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Certainty in Choice of Law

One of the most important steps to minimise uncertainty in a contractual transaction, especially one involving cross-border elements, is to expressly choose, at the outset, the law to govern the contract. Generally, the choice of law of the contracting parties will be given effect to by most countries. However, there is no assurance that this will always be the case. The danger comes particularly from the parties’ choice of a law, because it is especially in such cases the forum asked to enforce the choice of law clause may not find any connection between the transaction and the chosen law. Thus, an important strategic consideration to ensure that the parties’ choice of law will be upheld is to select the forum that will give effect to the parties’ intention. Whether a particular forum will give effect to the parties’ choice of law, and to what extent, depends on the conflict of laws rules that it applies.

English courts will apply the Rome Convention on the Law Applicable to Contractual Obligations¹ to the question, whether the underlying transaction or the parties have anything to do with the European Union or not. Under the Rome Convention, the English court will give generally effect to the choice of law of the parties.² As usual, the application of laws of the forum which are mandatory irrespective of any foreign elements in the case is preserved.³ In addition, there are a number of other important limitations to party autonomy.

If all other elements relevant to the situation at the time of the choice are connected with one country only, then the “mandatory rules” of that country shall apply in spite of the parties’ agreement that the law of another country should apply.⁴ “Mandatory rules” in this context are rules of law that cannot be derogated from by contract. Rules that parties cannot contract out of could include rules against penalties, or the doctrine of consideration in common law countries. Moreover, the parties’ ability to choose the applicable law is restricted in the case of consumer⁵ and employment⁶ contracts.

The UK had entered a reservation⁷ under the Rome Convention, which means that it is not required to consider the application of the international mandatory rules of a country which has a close connection with the transaction, but which law is not the one chosen by the parties to govern their contract.⁸ International mandatory rules are the mandatory rules of law of a country which would be applied by its court irrespective of the parties’ choice of another law to govern the contract. However, this position may change in the future. Under the current version of the proposed Rome I Regulation on the law applicable to contractual obligations,⁹ intended to supersede the Rome Convention, such a reservation would no longer be possible. If this change occurs, it means that the English court would be obliged to consider the application of laws of connected countries even if the parties did not want such laws to apply.

Under New York conflict of laws rules, the parties’ choice of law will be given effect to generally, subject to the fundamental public policies of the forum. There are a number of important qualifications to this principle under New York law. The courts apply the Restatement (Second) of Conflict of Laws, under which the law chosen will not be given effect if the state which law has been chosen has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice.¹⁰ Thus, there is a specific requirement of connection between the parties or their transaction and the chosen law; otherwise, the choice may fail.¹¹

Specific New York legislation addresses the situation before a New York court where contracting parties have chosen New York as the exclusive forum for litigation and New York law to govern their transaction, and the value of the transaction is at least US$250,000.¹² Major commercial transactions would thus be covered by this legislation. In such a case, it is provided that contracting parties may choose New York law whether or not their contract bears any reasonable relationship with the state of New York . However, it would appear that, in spite of the statute law of New York, the court will still consider whether the transaction bears a reasonable relationship to the State of New York before upholding the parties’ choice of New York law, because the requirement of a connection with New York state is dictated by the Constitution.¹³

The Singapore court will apply the common law. Under the common law, the choice of the parties will be given effect to, unless the choice is not bona fide or legal or if the choice is against public policy.¹⁴ The application of the chosen law is, consistent with prevalent principles of conflict of laws, subject to the fundamental public policies and international mandatory rules of the forum. There is no requirement for any connection between the parties or the transaction and the country which law is chosen. There is no possibility of the application of a foreign law that is not the chosen law. Moreover, the Singapore court has taken a very narrow approach to the limitations to party autonomy in choice of law.¹⁵ It has interpreted the last limitation as equivalent to the requirement that the application of the law chosen by the parties should not be against the fundamental public policy of the forum, which is a standard limitation to all choice of law rules in the common law. Effectively, the only qualification to the parties’ choice of law is the principle that if the only purpose of choosing the law was to evade the operation of the law of a country that would otherwise apply to the contract in the absence of the choice of law, then the choice would not be regarded as bona fide.

In practical terms, New York courts require some connection with New York before accepting a New York choice of law clause, English courts require that the relevant elements are not all connected with another country before accepting an English choice of law clause, while Singapore courts are not concerned with connections in accepting a Singapore choice of law clause provided that the parties did not act with the sole objective of avoiding the application of the foreign law that would otherwise govern the contract. Most choice of law clauses are given effect to, but the limitations to party autonomy must nevertheless be noted with care in the planning of cross-border transactions. It would be an extremely rare case indeed, more rare than in the context of English or New York conflict of laws rules, that a Singapore court would not give effect to the parties’ choice of law in the contract.

