What is a Choice of Law clause?

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A choice of law clause, also called a “governing law clause” or “proper law clause,” is a clause used in contracts to identify the type of law that should be applied to interpret the contract.  Since the laws of various countries can differ in how they interpret contracts, without a choice of law clause, a contract may be valid when interpreted under one country’s laws but may be found invalid under the laws of another country.

Since international business transactions by definition involve two countries, and therefore two different systems of law, it is very important to specify which country’s laws will apply to the contract in the case of a breach.  Without a choice of law clause, whichever court or arbitrator hears the case will need to decide the governing law, making predicting the outcome of a dispute very difficult and preventing businesses from adequately planning for the future.

A choice of law clause will apply even if the litigation or arbitration arising out of the contract takes place in a foreign country.  For example, a contract specifying Japanese law as the governing law will mandate that Japanese law be applied even if the contract is eventually litigated in a different country.  In some international contracts, parties will purposefully specify a neutral country’s laws to be applied to the contract.  Picking a jurisdiction with well-developed contract law, such as New York or California may be preferable to using the laws of the contracting parties’ jurisdictions if their countries do not have a strong basis of contract law or stable judicial system that can provide the predictability that businesses look for.

If you have any questions about contracting in Japan, please contact our office to set up a legal consultation.