Wednesday, November 13, 2013

Applicable Law versus Governing Law

I had a major discussion about the use of “applicable law” and “governing law” and thought that I would share my thoughts with my readers.

Under “choice of laws” principals the parties to a contract can agree upon which law will be used for the interpretation of the contract in the event of a dispute. I refer to that as the “governing law”. It is the law that will govern the interpretation of the contract. The parties can also select the specific jurisdiction where they want the dispute to be heard. Further the parties may also specify the specific forum where they want the case to be heard within the specified jurisdiction. For example, the Governing Law could be the State of Delaware, the jurisdiction could be the State of New York, and the forum could be the Federal District Court in Lower Manhattan, New York, New York. Courts have the right to decide whether there is a nexus or connection between the case and the court to determine whether they “have standing” to hear the case. If they don’t find that connection, they may refuse to hear the case.

In most cases there will be a specific section within the contract that establishes the governing law, jurisdiction and sometimes forum. If no forum was specified, the case could potentially be filed either in a state court or Federal District Court within the agreed jurisdiction. The major difference between the two would are the court’s rules. In supporting the parties choice of governing law using the above example, the Federal District Court in Manhattan would interpret the contract using the Governing Law, which the parties agreed would be the State of Delaware.

When I refer to “Applicable Law” there are actually two basic types of applicable law. The first would be the laws of the jurisdiction where the work is being performed. In that the supplier is already legally obligated to comply with those laws. Still it is not uncommon for a Buyer's contract to have a statement of warranty that the work performed shall comply with applicable laws. This creates an obligation of conformance that runs to the buyer so if the supplier failed to comply with those laws, the buyer would have the right to claim breach and pursue damages they sustained as a result of the breach.

The second type of applicable law involves requirement that the product delivered or service performed complies with the laws of locations where it will be delivered or used. The ability to sell a product in another states will require compliance with the laws of that State. The ability to export or import products into other countries require compliance with the laws of those countries.

For example the European Economic Community enacted a law called RoHS, which was a Restriction on Hazardous Substances. This law set a time line after which products containing the specified substances were prevented from importation into the EEC and violators would be subject to significant fines and other sanctions. As a buyer of product that you intend to ship to other locations you need to ensure that not only do they meet the laws of where the product is produced, you also need a commitment that they will meet the laws of where they will be used.

As such its very clear to be specific when you use these words so it is clear what the intent is. For example in the example let's assume the following:
Governing Law was agreed to be Delaware
Jurisdiction was New York
Company A was headquartered in New York.
Company B was headquartered in California.
Company A manufactured the product in China
Company B wanted to buy the products for use in Texas and Colorado
Company A imported the products from China and stored them in a Warehouse in New Jersey

Company A has to comply with the Laws of New York State
Company B has to comply with the laws of the State of California
Company A, by manufacturing the product in China has to comply with the Laws of China
Company A, by exporting the product from China has to comply with the Chinese export laws.
Company A, be importing the product into the United States has to comply with the U.S. Import laws.
By selling the products for use in Texas and Colorado, company A has to comply with any U.S. Laws on the product and also for the individual sales must comply with the state laws.
As no transactions occurred in the State of Delaware there is no requirement to comply with Delaware state law, but Delaware state law would be used to interpret the contract.

If you used “Governing Law” that could limit the protection to only the governing law of the single jurisdiction you selected for interpreting the contract, Delaware, If you want compliance with the laws of more locations you would include a much broader statement. For example:
"Supplier is responsible for complying with all applicable laws that restrict, regulate or otherwise govern Buyer’s direct or indirect import, export, sale or other distribution of a product that is or contains Supplier’s Products or Deliverables."

Many supplier have concerns with "all applicable law" requirements as needing to potentially comply with laws of 180 plus countries. A common fall back solution I’ve used was to have a form of 80/20 compliance requirement listing the names of all the countries we wanted compliance with that also happened to be where we generated the majority of our sales. Most of the time the percentage was also the same countries where we had subsidiaries that needed to do import.