Editor’s Note: This article was originally published in CLI sister publication Corporate Counsel on Oct. 23.
Contractual choice-of-law provisions are one of the most frequently used yet repeatedly misunderstood provisions in modern contracts. In-house counsel and other practitioners frequently assume—often incorrectly—that a “standard” choice-of-law provision will cover all claims and issues. However, several recent decisions make clear that this is not the case. In-house counsel should take heed of the lessons derived from those opinions so as not to be caught off guard by choice-of-law provisions that fall short of expectations.
Consider the following scenario: a company enters into a contract and chooses to have New York law applied to any disputes that may arise. Its in-house counsel thus drafts the following seemingly broad choice-of-law clause:
“This Agreement shall be deemed to be executed and to be performed in the State of New York, and shall be construed in accordance with the laws of the State of New York as to all matters, including but not limited to matters of validity, construction, effect, and performance.”
Litigation ensues. The opposing party interposes tort causes of action relating to the performance of the contract. The company is not concerned because New York law is clearly in its favor. But is this choice of law clause broad enough to cover tort claims that arise from the performance of the agreement?
This summer, in Innovative Biodefense Inc. v. VSP Technologies Inc., the Southern District of New York was presented with this question and answered “no.” Despite the seemingly broad “all matters” language, the District Court found that the choice-of-law provision was not sufficiently broad to encompass the tort claims.
Innovative serves as a reminder that the intricacies of choice-of-law provisions can trip up drafters and litigators alike. This article explores three pitfalls that should be on every in-house counsel’s radar when dealing with choice-of-law provisions.
1. WORDS MATTER
The Innovative opinion is informative on two levels. First, although we do not know the intent of the drafters, we do know that the language they used—“as to all matters”—was not broad enough to capture tort claims. According to the court, the broad “all matters” language could not overcome the narrowly worded opening phrase of the choice-of-law clause—i.e. the reference to “[t]his agreement.”
New York courts consistently hold that choice-of-law provisions referring to the “agreement itself” are too narrow to cover noncontractual claims. Accordingly, parties that wish to control the law to be applied to all matters, including tort claims, would do well to employ the “magic words”—“arising out of or related to the agreement” or “arising directly or indirectly from the agreement.”
An extra degree of certainty can be attained by also specifying the law that will govern threshold issues, such as enforceability and scope. By including language about “scope,” the drafter can ensure that the interpretation of the choice-of-law clause itself will be performed under the law of the chosen state as opposed to the law of the forum. Of course, it would never hurt to add the phrase, “including tort claims,” to your choice-of-law clause.
Second, Innovative teaches that counsel must pay careful attention to the wording of similar clauses found elsewhere in the contract. For example, in further support of its holding in Innovative, the District Court compared the choice-of-law clause with the more expansive forum-selection clause also contained in the parties’ agreement. The latter clause provided that “[i]n the event of any controversy, claim or dispute between the Parties hereto arising out of or relating to this Agreement, such controversy, claim or dispute may be tried exclusively in the courts of the State of New York[.]” The court reasoned that use of narrower language in the parties’ choice-of-law clause, as compared to the forum selection clause, indicated an intent that the former should be read more narrowly. Thus, the Innovative opinion provides a clear warning that the scope of choice-of-law provisions will be interpreted not only according to the language they include, but also with consideration to language that is excluded. In short, words matter. Choose them thoughtfully.
2. BEWARE OF THE BORROWING STATUTE
Assume that in the context of a contractual dispute, a choice-of-law provision is deemed enforceable as to all claims. That result still may not answer the question of which statute of limitations will apply as between several states.
Take, for example, the situation in Chiste v. Hotels.com, a class action with three named plaintiffs, each residing in a different state. There, the agreement at issue contained the following choice-of-law provision:
“This Agreement and its performance shall be governed by the laws of the state of Texas, United States of America, without regard to its conflict of laws provisions.”
When an action with respect to the agreement was brought in the Southern District of New York, the court upheld the enforceability of the parties’ Texas choice-of-law clause. Despite this holding, the court did not apply Texas’s statute of limitations to the plaintiffs’ claims. Rather, it applied New York’s shorter statute of limitations to one claim and Wisconsin’s shorter limitations period to another claim.
How did that happen?
In diversity cases, the court will apply the choice-of-law rules of the forum state in order to determine which state’s statute of limitations will apply. Enter New York’s “borrowing statute,” which provides that when a cause of action accrues to a non-New York resident plaintiff, outside of New York, the court must apply whichever statute of limitation is shorter—New York’s or that of the state where the cause of action accrued.
Application of the borrowing statute in Chiste led to a most unexpected outcome. Under New York law, a cause of action for economic injury—which was at issue in Chiste—accrues where the plaintiff resides, in this case Wisconsin. Therefore, applying the New York borrowing statute required the court to consider which state—New York or Wisconsin—had the shorter statute of limitations as to each claim. The result? The court applied New York’s three-year statute of limitations to plaintiff’s conversion claim and Wisconsin’s two-year statute of limitations to plaintiff’s breach of fiduciary duty claim.
So much for the parties’ choice of Texas law.
3. ENFORCING ARBITRATION AWARDS: KEEP AN EYE ON FEDERAL LAW
Congress enacted the Federal Arbitration Act (FAA) specifically to ensure that private agreements to arbitrate are enforced according to their terms. Now, assume that the parties include a choice-of-law clause in their contract that broadly states that New York law will govern all matters arising from or relating to their agreement and/or its performance. Will New York law or the FAA apply to enforcement of an arbitration award? The answer is the FAA.
New York courts have held that a general, albeit broad, choice-of-law clause is insufficient to demonstrate the parties’ intent to modify or supplant the rules and enforcement provisions of the FAA. Rather, as the New York Court of Appeals found in Diamond Waterproofing v. 55 Liberty Owners, a more explicit statement of the parties’ intent is required. For example, a provision stating that both the agreement “and its enforcement” are to be governed by New York law would suffice.
Courts have subsequently clarified that where an arbitration clause itself demonstrates a clear intent to apply New York law, Diamond Waterproofing’s “enforcement” language is not an absolute requirement. However, one case in the same court—McQueen-Starling v. United Health Care Group, Inc.—held to the contrary. So, a word to the wise: Even if your choice-of-law clause is explicit in applying state law, the FAA might still apply at the arbitral award enforcement stage.
The foregoing are but a few issues to consider when drafting a choice-of-law provision. They serve to demonstrate that the greatest pitfall facing practitioners is the knee-jerk assumption that a standard choice-of-law provision will unequivocally establish the law to be applied to all issues arising from, or relating in some way to, the contract. Do not make that mistake.
John Calandra and Michael Dillon, partners in the law firm of McDermott Will & Emery, focus their practices on complex commercial litigation. Lisa Gerson is a litigation associate at McDermott Will & Emery, with a focus on complex commercial, environmental, and products liability litigation matters.