17, 2017), Vice Chancellor Slights found that non-contractual, tort–based claims arising from an agreement that provided that it was to be “construed in accordance with the laws of the United Kingdom,” were governed not by the chosen jurisdiction’s law but by the law of Italy, which had the most significant relationship to the dispute. Vice Chancellor Slights reached this conclusion based upon the limited wording of the clause and a 2014 Delaware Court of Chancery decision construing a similar clause.3 Based upon that court’s review of applicable English law determining the scope of the choice-of-law clause, the court concluded that it did not cover non-contractual claims such as fraud.
A recent law review article by Professor John Coyle, published in the Washington Law Review, thoroughly reviews the approaches of the various state and federal courts in construing choice-of-law provisions.4 The article is a treasure trove of information for practicing lawyers. But the most important contribution of that article is his observation that there is no need to understand the different approaches of the courts to interpreting the standard-variety choice-of-law clause if, instead of continuing to rely upon a boilerplate clause, draftspersons actually drafted the choice-of-law clause to cover all of the issues giving rise to the differing approaches of these courts. And he even offered a clause that would appear to foreclose any questions concerning whether the chosen law applied to both procedural and substantive law, and contractual and non-contractual claims.5
A 2009 The Business Lawyer article offered a similar suggestion and proposed clause.6 Based on Professor Coyle’s recent article, I would offer a slightly revised version of that 2009 suggested choice-of-law clause as follows:
Governing Law. 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, or the negotiation, execution or performance of this Agreement (including any claim or cause of action based upon, arising out of or related to any representation or warranty made in or in connection with this Agreement or as an inducement to enter into this Agreement), shall be governed by, and enforced in accordance with, the internal laws of the State of [ ], including its statutes of limitations.
All boilerplate provisions need to be treated with the respect they deserve; indeed, a choice-of-law clause may be outcome determinative regarding the availability or lack of availability of a specific cause of action. A choice-of-law clause is an important part of the entire written agreement that was designed to provide certainty as to the agreed deal between the parties. Failing to ensure that both tort and contract claims are governed by the same law creates the very uncertainty the agreement was designed to avoid.