Out-Law Guide | 05 Aug 2011 | 4:01 pm | 5 min. read
Resolving disputes which arise under contracts can be complicated where the parties to the contract are based in different countries. It is important to establish what law will apply to a contract before the parties enter into any binding agreement.
This guide considers what will happen if you do not include a governing law clause in your contract or if this is incorrectly drafted, and sets out the European law relating to contractual obligations (Rome I). For information about the European law relating to non-contractual obligations (Rome II), please see our separate OUT-LAW Guide.
Why include a governing law clause?
A governing law clause enables the parties to specify the system of law which will be used to interpret a contract and deal with any disputes which arise under that contract. It is not a dispute resolution clause in the sense that it does not indicate how disputes will be resolved - rather, it determines the system of law which will be applied to decide what the parties' rights and obligations are.
The choice of governing law should be considered before a contract is drafted. If English law is not used, a lawyer qualified in the relevant jurisdiction will need to advise on how the chosen governing law will apply to the contract.
If there is no express choice of governing law provided in the contract then, in the event of a dispute, a court will decide which law to apply in accordance with the relevant conflict of laws principles in that jurisdiction.
Why include a jurisdiction clause?
If there is no jurisdiction clause, the courts which will be able to settle any dispute arising from the contract will be determined by the rules of private international law. This can cause uncertainty and lead to additional costs and delay. In Europe various instruments and conventions have been enacted to determine where a case can be heard. The basic rule is that a party must be sued in the court in its own country, subject to various exceptions.
The Rome Convention
The Rome Convention on the Law Applicable to Contractual Obligations (Rome Convention) governs contracts entered into before 17 December 2009. The Rome Convention sets out the rules for determining the law which should be applied by courts when resolving contractual disputes, but it does not apply to non-contractual obligations including obligations in tort. It was enacted as a means of harmonising contract law across the European Union and came into force in 1991.
The Rome Convention applies to any contract where there is no express choice of law. It contains special provisions relating to employment and consumer contracts, but does not apply to certain disputes including those involving wills and trusts, property rights related to family relationships, arbitration agreements and disputes governed by company law.
Under the Rome Convention parties are free to choose the law that governs their contract. In the absence of party choice the contract will be governed by the law of the country with which it is most closely connected. It will be assumed that this is the country where the party which has to perform the main obligations of the contract is normally resident. However this test can raise complicated issues.
The European Union decided that the Rome Convention required some updating and that its status should change from being a multilateral inter-governmental agreement to a Community Regulation that is directly enforceable by individuals and under the jurisdiction of the Court of Justice of the European Union in Luxemburg. Contracts entered into on or after 17 December 2009 are therefore governed by Rome I, or the Rome Regulation on the law applicable to contractual obligations (10-page / 95KB PDF).
Rome I covers much of the same ground as the Rome Convention. The basic rule has been preserved – in the absence of party choice the applicable law is the law of the place where the party which has to perform the main obligations of the contract is normally resident. However, Rome I converts the existing presumption into a fixed rule.
The most important changes are:
In order for Rome I to apply, the parties need not have any EU connection – all that is required is that the case is raised in a relevant court which raises a choice of law issue in subject matter that falls within the regulation. Any law may be specified as the applicable law of the contract, whether or not it is the law of an EU member state.
Although not required to do so, the UK has applied Rome I to settle conflicts between the laws of the different parts of the UK – for example, England and Scotland.
Rome I applies to "contractual obligations in civil and commercial matters". The term 'contractual obligation' is not defined, and care must be taken about whether a claim is one made in tort (to which Rome II will apply) or one made in contract. Some claims which are regarded as torts in English law may be regarded as contract claims for the purpose of the two regulations.
Matters which are expressly excluded from Rome I include:
In addition to these specific subject matters listed above, Rome I does not apply to matters of evidence and procedure. These are governed exclusively by the law of the court hearing the claim, regardless of the law which applies to the substantive issues.
Negotiations on Rome I were at times extremely heated and the final text is in some places a compromise between competing approaches. It is therefore important to be aware that the text of Rome I should not be read too literally in places, and that further research on specific matters may be necessary.
Practically, Rome I reinforces the need to identify the applicable governing law at the outset of negotiations and to state expressly whenever possible which governing law should apply in particular circumstances. It will also be advisable for a brief assessment to be made as to whether any mandatory rules of law of another country could interfere with the parties' commercial objectives. Clearly, too, the Rome Convention will continue to be relevant for many years to come and care will have to be exercised when revisiting and interpreting contracts that predate the implementation of Rome I.