 

Certainty in the Domestic Law

Sophistication in commercial law is an important reason why parties in commercial transactions gravitate towards English or New York law. One of the most important considerations in the choice of a system of law to govern a commercial transaction is the certainty of outcome in the event of a dispute. Another important consideration is of course the justice and fairness in the law. Different countries balance the opposing desiderata of certainty and justice in different ways. One of the important factors in this balance is the presence, scope and content of a general doctrine of good faith in contract law.

Good faith is a notoriously murky concept and it has always been a controversial question how much of it should be allowed to surface in commercial bargains, especially in the enforcement of such bargains. Within the US, there is judicial disagreement on the balance to be struck between getting the parties to stick to the terms of the contract and modifying the performance of the contract in accordance with notions of good faith: some courts use the doctrine as a gap-filler only where the contract is silent, while some go further to utilise the notion of good faith to qualify how contractual rights may be exercised.¹⁶ As to the standard of good faith, different standards can be discerned from the scholarship in the law of the US .¹⁷ Good faith could mean acting honestly in fact and the observance of reasonable commercial standards of fair dealing in the trade. This is a flexible standard, which depends on the classification of the transaction into specific industries, and assumes that standards are ascertainable within those industries.¹⁸ Secondly, good faith could simply mean not acting in bad faith.¹⁹ Thirdly, good faith could mean exercising contractual rights for any purpose within the reasonable contemplation of the parties at the time the contract was made in order to capture opportunities that were preserved at the time of contracting.²⁰ Good faith could mean the avoidance of subterfuge and evasive conduct, as well as the taking of affirmative action to realise contractual goals.²¹ Or it could mean any combination of the above.²² A separate controversy is whether the test is subjective or objective.²³

New York law certainly has the very attractive quality of sophistication in commercial laws. However, it should be noted that unlike most common law countries, there is a general duty of good faith in the law of the US ²⁴ in the performance and enforcement of contracts. The Uniform Commercial Code, §1-203, as enacted as statute in New York ²⁵ provides that “every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.” More generally, the Restatement (Second) on Contracts, §205 provides that “[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and enforcement”. Between these two provisions, all contracts, whether commercial or not, governed by New York law would be subject to a general doctrine of good faith. “Under New York law, every contract contains an implied covenant of good faith and fair dealing.”²⁶ Thus, for example, it has recently been decided that shareholders in closely held corporations do not have an unfettered right to exercise their contractual rights against one another; such rights must be exercised with regard to good faith and fair dealing.²⁷

Certainty is a very important reason why English law carries a premium label today for many commercial transactions.²⁸ One very important factor underpinning this certainty in the English common law is that contracting parties can specify their mutual obligations in detail and be confident that they will be enforced as they are stated. One important reason why that is so is that there is no general doctrine of good faith that could affect the obligations undertaken by the parties. Good faith principles do appear in pockets of law. It is an intrinsic part of insurance law (though limited to the pre-contractual stage). Fiduciary law imposes duties that are higher than good faith standards. Courts also resort to interpretative techniques and use the doctrines of implied terms to ensure that justice and fairness result. Various doctrines in equity (undue influence, misrepresentation, mistake, estoppel, laches, conditions of relief, clean hands, etc) reflect a moral underpinning of good faith in the parties’ conduct towards one another. However, there is no general principle, and the frameworks for the application of good faith principles in these pockets of law are restrictive: fiduciary law is severely restrained in commercial transactions; implied terms are subject to restrictive rules (implication by law according to specific but limited categories of contracts, and implication of fact if necessary (and not merely reasonable) for business efficacy), and equitable principles do not generally apply to the enforcement of common law rights.

The distinction between a system like English law that relies on scattered pieces of good faith principles and one that relies on a more coherent and pervasive doctrine of good faith should not be overemphasised. In many cases, the same result would be achieved. In the context of English law, Lord Steyn has observed:²⁹

“As long as our courts always respect the reasonable expectations of parties our contract law can be left to develop in accordance with its own pragmatic traditions. And where in specific contexts duties of good faith are imposed on parties our legal system can readily accommodate such a well tried notion. After all, there is not a world of difference between the objective requirement of good faith and the reasonable expectations of parties.”

Nevertheless, the processes of getting to the result are different. The English common law has its focus trained strongly on the certainty of commercial law and the predictability of commercial transactions.

However, there are three important developments that need to be taken into consideration.³⁰

First, today it is uncertain how the law of contract is affected by the Human Rights Act 1998³¹ incorporating the European Convention on Human Rights³². It is clear that private law can and will be affected by the Convention. Evidence of this can already be seen in the expansion of the law of confidence to enable private parties to sue to protect rights of privacy. How are contractual rights in English law affected? It is not clear, but Prof McKendrick, Professor of English Private Law at the University of Oxford , has commented that the Human Rights Act could turn out to be a “time-bomb ticking away under the law of contract and private law generally”.³³ The House of Lords has considered that the statutory law affecting contracts could be subject to scrutiny for compliance with the Act.³⁴ Similarly, the Act could affect the common law. For example, it could affect contractual remedies that are seen to be disproportionate to the breach of obligation; it could affect the denial of remedies in an illegal transaction that may be disproportionate to the illegality involved; or it could change the law on penalties and liquidated damages.

