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Why You Should Care What Law Applies to Your Contract

Articles & Publications

July 20, 2011
By: Edward M. McNally
Delaware Business Court Insider

It is striking how often drafters fail to consider what law applies to the contract they write. This is true of even big contracts. For example, Directors & Officers insurance policies frequently fail to choose the applicable law, leaving the choice of law to depend on where the policy is written or the insured company resides. But to ignore the choice of law is to forego many possible advantages that the right choice may provide. This article touches upon those advantages in the context of two recent decisions where the result turned on the choice of Delaware law.

Choosing the right law for your client will always be the right choice compared to ignoring the issue. First, at least the choice may avoid costly arguments later. People argue over what law applies because it may make a real difference. Those arguments cost real money. Second, if you choose wisely, you will choose in favor of predictability. Trying to decipher the law of some jurisdictions (such as Saudi Arabia) can be very difficult. If you do not know for sure what the applicable law provides, then you do not know if what you wrote in your contract actually works as you thought. Third, you can often simplify a contract by choosing the law that applies. That saves money just in the drafting process alone.

What law, then, should you choose? Better to pick the law you know than to guess at what some other jurisdiction's law might be. That just is common sense. However, two recent decisions illustrate why you might want to consider Delaware law for your next contract. Indeed, Delaware law is now the preferred law in most merger and acquisition documents, even for those not involving a Delaware corporation. In that practice area, Delaware law is considered a neutral compromise when the parties are from different jurisdictions whose laws might otherwise apply but for the contractual choice of Delaware. Delaware M&A law is also well-developed and thus more predictable than the law in some other jurisdiction.

So why choose Delaware law for your contract? To begin with, if you choose Delaware law, you have a good chance your choice will be respected. The 3rd U.S. Circuit Court of Appeals' June 6 decision in Coface Collections v. Newton shows why that is important. Many states have statutes that nullify contracts restricting competition by former employees against their prior employer. In those states, an employee may walk out the door with years of important information to join a competitor. That is true of Louisiana, where Coface bought Newton's business and then sought to enforce a non-competition agreement to stop him from later competing with Coface. The Delaware District Court upheld the non-competition agreement because it had a Delaware choice-of-law provision and Delaware permits non-competition agreements. The court of appeals affirmed the choice of Delaware law and the injunction against competition that Delaware law supported. That was true even though the contract was signed in Louisiana by a Louisiana resident and Louisiana law would have nullified that contract provision. Thus, by choosing Delaware law, Coface obtained substantive advantages not available to it under the Louisiana law that by default would have otherwise applied.

This decision, in part, turned on a unique new Delaware statute, 6 Del. C § 2708. Under Section 2708, a Delaware choice of law provision in itself provides the proof of a "material and reasonable relationship with [Delaware] and shall be enforced whether or not there are other relationships with this state." That provision then provides the justification to apply Delaware law that used to be only found when some act or business actually occurred in Delaware. In short, by statute Delaware now provides for the enforcement of Delaware choice-of-law provision.

In addition to ensuring that your choice of law will be upheld, Delaware law has other advantages as well. For example, Delaware contract law is well developed and largely mirrors the general principles of contract law taught in law school. There are no big surprises. In particular, there are no hidden rules that affect whether a contract will be enforced or not, but instead a strong policy exists to let the parties bargain as they wish free of artificial restraints.

The Delaware Chancery Court case of GRT Inc. v. Marathon GTF Technology Ltd. decided July 11 illustrates this point. The issue in GRT was whether a joint venture agreement barred litigation over its representations after one year from the parties' closing on their deal. The Delaware court, applying Delaware law, upheld the one-year ban on litigation and dismissed the breach of contract claim. The court carefully explained that Delaware law permits the parties to a contract to limit the time to file suit and distinguished the law of other jurisdictions that would have rejected such a contractual limitation. Thus, by choosing Delaware law the parties affected their substantive rights and the court enforced that choice. That provided desirable certainty that fosters commerce.

Finally, it is important to note that these decisions and the Delaware statute do not require that any litigation be actually filed in Delaware for Delaware law to apply. To be sure the dispute ends up in Delaware, a forum selection clause together with consent to jurisdiction by a Delaware court from non-Delaware parties should be used as well. These clauses too are becoming more popular, but that is another story

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