There Is More to a Choice-of-Law Clause Than Filling in the Name of the Selected State

There Is More to a Choice-of-Law Clause Than Filling in the Name of the Selected State


Choice-of-law clauses are part of the much-maligned miscellany that are consigned to the back of a merger or acquisition agreement. As long as the clause purports to select the law of the state chosen by the parties, why worry about the details of the exact words used to select that chosen law? Indeed, with all of the complex issues requiring attention at the front of the agreement, many consider it the M&A equivalent of “bikeshedding”[1] to spend any time on such trivial issues as the specific wording of a choice-of-law clause. But when disputes arise regarding the front part of that complex merger or acquisition agreement, the exact wording of that otherwise trivial choice-of-law clause can actually be outcome determinative. And many deal professionals and their counsel remain blissfully unaware of the impact slight changes in the wording of a choice-of-law clause can have—i.e., does the chosen state’s law apply to only contract-based claims, or to all claims arising out of the parties dealings related to the agreement (whether based in contract or tort), and does the chosen state’s statute of limitations apply to the substantive cause of action (whether in contract or tort), or does the statute of limitations of the forum state (when different from the chosen state) apply, even when the forum court is otherwise applying the substantive law of the chosen state?

A remarkable number of M&A agreements continue to use what should now be considered outdated language that fails take into account the caselaw requirements for maximizing the effectiveness of a choice-of-law clause.[2] Although not involving an M&A agreement, a recent Delaware Superior Court case, Arkray America, Inc. v. Navigator Business Solutions, Inc., 2021 WL 2355234 (Del Super. June 9, 2021), illustrates this phenomenon and provides an opportunity to reinforce the importance of broadly wording your choice-of-law clause to select all of the internal law of the chosen state.

In Arkway America, Arkway entered into two separate agreements with two different parties regarding the licensing of software and certain consulting services related thereto. One agreement was governed by Utah law and one agreement was governed by Delaware law. When the system required to be developed pursuant to those agreements did not perform as Arkway expected, Arkway sued the two counterparties for breach of contract and fraudulent misrepresentation (as well as certain statutory actions). Among the issues to be decided by the court was whether the chosen law in each agreement governed just contractual claims, or also governed tort claims (like fraud) as well.

The two choice-of-law clauses were substantially similar (except for choosing Utah law in one and Delaware law in the other) and each utilized the old-fashioned formulation: “[This Agreement] shall be governed by and construed in accordance with the laws of the State of [Utah/Delaware].” Recognizing that there was “divergent precedent in Delaware”[3] on whether this old-fashioned formulation applied broadly to “all claims between the parties,” or only applied to “contract-based claims,” the court concluded that this formulation of a choice-of-law clause was “narrow and appl[ied] only to the contract-based claims,” not to the tort or statutory claims.[4]

In this particular case, this ruling did not have an outcome determinative effect because it turned out that the laws of all of the potentially applicable states that would govern the tort and statutory claims did not conflict with the chosen state’s law applying to the contract claims—i.e., there was no real difference between the laws of the potentially applicable states. But that is not always the case. In fact, there can be significant differences between the law of the chosen state in a choice-of-law clause, and the law of a state that might otherwise be applicable absence a valid choice-of-law clause. This is particularly true with respect to tort-based claims, especially with respect to what is required to constitute a valid disclaimer of reliance upon a purported extra-contractual representation (or even if such a disclaimer is possible at all). If the choice-of-law clause validly selects both the tort and contract law of the chosen state, then the chosen law should apply to both contract claims and tort claims (not the law of some other state in which some aspect of an alleged tort occurred). But if the law of a state potentially applicable to a tort claim arising from a contractual relationship does not recognize the validity of a non-reliance clause to eliminate alleged extra-contractual misrepresentations, and your choice-of-law clause is limited to only contract claims, your non-reliance clause could well be construed under the chosen state law, but be wholly ineffective under the law applicable to the tort claim.[5]

And making sure your choice-of-law clause covers both tort and contract claims arising from the agreement is not the end of the issues requiring specific drafting. Even if you properly select a specific state law to govern any disputes arising in tort or contract out of your contract, that does not mean that you have necessarily selected the statute of limitations of that chosen state to govern any cause of action that may be brought by a party to the agreement (whether in contract or tort). Because of some historic peculiarities of the common law, statutes of limitation are considered procedural law in most states, not substantive law; and choice-of-law clauses are generally viewed (in the absence of specific language to the contrary) as only choosing the substantive law of the chosen state.[6] As an example, in Pivotal Payments Direct Corp. v. Planet Payment, Inc., 2015 WL 11120934, at *3 (Del Super. January 4, 2016), the court held:

Under Delaware law, choice-of-law provisions in contracts do not apply to statutes of limitations, unless a provision expressly includes it. If no provision expressly includes it, then the law of the forum applies because the statute of limitations is a procedural matter.

As a result, because the claims had been brought in a Delaware court (the law of the forum), the court applied Delaware’s three-year statute of limitations, instead of New York’s six-year statute of limitations, to breach of contract claims arising from an agreement containing a choice-of-law clause selecting New York law.

