Choice-of-laws Clauses

Once a music classmate asked me for help on his music theory homework. He said he could not figure out what key a piano composition was in. I looked at the music, starting with the clef[1] and the key signature[2] to narrow the options for keys. Immediately, I saw his challenge; unlike almost every other piano piece where the bottom stave is in bass clef, both staves were in treble clef.[3] My classmate he had glossed over the clef signs, thinking they were “boilerplate.”

Like my music theory classmate, when reviewing real estate contracts, many people gloss over miscellaneous “boilerplate” sections. People believing "boilerplate" to be “standard” and think there is no need to read, much less negotiate, them. In reality, “boilerplate” sections are important, and contracting party can get burned by not carefully reviewing and negotiating them.

This is one of a series of blog posts discussing typical “boilerplate” terms and how they impact real estate contracts.

Choice-of-Law Clauses

Choice-of-Law clauses usually read something like the following:

The parties agree that this contract shall be interpreted under the laws of the State of New York, without regard to conflict of law rules, because Buyer’s corporate headquarters is in New York state.

This contract term sounds simple–the parties are agreeing that anyone who interprets the contract is to apply New York law. New York is a populous state with a large body cases interpreting business law, so a lot of mortgage lenders in particular like New York law to apply to their loan documents. In some circumstances, it may make sense for the buyer's headquarters location to govern the law that applies.

However, no matter how simple the contract language seems, before agreeing to a state’s law, parties to a real estate contract should consider the following:

1. What law would apply if I do not agree to this choice of law? That usually will be either where the real estate is located or where the contract was signed.
2. What law would apply if I do not agree to this choice of law? That usually will be either where the real estate use? State laws can vary in important areas such as the length of a statute of limitations or whether indemnification clauses are enforceable. Contracting parties should understand both what legal protections they are giving up and what they are gaining in the choice-of law-clause.
3. Is the choice-of-law clause enforceable? Some courts will not apply the law of a state that has no connection to the contracting parties or the contract. That is why the clause mentions that the connection between New York and one of the parties in that its corporate headquarters is located there. For some states, that connection may be enough to show a connection between the state and the contract. In other states, more may be required.

What are Conflict of Laws Rules?

The second part of the sample contract clause, which talks about “conflict of law rules[4]”, may not seem important, but it can make a difference in which law is applied. Each state has something called “conflict of law rules,” or rules that decide what law applies if the contract is silent. Those “conflict of law rules” are what an attorney or judge would use to decide what law would apply in response to question 1 above.

Suppose that our real estate contract is signed by an Ohio seller and a Florida buyer relating to real estate in Georgia has no choice-of-law clause. The parties, then, would be required use complex rules in the three states which had a connection to the contract, and they might find that the law differed depending upon which state’s conflict of laws rules were applied.

Conflict of laws determinations are based upon a variety of factors, including connection of the contract to a state (e.g., where the contract was signed and where the contract is to be performed) and what societal interests the various states have in the contract. Sometimes, it is even possible to have one state’s law apply to one legal issue and different state law apply to another legal issue in dispute.

With our contract between the Ohio seller and Florida buyer, suppose each party signing the contract in that party’s state of residence. Suppose the seller sued the buyer for breach of contract claiming the buyer reneged on the acquisition of the property. Buyer responds that the contract is invalid because specific formalities required for signing a contract under Florida law were not met. The court might choose to apply Florida law to Buyer’s defense about contract execution but Georgia law (the location of the property) to Seller’s underlying breach-of-contract claim. Meanwhile, both parties will be paying their attorneys just to determine what state’s law governs–without even getting to the underlying dispute!

Parties rarely are well-served by litigating choice-of-laws issues rather than getting to the core dispute. Further, lack of clarity on which legal rules apply can contribute to the likelihood of disputes when parties find themselves disagreeing on what rules should be applied to a particular circumstance. The parties are nearly always better off agreeing up front what law will apply and putting that language in the contract.

How to Choose a State for Your Choice-of-Law Clause

As long as there is a choice-of-laws clause, does it matter what state is listed? Frequently, yes. State laws do differ, making some laws more favorable for the parties in particular circumstances.

However, the selection of the state involves more than negotiating the most favorable law for one party or another. In our previous example, deciding that Nevada law would apply to the contract between an Ohio and Florida party with respect to the sale of Georgia real estate might not be enforceable, because many courts will require some minimal nexus to the state whose law is being applied.

Further, judges and attorneys are nearly always going to be most familiar with the laws of the state in which they practice. If a lawsuit were brought in Georgia in our example but the contract required application of Ohio law, that would require the attorneys and court to get up to speed on applicable Ohio law. The result likely would be increased legal fees and possibly, a less well-informed result.

Another reason to select a state’s law might be clarity on the state law. Some states, including Maryland where my office is located, do not have a huge body of court cases interpreting state commercial law. Other states, for instance, New York, have a rich history of commercial law. Parties might choose a state where there more applicable case law, which can increase the predictability of the result in a lawsuit. Many commercial lenders want their loan documents to be subject to New York law for this reason.

Don’t Ignore the Boilerplate!

A choice-of-law clause should not be overlooked as "boilerplate." Rather, the state law selected will depend upon the states involved, the type of contract, and the parties’ relative goals and negotiating power. Parties should work with their attorneys to make sure both that there is choice-of-law clause and that they understand the implications of the law they ultimately select.

© 2018 by Elizabeth A. Whitman

DISCLAIMER: The content of this blog is for informational purposes only and does not provide legal advice to any person. No one should take any action regarding the information contained in this blog without first seeking the advice of an attorney. Neither reading this blog nor communication with Whitman Legal Solutions, LLC or Elizabeth A. Whitman creates an attorney-client relationship. No attorney-client relationship will exist with Whitman Legal Solutions, LLC or any attorney affiliated with it unless and until a written contract is signed by all parties and any conditions in such contract are fully satisfied.

[1] In Western music, we typically see one of three possible clefs, which are placed on a “stave” consisting of five parallel horizontal lines. The three clefs are: a G clef (which circles around the G on the stave), an F clef (which has two dots, one on either side of the F on the stave), and a C clef (which circles around the C on the clef. Piano music is typically written with the top stave as a G clef (known as a treble clef because it represents higher notes) which is to be played by the right hand and an F clef (known as the bass clef because it represents lower notes) on the bottom stave, which is to be played by the left hand.

[2] In traditional Western music, there are 30 possible keys of music. There 15 possible key signatures, each of which can represent either a major or “relative” minor key. The 15 possible key signatures are comprised of either all sharps (up to a possible seven sharps) or all flats (up to a possible seven flats), plus no sharps or flats. There are no key signatures comprised of both sharps and flats. C major as many know, has no sharps or flats in the key signature. Its relative minor is a minor. Therefore, if I had seen no sharps or flats in the key signature, that would have tipped me off that the key was likely either C major or a minor, thereby narrowing the possibilities from 30 down to two.

[3] Sometimes composers will use an alternate clef for an instrument’s part when the instrument is being performed in the extremes of its range. The purpose of this is to enable the music to be written largely within the five staves, rather than by adding additional lines known as “ledger lines.” In this instance, the piano was to perform this entire portion of the composition very high on the keyboard, so the composer elected to write both the left-hand and right-hand parts were to be played in treble clef.

[4] Many attorneys will use the terms choice of law and conflict of laws interchangeably, and they have very similar meanings. For the purposes of this blog post, I will refer to the contract provision in which the parties choose a state law as “choice of law,” and the more general state law rules under which the applicable law is chosen as the “conflict of law” rules.