Choice of Law by the Parties

by Giesela Rühl

1. Concept and function

Choice of law by the parties, also known as party autonomy, refers to the parties’ right to designate the law applicable to their legal relationship. Alongside the freedom to select the competent forum (choice of court agreements), choice of law is, thus, an expression of the parties’ autonomy also to be found in substantive law. However, it goes beyond the parties’ substantive autonomy (freedom of contract) because it allows parties to avoid the default as well as mandatory provisions of the otherwise applicable law.

As a connecting factor (connecting factors (PIL)), choice of law plays a prominent role in a globalized world: it facilitates the proper regulation of individual cases, fosters legal certainty and reduces the costs of determining the applicable law. From an economic point of view, efficiency speaks for choice of law: since rational parties only choose a law when they expect the choice to make them better off, choice of law regularly increases social welfare and therefore leads to the desirable economic state of pareto-efficiency. This holds true irrespective of the reasons for the parties’ choice. Therefore, it does not matter whether they choose a law because it best fits their needs or whether other factors—familiarity, neutrality, reputation—are decisive. As long as the parties freely choose a particular law the choice is pareto-efficient. However, choice of law’s fundamental role in a globalized world stems not only from the advantages it brings to parties and the economic efficiency it represents. It is significant, moreover, because it is an important instrument for fostering competition between legal orders (competition between legal systems). Since parties choosing a foreign law can avoid the otherwise applicable law, national legal orders have—under certain conditions—an incentive to ensure that their rules are attractive for contracting parties. Provided that there is no market failure, choice of law can thus lead to a qualitative improvement of legal rules, namely a race to the top.

2. Development

Compared with other connecting factors (PIL), choice of law is a relatively new ‘invention’. It is said to have arrived on the stage of private international law (PIL) in the 16th century with the Frenchman Charles Dumoulin (1500–66): in his Conclusiones de Statutis et Consuetudinibis Localibus he advanced the—assumed—will of the parties in order to subject international marriages to the law of the husband’s habitual residence rather than the law where the marriage was sworn. However, a closer look reveals that Dumolin was not concerned with establishing choice of law as an independent connecting factor. Rather, his interest was to argue for application of a law other than the lex loci contractus. Therefore, the parties’ will was, for him, nothing more than an argumentative aid. The same can be said for most authors of the 17th and 18th centuries: in De Conflictu Legum, the Dutchman Ulrich Huber (1636–94) relied on the assumed will of the parties to link contracts to the law of the place of performance. In his famous obiter dictum in Robinson v Bland (1760) 2 Burr 1077, Lord Mansfield justified application of English law as the law of the place of performance referring to the fact that the parties had probably wanted English law to be applied because the contractually owed sum was to be paid in English currency. Joseph Story (1779–1845) also invoked the assumed will of the parties in his ‘Commentaries on the Conflict of Laws’ only as an argumentative aid for application of the law of the place of performance. Similarly, Carl Friedrich von Savigny did not attribute independent significance to the parties’ will. Even though he emphasized in various places that the parties’ willing subjugation to the law of a particular province determines the ‘seat’ (Sitz) of a contractual relationship, nowhere did he refer to choice of law independently of the place of performance. As a consequence, the parties’ will was for Savigny—as for Huber, Lord Mansfield and Story—either an argumentative aid justifying application of the place of performance or an expression of an indirect choice of law, which is always possible where genuinely variable connecting factors exist.

