Choice of Law Clause in International Outsourcing Contracts: Some key considerations
By Harshvardhan Tripathi, for Legal Corner LLP. Harsh is a fourth year student of NALSAR University of Law and will be graduating in 2022.
The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (chetana@legalcornerllp.com) if you are planning to consider incorporate or expand your existing business in the US so as to get legal advice that is specific to your business needs.
With the growth of cross-border trade, more and more business entities are entering into international agreements. While negotiating terms of international contracts, customers and service providers must pay special attention to the choice of law clause. This clause assumes special importance because it specifies which governing law would regulate the legal relationship between the parties, determines their rights and liabilities under the legal regime and provides them legal remedies in case of a potential breach of the contract.
Generally, parties to the contract have autonomy and enjoy flexibility with respect to the naming the governing law of the contract, subject to some exceptions. Talking in the specific context of an international outsourcing contract between a US based entity or person and Indian entity or person, the parties are free to choose the governing law, except when the choice of law has no connection to either the parties of the contract or to the performance of the contract. However, notably New York allows the even non-domiciliaries of the state (which would include American citizens not from New York and other foreigners) to choose the NY local law to govern their contracts for transactions above $250,000. The conflict of law rules of India are well recognized by the India Courts and the judiciary generally enforces the choice of law decided by the parties in the contract, except in the rare circumstances where the chosen governing law violates India’s public Policy in some manner.
The parties must seek reliable quality legal advice while negotiating the choice of law clause to fully appreciate the legal implications and avoid future risks. In order to assess which legal regime would be best suited to regulate their contract, the parties must consider the following factors:
• Predictability: It must be remembered that legal systems prevailing in other jurisdictions might have divergent positions of law on the same issue. For parties about to choose a governing law, it is important to consider whether the legal system under consideration has followed a uniform standard or approach in dealing with a legal issue. This is essential because if the legal system is predictable, in case of a dispute arising, the parties can determine their legal positions and possible options under that legal system with reasonable certainty.
• Insulation: When parties decide upon their governing law of the contract, they accept the risk that any changes in this law will affect their rights and obligations. Depending upon the nature of the international contract, the parties need to negotiate a choice of law clause based upon the consideration that whether they are adequately insulated against such changes in the law. For instance in a case where the contract involves debt, the debtor would prefer a governing law that is more protective of its position while the creditor would want a governing law that ensures quick and effective enforcement. Hence, negotiation of governing law between parties should be done keeping in mind insulation from risk as an essential factor.
• Creditor Orientation: The public policy of legal systems is inclined more towards protecting the interests of either the debtor or the creditor; or it could be neutral. Depending upon which recourse is preferable to both in case of a potential insolvency, the governing law of the contract should be chosen reflecting either pro-debtor, pro-creditor or a neutral orientation.
• Nullification of transactions on formal grounds: Some legal systems have the approach of upholding the validity of a transaction when some formal requirements have not been satisfied. Other jurisdictions however, adopt a strict approach requiring complete compliance, and would not hesitate nullifying transactions based on lapse to meet the formal requirements. Governing law of the contract should be chosen keeping in mind this key factor of consideration.
• Ease of enforcement of judgments abroad: From a practical point of view, before choosing a governing law for the international contract, the overall record of enforceability of that legal system’s judgement in other jurisdictions should be considered. Judgements from certain legal jurisdictions have a higher rate of acceptability in foreign jurisdictions as compared to others. For parties looking to have a speedy and effective recovery of debts, effective enforcement of judgements becomes a priority, and the choice of governing law should reflect this priority.
• Extent of freedom of contract: Parties might want to consider the relative extent of freedom granted by different legal systems in allowing freedom of contract and choose the governing law of contract accordingly.
• Language: Parties to the contract must keep in mind that it is hard to conduct litigation or to know one’s rights and protect oneself when statutes, case law and court proceedings are in a foreign language. Hence ideally, the governing law of the contract should be chosen in a language familiar to the parties.
• Acceptability in the market: Certain governing laws are widely accepted in international markets due to their proven efficacy over the period of time, familiarity of concepts and wide range of legal authorities. A transaction can be strengthened by adopting a widely acceptable governing law of contact.
• Stability of the law: Before choosing a governing law of contract, parties must examine the extent to which that legal system adheres to the rule of law and whether it has sound and efficient legal infrastructure. This is an important indicator for a stable legal system alongside a uniform approach in the legal direction. The parties can substantially lower their legal risks by investigating the stability of a legal system before choosing their governing law of contract.
If you have any questions on choice of law, please email me at chetana@legalcornerllp.com . I will be happy to set up a free consultation.