proper law of the contract

Every contract must be governed by a system of law. In the absence of any express or implied choice of law to be applied to interpret an agreement between contracting parties, English common law developed a test to determine which system of private law would be used to govern the interpretation of the contract. This test determines what is known the proper law of the contract.

Determining the Proper Law of a Contract

In the case that the contract does not contain an express selection of law to be applied to the contract, the court may take into consideration the text of the contractual document to determine whether the parties may be said to impliedly agreed the system of private law that would apply to disputes. Selection of jurisdiction of court within which proceedings would be brought (known as a jurisdiction clause), arbitration clauses, references to regulations or by-laws of a particular country, the currency in which sums are to be paid under the contract, the form of the documents, the language used in the contractual document give guidance as to whether the parties have impliedly agreed to a system of law to govern the contract.

In the absence such express or implied agreements, English common law will determine the proper law of the contract to be the system of private law which “the transaction has the closest and most real connection”. This is an objective test to be ascertained by all the circumstances of the case. Amongst the factors that a court will consider in determining the system of law that has the closest and most real connection are:

1. where the contract was made;
2. the place of performance of the obligations arising under the contract;
3. the place of incorporation of the incorporated entities to the contract;
4. place where any security to taken; and
5. whether the contract is associated with another contract that does contain a choice of law.

That system of law is known as the lex contractus, namely the law used to resolve substantive disputes between the parties in respect to the particular contract. It would apply to the interpretation of the contract from the time that the contract was formed. Having said that, in rare cases, it may be appropriate for a court to order that more than one system of law applies to a contract, where the nature and type of obligations are distinct and severable from the remainder of the obligations.

Selecting the Proper Law

Under the applicable common law principles, choice of law clauses would not at liberty to arbitrarily select systems of law that bore no connection to the contract or its performance; further courts would not apply a foreign system of law if it were contrary to public policy.

Integration with the European Union has encroached upon these traditional rules where the contract has some nexus between England and another state of the European Union. English common law has been superseded since 1991 by the Contracts (Applicable Law) Act 1990 to determine the proper law of the contract. These traditional rules were reformulated after the passage of the Contracts (Applicable Law) Act 1990, which implemented the Rome (EC) Convention on the Law Applicable to Contractual Obligations 1990 (the “Rome Convention”). The Rome Convention applies to contracts entered into after 1 April 1991 and before 17 December 2009. Thereafter, Rome I Regulation applies to resolve choice of law issues in contracts to which it applies.

The test still relevant in international disputes and litigation, and the test applies for contracts where one of the contracting parties is said to be outside the European Union. if the proper law of the contract is found to be English law, English Courts have jurisdiction to hear and determine the dispute.