As a self-standing connecting factor, the will of the parties—real or assumed—only first gained importance in the 19th century in the work of Pasquale Stanislao Mancini (1817–88). Under the influence of the will theory prevailing on the European continent, he dismissed the territorial connecting factors, in particular the lex loci contractus which had dominated the discussion theretofore, and introduced choice of law as an independent principle of private international law (contractual obligations (PIL)). At first, however, Mancini’s ideas did not attract much attention. It was the political and economic liberalism of the late 19th century that eventually laid the foundation for a serious discussion of his work. However, for a long time agreement about the role of choice of law in general and its role in the private international law of contracts in particular could not be achieved. In Europe, courts were divided in their attitudes. Whereas judges in England, Germany and France generally tended to favour free choice of law, courts in other states proved to be more hostile. By the same token, the European academic community was split. While some followed the courts and supported free choice of law with reference to the concept of individual freedom as well as the virtue of legal certainty, many prominent conflicts scholars did not allow the parties to avoid the otherwise applicable law. They essentially argued that parties could not raise themselves above the law by choosing another. In view of increased international trade, however, the resistance against free party choice of law melted away in the course of the 20th century. As early as the 1960s, little was left of the former opposition to choice of law clauses, and the parties’ freedom to choose was generally accepted. The final victory came in 1980 when the principle of party autonomy was incorporated in Art 3(1) of the Rome Convention.

In the United States as well, just as in Europe, party autonomy was the focal point of a fierce debate up until the middle of the 20th century. And just as in Europe, the divide ran more or less between courts and scholars. While most American courts and especially the Supreme Court (Pritchard v Norton (1882) 106 US 124) accepted a party choice of law, many scholars vehemently refused to recognize the concept. Notably, Joseph H Beale, the Reporter for the Restatement (First) of Conflict of Laws (restatements), considered the applicable law a matter of state sovereignty and thus beyond the reach of the parties. As a result, the Restatement (First) remained silent on the issue, implicitly denying any freedom to choose the applicable law. However, over the years the judges’ viewpoint held sway. Today, § 187 Restatement (Second) of Conflict of Laws allows for party autonomy and—even though not binding in itself—is followed throughout the United States. Even states that formally still adhere to the Restatement (First) or apply various forms of interest analysis accept the free choice of law as a basic principle of contract conflicts. After lengthy discussion, choice of law has thus been recognized as a general principle of the private international law of contracts in both Europe and the United States. In other fields of private international law it is lagging behind.

3. Scope of application

The classic—and until today the least contested— area of application of choice of law are international contracts (contractual obligations (PIL)). Here, with the exception of some South American and Middle Eastern countries, it claims widespread application. In other fields, it has gained recognition in recent years. This holds particularly true for the private international law of non-contractual obligations (non-contractual obligations (PIL)). Here, national legal orders and international instruments very often provide that agreements on the applicable law are permissible after the event generating the non-contractual obligation has taken place. Article 14(1) Rome II (Reg 864/2007), for example, allows parties to submit non-contractual obligations to the law of their choice by an agreement entered into after the event giving rise to the damage has occurred. In international family and probate law the parties are now in many legal orders allowed to choose from a range of laws (family law (international); succession law (international)). According to Art 5(1) Rome III (Reg 1259/2010), for example, to spouses may designate the law applicable to their divorce or legal separation provided that it is the law of their common habitual residence, the law of their last common habitual residence, the law of the nationality of either spouse or the law of the forum. By the same token, Art 15 of the new Maintenance Regulation (Reg 4/2009) provides —referring to Art 8(1) of the Protocol to the new Hague Maintenance Convention—that the parties may submit their maintenance obligation to the law of either party’s nationality or habitual residence.

Against this background, the scope of choice of law is already large. The only field where it does not claim widespread application is international property law. Here, the applicable law is for the most part determined with the help of the lex rei sitae. A noteworthy exception to this rule is to be found in the Hague Convention on Securities issued by the Hague Conference on Private International Law: according to its Art 4(1) the disposal of securities is subject to the state’s law which is expressly agreed upon in the account agreement. This version of choice of law, however, has to be distinguished from the above insofar as it does not concern the relationship of the parties who are privy to the transaction—the securities transfer. The choice of law, therefore, is not made by the issuer and the purchaser of the security, but by the issuer and his bank on one side and the purchaser and his bank on the other.

