Choosing a governing law in trade finance transactions
The term conflict of law refers to situations where the laws of different countries that apply to a specific legal matter are dissimilar. In these instances, a choice of law has to be undertaken by the parties to determine which law applies.
This situation arises when an international financial transaction is concluded. Then, the parties need to choose a law to govern the associated financial agreement. Since there is no unique international law applying to transnational relationships, the international contract will be governed by the national legal system chosen by the parties. In other words, the chosen law expresses the parties’ choice as to what the law related to their agreement should be. This choice of law is of crucial importance for the parties, as it will determine the interpretation of the agreement’s clauses, the parties’ rights and obligations. In the same vein, the parties will have to determine the jurisdiction where arising disputes will be resolved.
Governing law and jurisdiction clauses – Importance in international financial transactions
Two types of clauses will determine the parties’ choice of law and of jurisdiction. Firstly, the parties’ choice of law is generally expressed through a governing law clause inserted in the financial contract. The primary purpose of this governing law provision is to elect the jurisdiction’s law that will be applied in resolving legal issues arising from the financial agreement. On the other hand, a jurisdiction clause will dictate the location and thereby which courts will resolve the dispute.
In practice, these clauses do not become an issue unless an international dispute arise between the parties. In brief, it is only once a question cannot be answered by examining the contract that a recourse to the parties’ choice of law is needed. However, it is of crucial importance for the parties to determine a law and a jurisdiction during the negotiation of the contract, in order to achieve certainty in their financial relationship. In fact, parties know what law is likely to be applied in resolving legal issues regarding their rights and obligations under the contract, allowing them to analyse and anticipate their legal position. On the contrary, where parties omit to insert a governing law clause, complex legal rules exist by which the f-governing law of the contract is determined. When the courts will decide on a choice of law issue, they have two options:
- The law of the forum (lex fori)
- The law of the site of transaction/occurrence that resulted in the legal action
In the EU, the Rome I Regulation provides for a rule in the absence of choice, whereby “the contract should be governed by the law of the country with which it is the most closely connected” (Rome I – (21)). Nevertheless, parties do not have control over the chosen law, leading to a higher uncertainty as to the legal outcomes.
In negotiating these clauses, disagreements may arise as to the optimal law and jurisdiction to choose. Actually, several factors play a role in deciding which law and jurisdiction to elect, such as legal costs, the potential for biased treatment by local judges or arbitrators and the language. Generally, each party will advocate for its home jurisdiction for the aforementioned reasons. Further, parties will want consistency between the governing law and the jurisdiction clause. For instance, if disputes are to be resolved in English courts, English law will probably be chosen as the governing law.
Scope of governing clauses
When the parties negotiate a financial agreement, such agreement will set out their contractual obligations. However, other “non-contractual” obligations may arise during their relationship, mainly during:
- The pre-contractual negotiations, before the contract is finalised
- The period after the contract has been entered into: non-contractual obligations can be added to contractual obligations
In light of this, the parties should, when negotiating a choice of law clause, decide whether to limit such clause to the agreement itself or extend it to cover related non-contractual obligations.
In order to determine the governing law regarding non-contractual obligations, the Rome II Regulation sets out a general rule in its article 4, by which the law applicable to non-contractual obligations will be the law of the country in which the relevant damage occurs, “irrespective of the country in which the event giving rise to the damage occurred and irrespective of the country or countries in which the indirect consequences of that event occur.” Exceptions to this rule exist, especially one by which “the parties may agree to submit non-contractual obligations to the law of their choice” (Article 14), allowing parties to extend their choice of law clause to non-contractual obligations related to their financial agreement.
Samples of a governing law and jurisdiction clauses
“The law of XXX shall govern all questions concerning the construction, validity, interpretation and performance of this Agreement, without regard to its conflict of law rules.”
Parties can also draft a clause comprising their choice of law and jurisdiction:
“This Agreement shall be governed by and construed in accordance with the laws of XXX, without reference to its conflict of law provisions. Any dispute or claim arising out or relating to the Agreement or claim of breach hereof shall be brought exclusively in the court for the XXX or XXX. By execution of this Agreement, Company A and B hereby consent to the exclusive jurisdiction of such courts and waive the right to challenge jurisdiction or venue in such courts with regard to any suit, action or proceeding under or in connection with the Agreement.”
REGULATION (EC) No 593/2008 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 17 June 2008 on the law applicable to contractual obligations (Rome I)
REGULATION (EC) No 864/2007 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 11 July 2007 on the law applicable to non-contractual obligations (Rome II)
Legal Trade Finance Hub
1 | Introduction to Legal Trade Finance
2 | Standard Legal Charges
3 | Borrowing Base Facilities
4 | Governing law in trade finance transactions
5 | SPV Financing
6 | Guarantees and Indemnities
7 | Taking security over assets
8 | Receivables finance and the assignment of receivables