Choice of Law, Designation of Forum, and Senate Bill 171

100_3698-300x225.jpgTwo provisions commonly found in commercial contracts, particularly contracts between parties that reside in different states, are a choice of law section and a designation of forum section. The choice of law section specifies which state’s laws govern the contract, and the designation of forum section specifies the court in which lawsuits that arise from the contract are to be filed and litigated. Examples:

The laws of the state of _______ (without giving effect to its conflicts of law principles) govern all matters arising out of or relating to this Agreement, including, without limitation, its validity, interpretation, construction, performance, and enforcement.

Any party bringing a legal action or proceeding against any other party arising out of or relating to this Agreement shall bring the legal action or proceeding only in the United States District Court for the ______ District of ________ or, if that court does not have subject matter jurisdiction, in a state court of general jurisdiction sitting in ___________ County, __________.

When a lawsuit is filed and a question is raised as to which state’s law applies, the court first looks to its own state’s principles for deciding which law applies to a particular lawsuit. In most states, those principles will, with some exceptions or conditions, defer to the parties’ agreement on choice of law as set forth in the contract. Similarly, most states will give effect to the parties’ agreement that lawsuits must be filed and litigated in a particular court, again with some exceptions or conditions. A bill proposed in the current session of the Indiana General Assembly seeks to change that for contracts in which one party is a resident of Indiana or has a place of business in Indiana, for which the performance of the contract is to occur in Indiana, or for which a substantial part of the subject matter of the contract is located in Indiana.

Senate Bill 171 would invalidate contract provisions designating a forum outside of Indiana for a claim that arises within Indiana or requiring the contract to be governed by Indiana law for a controversy that arises within Indiana. Although on first blush that may appear to be favorable to Indiana businesses, it will actually make it more difficult for Indiana companies to do business with companies in other states.

There are good reasons to include choice of law and designation of forum provisions in contracts. They are not merely boilerplate clauses that the party who drafts the contract inserts to gain an advantage over the other party. Instead, both clauses reduce the likelihood and expense of litigation, and parties to contracts often negotiate them very carefully.

A choice of law provision has consequences that begin well before a lawsuit is filed or even if a lawsuit is never filed. Different states have slightly different laws regarding contracts, and the answer to a question regarding the meaning of a particular contract term, or the consequences if that term is breached, depends on which state’s laws govern. Unfortunately, the answer may depend on where the lawsuit is ultimately filed because the court will first look to its own principles to decide what state’s law controls. Although those principles are relatively consistent from state to state, they are not identical. As a result, the lawyer asked for an opinion about the parties’ rights or obligations under a contract may have to give more than one answer, one for each state in which a lawsuit may be brought. Including a choice of law provision in a contract reduces the uncertainty in predicting how a particular lawsuit may come out, and it reduces the cost of litigation by removing a threshold question the court must answer.

When parties negotiate a choice of law provision, they are usually not trying to gain an advantage over the other side because it is impossible to predict in advance which state’s laws may favor which particular party should a dispute arise. Instead, most lawyers want a choice of law provision that designates the laws of a state with which they are familiar, reducing the chances of unexpected surprises.

In contrast, a designation of forum clause can favor one party over the other through “home court advantage.” Some people believe that juries are likely to favor home-state litigants, and there may be some truth to that. In any event, the location of the litigation can affect the cost. It will likely cost an Indiana resident less to litigate a case in Indiana than to litigate the same case in, say, New Mexico, and vice versa. If nothing else, travel expenses can be considerable. For that reason, contracts sometimes require litigation to be brought in a state in which neither party resides in order to keep a more level playing field.

Designation of forum clauses also reduce the likelihood of litigation because, without one, the party who files the lawsuit picks the court in which the case is filed. That can create a “race to the courthouse” in which each party tries to sue the other first. An advance agreement on the location of the litigation reduces the incentive to file a lawsuit quickly, giving the parties more time to negotiate a resolution of a dispute without going to court.

Senate Bill 171 seeks to deny Indiana companies the freedom to contractually specify which law will apply to a contract and where disputes will be litigated, making it less attractive for companies in other states to do business in Indiana. Hoosiers and Hoosier companies are perfectly capable of looking after their own interests when negotiating contracts, and they don’t need the General Assembly to interfere with those agreements, especially when that interference will ultimately work to the detriment of Indiana residents and businesses. We hope Senate Bill 171 dies a quiet death in committee.