4. Object

The object of a choice of law can, in most national legal orders and international instruments, only be the law of a state. Non-state law (lex mercatoria), like the UNIDROIT PICC (UNIDROIT Principles of International Commercial Contracts (PICC)) or the PECL (Principles of European Contract Law (PECL)) cannot therefore be chosen. In view of European private international law this follows from the fact that the relevant or framing norms speak of the choice of a ‘state law’. In view of Art 3 Rome I (Reg 593/2008), recital 14 adds that the parties may choose contractual instruments issued by the European Union, and in particular the Common Frame of Reference (European private law). This means, in turn, that other non-state laws must not be the object of a choice of law. In the United States the situation looks very much the same. The relevant provisions, in particular § 187 Restatement (Second) of Conflict of Laws (restatements) and § 1-301(a) UCC speak of the ‘law of a state’. Only the recently adopted private international law codifications of Louisiana and Oregon do not use this term and mention that the parties can choose the applicable law—and not solely the law of a state. The same holds true in the dominant—though contested—opinion about the Mexico Convention of 1994. However, there is no express provision to this effect in the text. The authors who support the choice of a non-state law refer to Art 9(2)2 of the Convention which allows courts to consider and apply general principles of trade law which are recognized by international organizations.

Further, many national orders and international instruments provide that the object of the choice of law may only be the law of a state to which the parties have a connection. This holds particularly true for international family and probate law (family law (international); succession law (international)). Here, the relevant European rules provide that the parties can only choose from a certain group of laws. Normally, these laws include the law of the parties’ nationality and the law of the parties’ habitual residence. In the private international law of contracts, the relevant norms diverge: in the United States, on the basis of § 187(2)a Restatement (Second) and § 1-301(a) UCC, a choice of law clause will be respected only if the parties or the contract evince a relationship to the chosen law (contractual obligations (PIL)). In Europe, in contrast, the parties may submit their contract to an unconnected law pursuant to Art 3 Rome I. Only for contracts of carriage and insurance contracts do Arts 5 and 7 Rome I limit the selection of laws as in international family and probate law (insurance contract law (international)). In practice, however, the differences between European and American law are far smaller, as suggested by a glance at the relevant provisions. First, according to § 187(2)(a) Restatement (Second) the lack of a connection to a chosen law can be remedied if there is a reasonable basis for the choice. Secondly, the US courts do not set a very high hurdle for the establishment of a connection to the chosen law.

5. Limitations

In all legal systems and international instruments, choice of law is subject to certain limitations. These limitations are either functional, situational or technical.

a) Functional limitations

Functional limitations limit the free choice of law either for the protection of a perceived weaker party or for the protection of a third party or the public at large. With respect to the protection of weaker parties, in particular consumers and employees, the limitation is designed to remedy the negative effects of information asymmetries: the structurally less informed party is to be protected from exploitation by the structurally more informed party. With respect to the protection of third parties or the public at large, the relevant rules are driven by the concern to avoid negative external effects. Third parties and the public are to be protected from a situation in which the parties externalize and therefore socialize the costs associated with their choice of law. However, despite these shared rationales, the set-up of the functional limitations is different in various legal orders and international instruments. In the United States, the protection of a party or the protection of third parties is achieved through application of the general fundamental public policy doctrine. In Europe, the trend is for a specific regulation of relevant cases: with respect to the protection of weaker parties, Arts 6 and 8 Rome I, for example, limit the effect of a choice of law where it would be detrimental to consumers and employees (consumer contracts (PIL); employment contracts, individual (PIL)). Arts 5 and 7 Rome I limit the selection of laws in order to protect passengers and policyholders (insurance contract law (international)). Article 14 Rome II permits the choice of law only after the event giving rise to the damage has occurred if the incident involves a party not engaged in commercial activities. Article 15 of the new Maintenance Regulation (Reg 4/2009)—referring to the Protocol to the new Hague Maintenance Convention—prohibits a choice of law related to the protection of a minor or adult who, by reason of an impairment or insufficiency of his or her personal faculties, is not in a position to protect his or her interest. With respect to the protection of third parties, Art 3(3)2 Rome I and Art 14(1)2 Rome II declare that a choice of law made after the conclusion of the contract shall not adversely affect the rights of third parties. Moreover, in both regulations there are specific provisions which reduce or exclude the choice of law to protect third parties. For example, Art 14(2) Rome I limits the effect of a choice of law between the assignor and assignee to the extent that certain questions affecting the position of the debtor are governed by the law applicable to the assigned or subjugated claim. And Art 6(4) Rome II entirely excludes a choice of law in view of non-contractual obligations arising out of an act of unfair competition, since competition law is widely considered as serving the interests of third parties and the public at large.

