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Why you need the right choice of law clause in your contract

Most contracts have a choice of law provision which identifies the state law which will apply in actions brought under the agreement. Often this clause isn’t given a lot of attention until there is a dispute. However, the choice of law can have a big impact on how a contract is interpreted and enforced so it’s crucial to consider carefully what law to use.

Choice of law provisions are especially important where the parties are from different states and there are significant differences between the laws of one state versus another. For example, the state of Arizona has a provision which provides for a mandatory award of attorney’s fees to a prevailing party in a contract action. To the contrary, New York generally requires each party to bear responsibility for their own fees unless a contract provision provides otherwise.

Typically, the party drafting the agreement will select the state where it is located as the law that will apply. However, the parties can decide to use another state’s law with some limitations on what state can be chosen. For instance, in order to enforce a choice of law provision in New York, generally the jurisdiction chosen must have a “reasonable relationship” to the agreement. However, there is an exception. If you are a party without New York contacts, you can still select New York law if the value of the transaction exceeds $250,000. This rule recognizes that New York is a commercial center and parties want predictability in knowing their choice of law will be enforced.

New York is not always as forgiving when it comes to applying the law of another state. The Court of Appeals has recognized a New York court’s ability to set aside a choice of law provision where the law of the selected jurisdiction offends a “fundamental public policy” of New York. This exception only applies to foreign laws which the court finds to be “truly obnoxious” or violative of “some prevalent concept of good morals.” For example, New York courts have refused to enforce a choice of law provision in cases related to gambling. Surprisingly, it has also applied this rule to cases involving enforcement of a non-compete agreement.

Choice of law clauses can have a big impact on how a contract is enforced. For parties entering into a transaction where there are contacts in multiple states, a qualified contract attorney should be consulted to assess the possible benefits of choosing one state over another. Similarly, if a party is seeking to enforce a contract or is facing an enforcement action regarding a contract containing a choice of law provision, experienced litigation counsel may be able to avoid the impact of such a provision.

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