Why Governing Law Clauses Matter More Than You Think

Buried in the final pages of most contracts, you will find a clause specifying which state's laws govern the agreement and where disputes must be resolved. Many people glance past these provisions, assuming they are mere formalities. This is a serious mistake. The governing law clause can fundamentally alter your rights, remedies, and the cost of enforcing or defending against claims.

What Is a Governing Law Clause?

A governing law clause, sometimes called a choice of law clause, specifies which jurisdiction's laws will be used to interpret the contract and resolve any disputes. For example, a contract might state that it shall be governed by and construed in accordance with the laws of the State of Delaware, without regard to its conflict of laws principles.

This seemingly simple provision has profound implications. Contract law varies significantly from state to state in the United States, and the choice of governing law can determine everything from how ambiguous terms are interpreted to what damages are available for breach.

Why the Choice Matters

Substantive Law Differences

Different states have different rules on numerous issues that can affect contract disputes. Consider non-compete agreements, which are generally enforceable in most states but completely unenforceable in California. If your employment contract specifies California law governs, a non-compete provision may be worthless to the employer. If it specifies Texas law, that same provision might be fully enforceable.

Other areas where state law varies significantly include limitations on consequential damages, enforceability of liquidated damages provisions, requirements for contract modifications, statutes of limitations, and consumer protection laws.

Procedural Implications

The jurisdiction clause in contract disputes also determines where cases will be heard. This affects convenience and travel costs for litigation, familiarity of local courts with relevant industries, availability of jury trials, speed of court proceedings, and local legal culture and tendencies.

Understanding Jurisdiction Clauses

Related to but distinct from governing law, jurisdiction clauses specify where disputes must be brought. These provisions typically designate exclusive or non-exclusive jurisdiction in particular courts.

Exclusive Jurisdiction

An exclusive jurisdiction clause requires that all disputes be brought in specified courts, prohibiting either party from suing elsewhere. These provisions can significantly affect the practical ability to enforce rights if the designated forum is inconvenient or expensive to access.

Non-Exclusive Jurisdiction

Non-exclusive provisions allow disputes to be brought in the specified courts but do not prevent litigation in other appropriate forums. These are generally more favorable to the non-drafting party.

The Conflict of Laws Question

Many governing law clauses include language stating that the chosen law applies without regard to conflict of laws principles. This phrase has important implications.

Without this language, a court might apply its own conflict of laws rules to determine that a different jurisdiction's law should actually govern. By excluding conflict of laws principles, the parties attempt to ensure that the chosen law applies regardless of where litigation occurs.

However, courts do not always honor these provisions, particularly when applying the chosen law would violate important public policies of the forum state. Understanding governing law jurisdiction interactions requires recognizing that the drafting party's preferred choice may not always be enforced.

Strategic Considerations in Law Selection

Why Companies Choose Certain States

Many companies choose Delaware law because Delaware has well-developed corporate law and business-friendly courts. New York is popular for financial transactions because of its sophisticated commercial law jurisprudence. California law might be chosen to avoid enforcement of restrictive covenants.

The law governing contract interpretation in these jurisdictions has been extensively developed through decades of commercial litigation, providing greater predictability than jurisdictions with less developed case law.

Red Flags in Governing Law Choices

Be cautious when the other party insists on governing law from a jurisdiction with no apparent connection to the transaction, a distant and inconvenient forum for dispute resolution, laws known to favor particular types of parties, or limited consumer or business protections.

Impact on Specific Contract Types

Employment Agreements

Governing law in employment contracts is particularly important because of significant variations in state employment law. Issues affected include enforceability of non-compete and non-solicitation provisions, wage and hour requirements, wrongful termination claims, and mandatory arbitration of employment disputes.

Technology Contracts

Software and technology agreements often involve parties in multiple states or countries. The governing law choice can affect intellectual property ownership, liability limitations, data privacy requirements, and electronic signature validity.

Consumer Contracts

Many states have laws protecting consumers that cannot be waived by contract. Governing law clauses that attempt to circumvent these protections may not be enforceable, particularly when applied to residents of states with strong consumer protection laws.

Negotiating Governing Law Provisions

If you have concerns about the governing law or jurisdiction provisions in a contract, consider these negotiation strategies:

Request Your Home State

The most straightforward approach is requesting that your state's law govern and that disputes be resolved in your local courts. While the other party may resist, this is a reasonable request, particularly for significant contracts.

Propose Neutral Territory

If neither party will accept the other's preferred jurisdiction, consider proposing a neutral third state with well-developed commercial law, such as Delaware or New York for business disputes.

Separate Governing Law from Jurisdiction

Sometimes parties can agree that one state's law governs while disputes can be brought in either party's home courts. This compromise provides predictability on substantive law while preserving convenient forum options.

Limit Exclusive Jurisdiction

If you cannot avoid an exclusive jurisdiction clause, try to negotiate for non-exclusive jurisdiction instead, or at least ensure the designated forum is reasonably accessible.

Practical Implications of Distant Forums

Before agreeing to resolve disputes in a distant jurisdiction, consider the practical implications. Litigation costs increase significantly when attorneys, witnesses, and parties must travel. Local counsel may be needed in addition to your regular attorneys. Time zone differences can complicate proceedings. Unfamiliarity with local procedures and court culture can disadvantage out-of-state parties.

These factors can make the difference between pursuing a valid claim and abandoning it as economically impractical.

Arbitration as an Alternative

Many contracts specify arbitration rather than litigation for dispute resolution. Arbitration can somewhat mitigate the impact of inconvenient forum selections because arbitration locations are often more flexible, procedures are generally simpler, and discovery is typically limited regardless of forum.

However, arbitration has its own considerations, including limited appeal rights and potentially higher administrative costs.

When Governing Law Clauses May Not Be Enforced

Courts will not always enforce governing law selections. Common reasons for non-enforcement include no reasonable relationship between the chosen law and the parties or transaction, violation of fundamental public policy of the forum state, consumer protection laws that cannot be waived, and employment laws of the state where work is performed.

Understanding these limitations is important for realistic assessment of what the governing law clause will actually accomplish.

Conclusion

Governing law and jurisdiction clauses are far more than legal formalities. They can fundamentally affect your rights, the cost of enforcing those rights, and the practical outcome of any dispute. Before signing any significant contract, carefully review these provisions and consider their implications.

If the governing law choice seems unfavorable or the designated forum is inconvenient, do not hesitate to negotiate. These provisions are often more flexible than the drafting party suggests, and the effort invested in obtaining favorable terms can pay significant dividends if disputes arise.

Remember that the best time to address governing law concerns is before you sign. Once the contract is executed, you are bound by the choices made, regardless of how inconvenient they may prove to be.