What a Choice-of-Law Clause Achieves

Almost every commercial agreement contains a sentence naming a state whose law governs it, and almost everybody who signs one believes it does more than it does. The clause is genuinely useful and genuinely narrow, and the gap between those two facts accounts for a large share of unpleasant surprises when a relationship goes wrong.

What the clause settles

The law that interprets the bargain. Formation, construction of the terms, what performance requires, what excuses it, and the remedies available for breach are all determined by the chosen law.

Which removes a real uncertainty. Without the clause, a court would apply its conflicts rules to identify the governing law, producing an answer nobody could predict at the drafting stage. The clause converts a contested question into a settled one.

It applies whichever court hears the case. A court in a different state, applying its own conflicts rules, will generally give effect to the clause, so the interpretive law travels with the contract rather than with the venue.

It is respected in the great majority of commercial disputes. Between sophisticated parties, with a genuine connection to the chosen state, and no protective statute in play, courts apply the clause without difficulty.

And it supports predictability in drafting. Parties can write terms knowing which body of law will construe them, which is the reason the clause exists at all.

The conditions courts impose

A substantial relationship or a reasonable basis. The chosen state must have a genuine connection to the parties or the transaction, or there must be some other reasonable ground for the selection.

Easily satisfied in commercial cases. A party's headquarters, the place of performance, the location of the subject matter or the state of incorporation each supply it.

Harder where the choice looks purely tactical. A clause selecting a state with no connection to anything, chosen only for a favorable rule, is the case courts have refused, and the refusal is the reason the requirement exists.

No offense to a fundamental policy. Where applying the chosen law would contravene a fundamental policy of a state with a materially greater interest, the clause gives way, which is the subject of when a court sets the chosen law aside.

And ordinary contract defenses apply to the clause itself. A clause procured by fraud, or contained in an agreement that is unenforceable, does not survive independently of the contract it sits in.

What the clause does not settle

Where the case is heard. Forum is a separate question requiring a separate clause, and the two are frequently confused. A contract can select one state's law and another's courts.

Procedure. A court applies its own procedural rules whatever law governs the substance — pleading standards, discovery, evidence, and in most cases the rules about how a trial is run.

Limitation periods, sometimes. Historically treated as procedural and therefore governed by the forum, though borrowing statutes complicate this considerably, as examined in borrowing statutes and which limitation period runs.

Protective legislation elsewhere. Employment, consumer, insurance and franchise statutes in the state where a person lives or works frequently apply regardless of the clause, which is why the wage entitlements described in whose wage and hour law covers a remote worker are unaffected by it.

Claims outside the contract. Tort, statutory and misrepresentation claims may fall outside a narrowly drafted clause, and their governing law is determined separately under the tests in the place of injury and the modern test.

Drafting it usefully

Say what the clause covers. A clause extending to all claims arising out of or relating to the agreement is materially broader than one governing the agreement alone, and the difference decides whether tort claims are captured.

Pair it with a forum clause deliberately. Selecting law and forum together produces predictability; selecting only one produces half of it, and the combination should be a decision rather than an accident of the template.

Choose a state with a connection. Not merely a state with attractive law. The connection is what makes the clause robust.

Assume protective statutes will apply anyway. Where the counterparty is an employee, a consumer, an insured or a franchisee, draft on the basis that their own state's protective law reaches the relationship regardless of the clause.

And exclude renvoi expressly. Naming the internal law of the chosen state, rather than its law generally, avoids the circularity problem described in renvoi and why courts avoid it. It is one line and it removes an argument.

Reading one in somebody else's contract

Ask first what it covers. A clause governing the agreement is narrower than one governing all disputes arising out of or relating to it, and the difference decides whether a tort or statutory claim escapes the chosen law. This is a question of construction that can be answered by reading the sentence carefully.

Then ask whether a forum clause accompanies it. A governing law clause with no forum provision leaves the venue open, which frequently favors the party with more resources and more appetite for procedural argument. A forum clause without a governing law clause leaves the substance open, which is worse.

Then identify the protective statutes of the weaker party's own state. For an employee, a consumer, an insured, a franchisee or a small business in a regulated relationship, the statutes of the state where that party lives and works are the ones most likely to survive the clause, and they are frequently the most useful law available to it.

Then consider whether the chosen state has any connection at all. A clause naming a state that has nothing to do with either party or with the transaction is the most vulnerable kind, and the vulnerability is worth knowing about even if it is never litigated.

And do not assume the clause is negotiable only on its choice. Parties who resist changing the named state will frequently agree to narrow the clause's scope, to carve out statutory claims, or to add a forum provision, and those amendments are often worth more than substituting one state for another.

The general lesson is that a governing law clause is a real allocation of risk hiding in a sentence that reads like boilerplate. It is drafted by the party with more bargaining power, it is rarely discussed, and it decides which body of law construes every term above it. Reading it deliberately once, before signing, is the whole of the effort required, and it is skipped in the overwhelming majority of agreements by people who then spend a great deal on lawyers arguing about what it meant when the relationship it governed has already broken down.