REUTERS | Shailesh Andrade

Choice of law clauses: when you don’t get (just) the law you bargained for

Certainty and predictability are key considerations for any party entering into a commercial contract, and a key factor in this regard is knowing what law will be applied by a court called on to enforce the contract. Certainty as to the applicable law not only enables parties to anticipate how the contractual terms may be interpreted, but also enables them to ensure that the contract complies with any applicable mandatory requirements, so as to minimise the risk of it being unenforceable.

If you have agreed with a contractual counterparty that the law of a particular jurisdiction will govern the contract, you might think that you could comfortably assume that that will be the law applied should a dispute arise (to the exclusion of any other jurisdiction’s law). However, that is not always the case.

Two recent cases before the English courts have shone attention on a notable caveat to the general right of contractual parties to choose a governing law.

Article 3(3) Rome Convention

In the separate proceedings in Banco Santander Totta SA v Companhia de Carris de Ferro De Lisboa SA and Dexia Crediop SPA v Comune di Prato), the court was called on to consider the “mandatory rules” provision in Article 3(3) of the Rome Convention. (The Rome Convention contains the rules applied by EU member states’ courts to determine the governing law of contracts entered into before 17 December 2009. For contracts after that date, the Rome I Regulation applies, which reproduces Article 3(3) in substantially similar terms.)

Under both the Rome Convention and Rome I, the starting point is that a court should respect any choice by the parties as to the governing law and apply that nominated law. However, what is less well known by commercial parties is that this is subject to various qualifications, including under Article 3(3).

Broadly, Article 3(3) provides that, where a law is chosen to govern a contract but “all the other elements relevant to the situation at the time of the choice are connected with one country only”, the choice of law will not prejudice the application of any rules within the domestic law of that country that are “mandatory” (that is, rules that cannot be derogated from by contract).

Frequently, such non-derogable “mandatory rules” reflect consumer protections or other regulatory requirements which a jurisdiction has statutorily imposed across all transactions of a particular type (such as consumer information requirements or restrictions on clauses limiting liability). The policy rationale for Article 3(3) is to prevent such mandatory rules being simply circumvented by parties agreeing that a foreign law governs the contract. However, that policy can of course only be justified in the case of transactions over which it is reasonable to accept that the relevant jurisdiction should exert some control – that is, transactions that are properly considered domestic to that jurisdiction. The question of where that line should be drawn was effectively what was considered in the recent decisions, which examined the trigger requirement in Article 3(3) that “all the other elements relevant to the situation are connected with one country only”.

Both Dexia and Santander were amongst the numerous cases that have arisen since the global financial crisis involving disputes over interest rate swap contracts, where a bank seeks to recover payments due under such contracts and the counterparty seeks to avoid or set aside the contracts on various grounds. In both cases, the counterparty argued (amongst other things) that, apart from an express choice of English law to govern the swaps contracts, all other relevant aspects of the transactions were connected solely with the counterparty’s home jurisdiction (Italy and Portugal respectively) and that Article 3(3) of the Rome Convention therefore applied. They argued that, as a result, certain mandatory rules of Italian/Portuguese law allowed the swap contracts to be set aside.

The narrower approach

At first instance in Dexia, Walker J adopted a narrow approach to assessing whether all the other elements relevant to the situation (apart from the choice of English law) were connected with Italy alone. He approached the question by enquiring solely as to whether it was possible to identify any relevant elements connected with another country. Finding that there was no such connection with any other country, he concluded that all the relevant elements were connected solely with Italy, so that Article 3(3) applied. Accordingly, Italian mandatory rules applied and the swap contracts were set aside on that basis.

The broader approach

Nine months later, Blair J gave judgment in Santander. His refusal to apply Article 3(3) in that case was based upon a markedly different approach to the question of whether all the relevant elements were connected to Portugal alone.

In particular, he was prepared to take into account as relevant elements various factors that suggested an “international” transaction, as opposed to a purely domestic one. The elements he took into account included the fact that the parties had used the multi-currency cross border form of the International Swaps and Derivatives Association, Inc. (ISDA) master agreement, the international nature of the wider swaps market, and the existence of back-to-back hedging contracts that the bank had entered into outside Portugal. He therefore concluded that not all of the relevant elements were connected to Portugal, and refused to allow the Portuguese mandatory rules to be invoked.

Both decisions were appealed.

The broader approach adopted

The Court of Appeal came down firmly on the side of the broader approach adopted by Blair J.

In Santander (the first of the appeals to be decided), the court accepted that, as Article 3(3) is a limited exception to the basic principle of party autonomy, it must be construed narrowly. It agreed with Blair J that the elements that would prevent Article 3(3) from operating would include any elements that pointed to the contract having an international aspect, rather than a purely domestic one. In particular, relevant elements were not limited to those that had a connection with a particular foreign country.

Subsequently in Dexia, the Court of Appeal (now bound by its decision in Santander) accepted that, “[o]nce an international element comes into the picture, Article 3(3) with its reference to mandatory rules should have no application.” While the court in Dexia accepted that the international elements in that case were not as obvious as they had been in Santander, it concluded that they were “obvious enough”.

The Court of Appeal in Dexia refused permission to appeal to the Supreme Court.

A welcome clarification

It remains the case that, when drafting English law agreements, parties still need to turn their minds to whether all other elements relevant to the transaction point to a particular country other than England. However, the Court of Appeal’s confirmation that “an international element” will be sufficient to displace Article 3(3) should provide substantial comfort to commercial parties seeking predictability as to what laws will apply to their contracts (absent any different approach adopted by the Court of Justice of the EU, should it be called upon to consider the issue). As the court observed in Dexia, parties ought to know where they stand in swaps contracts regarding the possibility of mandatory rules overriding their chosen law – without them having to compare closely the facts of one case with another.

While there will of course be scope for argument in some cases as to whether a particular transaction is sufficiently “international”, the two decisions suggest a broad approach to that concept. Notably, the court in Santander observed that, while the transaction in this case involved both the use of the ISDA master agreement and the existence of back-to-back hedging contracts, the existence of either one of those factors on its own would have been sufficient for it to accept that the transaction had a sufficiently international element to preclude Article 3(3) being invoked.

The courts’ consideration of the back-to-back contracts also provides welcome confirmation that the elements that may be taken into account for the purposes of Article 3(3) are not limited to the details of the specific contract before the court. It is clear that the factors that may be relied on to demonstrate the international nature of the transaction extend to the surrounding circumstances of the transaction. That approach is clearly justified by the fact that Article 3(3) itself refers to “all the other elements relevant to the situation” (emphasis added), rather than all the other elements relevant to the contract.

The adoption of the broader approach is a commercially realistic recognition of the fact that, in the modern globalised world, a great many contracts that might first appear on their face to be primarily connected with a particular country are in fact more properly viewed as part of international business. To allow specific jurisdictions to impose controls on such contracts despite the parties’ choice of another law would be an unwarranted incursion on party autonomy and not justified by the policy underlying Article 3(3).

Herbert Smith Freehills Jan O’Neill

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