Similarly, in Reclaimant Corp. v. Deutch, 211 A.3d 976 (Conn. 2019), the Supreme Court of Connecticut held that Connecticut law (as the forum state) applied, rather than Delaware law, to the “timeliness of [plaintiff’s] unjust enrichment claims” arising from distributions made to limited partners from a Delaware limited partnership, notwithstanding that the limited partnership agreement’s choice-of-law clause stated that Delaware law was to govern the agreement (and the rights and liabilities of the parties); and under Delaware law the claim was clearly beyond the applicable limitations period.[7] Thus, in Pivotal Payments,by failing to specify that the statute of limitations of the chosen state was selected to apply, in addition to the substantive law of the chosen state, a claim that would otherwise have remained enforceable under the chosen state’s statute of limitations, was instead barred by the forum state’s statute of limitations. And, in Reclaimant Corp., the opposite occurred—a claim that would have been barred under the chosen state’s statute of limitations was instead allowed to proceed under the forum state’s statute of limitations.

In most cases, of course, this procedural/substantive distinction can be avoided by ensuring that your agreement includes both a broad choice-of-law clause selecting the chosen state’s law, and a broad forum selection provision that selects the courts of the same state as is chosen in the choice-of-law clause. Had the agreement in dispute in Pivotal Payments selected New York as the forum (instead of Delaware) and had the agreement in dispute in Reclaimant Corp. contained a Delaware forum selection clause, there would presumably have never been any different forum court applying its own procedural statute of limitations to disputes otherwise governed by another state’s law. But it always a good practice to cover the issue in the choice-of-law clause as a backup if a non-selected forum somehow becomes involved.

If you think we now should be done building the seemingly simple bike shed that is the choice-of-law clause; sorry, not quite yet. Even if you get all of the above right, there is still the troubling issue of borrowing statutes. Borrowing statutes are statutes that exist in about half the states, including New York, that require a forum court to “borrow” the statute of limitations of the state where the cause of action actually arose if that statute of limitations is less than the applicable statute of limitations in the forum state.[8] Borrowing statutes were enacted to prevent plaintiffs from “forum shopping” for longer statutes of limitations than those in the state where the actual cause of action arose.[9] Thus, in 2138747 Ontario, Inc. v. Samsung C&T Corp., 103 N.E.3d 774 (N.Y. 2018), New York’s highest court held that a breach of contract claim arising from a non-disclosure agreement containing a New York choice-of-law clause and brought in a New York state court was “time-barred pursuant to Ontario’s two-year statute of limitations.” The reason: New York’s procedural law included its borrowing statute and pursuant to the borrowing statute, Ontario’s two-year statute of limitation applied because the breach arose in Ontario and Ontario’s two-year statute of limitations was less than New York’s six-year statute of limitations. Thus, if you want to choose New York substantive law and its procedural statute of limitations, but avoid application of the borrowing statute that might apply some other statute of limitations, you need to say so.[10]

And finally, despite the fact that it is widely used and was in response to an outlier case almost 75 years ago, there is no particular reason to add the following provision to your choice-of-law clause: “without regard to conflict-of-laws principles.”[11] The same effect can be achieved by making clear that the laws you are choosing are only the “internal laws” of the chosen jurisdiction. Moreover, the idea that a court would enforce a choice-of-law clause only to then apply the chosen law’s conflict-of-laws principles to then apply the law of some other jurisdiction that would be applicable absent the choice-of-law clause was declared absurd many years ago by an eminent practitioner; and New York’s highest court has also stated that this language adds nothing to a New York choice-of-law clause.[12]

Where does this leave us? Where we have been at least since 2009, a need to revise our choice-of-law clauses so that all of the internal law of the chosen state will apply. Why, 2009? Well, that is when, according to certain U.S. scholars, there was an “exogenous shock” resulting from articles published on both sides of the Atlantic that encouraged practitioners to revise their choice-of-law clauses to address the non-contractual claims issue.[13] Our English colleagues should be pleased to note that these scholars give higher marks to the English lawyers response to these calls for revision than they do U.S. lawyers, at least with respect to bond indentures governed by New York and English law respectively.

So, what should a newer more modern choice-of-law clause look like that addresses all these hidden complexities? Certainly, there are more and more good examples now available in recent publicly filed M&A agreements, but here is one of my own (which is only slightly revised from the suggestions made in a 2009 article):

Governing Law. This Agreement, and all claims or causes of action (whether in contract, tort or statute) that may be based upon, arise out of or relate to this Agreement, or the negotiation, execution or performance of this Agreement (including any claim or cause of action based upon, arising out of or related to any representation or warranty made in or in connection with this Agreement or as an inducement to enter into this Agreement), shall be governed by, and enforced in accordance with, the internal laws of the State of [ ], including its statutes of limitations[, without regard to any borrowing statute that would result in the application of the statute of limitations of any other jurisdiction].[14]

Because choosing all of the internal law of the state the parties select as the governing law of their agreement and relationship really can matter, we need to treat choice-of-law clauses with more respect. While they do not involve the complexities inherent in a lot of other provisions of an M&A agreement, and they are not, therefore, the equivalent of building a nuclear power plant, they are much more complicated than simply building a bike shed to park workers’ bicycles at that plant.

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