Secondly, a number of European instruments have already introduced the concept of good faith into the English law of contract. So far, the doctrine has been introduced into the law of consumer contracts,³⁵ as well as a certain class of commercial agency contracts.³⁶ Some authors have argued that with this incremental introduction of the notion of good faith into English law, judges will become more openly accepting of a general principle of good faith in the common law.³⁷

In respect of commercial agency contracts, the common law does not generally have categories of agency contracts, so this is an alien superimposition upon the common law. Under this European directive, a commercial agent is a “self-employed intermediary who has continuing authority to negotiate the sale and purchase of goods on behalf of another person (“the principal”), or to negotiate and conclude the sale and purchase of goods on behalf of and in the name of that principal”.³⁸ It includes agents who have no authority to contract as well as those who have, but does not include agents authorised for a single transaction only, and does not include an intermediary who purchases for resale. Where the directive applies, there is imposed in every such contractual relationship mutual obligations to act in good faith,³⁹ which are mandatory;⁴⁰ they cannot be contracted out of. In addition, the directive gives the agent an action for common law damages where the agency is terminated in breach of contract. Generally, the directive is skewed towards protecting the commercial agent.

The directive is aimed at protecting commercial agents operating in the European Union. In such a situation, the directive will apply as mandatory law in an English court (or any other court in the European Union), irrespective of the parties’ choice of law to govern the contract.⁴¹ Apart from that, a choice of English law in a contract that falls within the definition of a commercial agency contract would attract the application of this law as part of English law, and the good faith duties would, under this law, appear to be mandatory, so long as the forum hearing the case (whether in England or elsewhere) gives effect to the parties’ choice of English law clause.

Thirdly, the European Union is working towards the idea of a unified law of contract for Europe in the longer term. The Principles of European Contract Law (PECL)⁴² has been proposed by the Commission on European Contract Law to encourage and facilitate the integration of the contract laws of the member states. The PECL specifically introduces a mandatory doctrine of good faith into the general law of contract. Article 1:201 of the PECL states that “(1) Each party must act in accordance with good faith and fair dealing. (2) The parties may not exclude or limit this duty.”

Some important aspects of the good faith doctrine are expressly spelt out:

·        While the common law may imply a duty on contracting parties to co-operate where necessary for business efficacy, the PECL imposes a general duty in all contracts. Article 1.202 states: “Each party owes to the other party a duty to co-operate in order to give full effect to the contract.”

·        While common law generally requires strict performance of contractual terms, Art 3.108(1) of the PECL provides that “[a] party's non-performance is excused if it proves that it is due to an impediment beyond its control and that it could not reasonably have been expected to take the impediment into account at the time of the conclusion of the contract, or to have avoided or overcome the impediment or its consequences”.

·        While the common law requires strict enforcement of obligations to pay an agreed price (once the debt has arisen and is due) subject to counterclaims for damages for breaches of contract for any shortfall in performance, Art 4.401 of the PECL provides that “[a] party who accepts a tender of performance not conforming to the contract may reduce the price. This reduction shall be proportionate to the decrease in the value of the performance at the time this was tendered compared to the value which a conforming tender would have had at that time”.

·        While the common law does not impose any duty to renegotiate contracts, Art 6.111(2) of the PECL provides that “[i]f … performance of the contract becomes excessively onerous because of a change of circumstances, the parties are bound to enter into negotiations with a view to adapting the contract or ending it”, provided that the change of circumstances occurred after the formation of the contract, and the possibility of the change was not one which could be reasonably foreseen at that time and the rise was not otherwise allocated in the contract. Should the parties not reach agreement within a reasonable period of time, the court may terminate the contract whether on terms or not, or modify the contract in a “just and equitable” manner. In addition the court may also award damages for losses suffered by one party because of the other party’s refusal to negotiate or breaking off negotiations in good faith.

·        While the common law takes a fairly strict approach about additional terms in an acceptance destroying an offer, this is not the case under Art 2.208 of the PECL, where additional terms in an acceptance forms part of the contract unless it is expressly stated otherwise in the offer, or the offeror rejects the terms without delay, or the offeror fails to respond within reasonable time to the offeree’s acceptance on condition of the additional terms.

Singapore ’s commercial law is primarily based on the English common law system. Like the English common law, Singapore law contains all the piecemeal principles and doctrines that perform similar functions as the doctrine of good faith in other jurisdictions. Unlike the English common law, however, there is no European influence in Singapore law.

At the end of the day, every legal system finds its own balance between party autonomy and other considerations of justice and fairness. These are not bipolar considerations; giving effect to party autonomy is an important principle of justice in itself. But at least in the context of cross-border transactions, businessmen and their advisors have the liberty of choosing, subject to few limitations, the legal system to apply to their transaction. English law and New York law remain strong contenders as choice of law for commercial transactions. But those who are concerned about the introduction of “softer” law into their commercial transactions should also start considering other options.

 

By: Yeo Tiong Min