b) Situational limitations

Situational limitations limit the effect of a choice of law where a certain state of affairs prevails. The most important limitations in this sense are concerned with purely internal situations. They are designed to prevent parties from choosing foreign law where their bargain has no connection to a foreign country. Pursuant to Art 3(3) Rome I and Art 14(2) Rome II, therefore, where a case is only connected to one single state, a choice of law leaves that state’s mandatory law unaffected. Pursuant to Art 3(4) Rome I and Art 14(3) Rome II, the same applies with respect to the binding norms of Union law if the bargain only has connections to Member States. As a result, the choice of law in both international and Union cases is only effective in so far as it does not contradict the mandatory provisions of the relevant state or Union law. In the United States, the same holds true pursuant to § 187 Restatement (Second) of Conflict of Laws (restatements). Admittedly, none of the provisions is as clear as its European counterparts. However, the official commentary to § 187 Restatement (Second) determines that the provision only applies if two or more states have an interest in the regulation of the situation in question. § 187 Restatement (Second) is therefore not applicable if only one state is affected, which is the case where an internal or a Union-based situation exists in the sense of Art 3(4) and (5) Rome I or Art 14(2) and (3) Rome II. In international family and probate law (family law (international); succession law (international)) most legal orders arrive at the same result by reducing the laws available for selection.

c) Technical limitations

Technical limitations limit the freedom of choice of the parties in those instances where a particular legal instrument favours other—superior— interests. These instruments are overriding mandatory provisions on the one hand (overriding mandatory provisions; unilateralism (PIL)) and the ordre public on the other (public policy). Overriding mandatory provisions are national prescriptions which are to be enforced irrespective of the otherwise applicable law in international situations. They can be recognized in that they express a public interest in the widest sense, and, unlike norms of classical private law, do not serve merely to balance private interests. Frequently, they are of an economic or socio-political nature and aim at the central regulation of areas of private life. Ordre public impedes the application of the chosen law if the result achieved violates the public policy of the forum state. It functions as an ultima ratio if fundamental values of the forum cannot be enforced in another manner.

Literature

Hessel E Yntema, ‘“Autonomy” in Choice of Law’ (1952) 1 Am J Comp L 341; Hessel E Yntema, ‘Contract and Conflict of Laws: “Autonomy” in Choice of Law in the United States’ (1955) 1 NYLF 45; André Aloys Wicki, Zur Dogmengeschichte der Parteiautonomie im Internationalen Privatrecht (1965); Larry E Ribstein, ‘Choosing Law by Contract’ (1993) 18 J Corp L 245; Dorothee Einsele, ‘Rechtswahlfreiheit im Internationalen Privatrecht’ (1996) 60 RabelsZ 417; Peter E Nygh, Autonomy in International Contracts (1999); Yuko Nishitani, Mancini und die Parteiautonomie im Internationalen Privatrecht (2000); Stefan Leible, ‘Parteiautonomie im Internationalen Privatrecht—Verlegenheitslösung oder Allgemeines Anknüpfungsprinzip?’ in Festschrift Erik Jayme, vol I (2004) 485; Giesela Rühl, ‘Party Autonomy in the Private International Law of Contracts: Transatlantic Convergence and Economic Efficiency’ in Eckart Gottschalk, Ralf Michaels, Giesela Rühl and Jan von Hein (eds), Conflict of Laws in a Globalized World (2007), 153; Giesela Rühl, ‘Rechtswahlfreiheit im europäischen Kollisionsrecht’ in Festschrift Jan Kropholler (2008) 187; Jürgen Basedow, ‘Theorie der Rechtswahl oder Parteiautonomie als Grundlage des Internationalen Privatrechts’ (2011) 75 RabelsZ 32.