Governing Law: Small Clause, Big Stakes
Yes, a governing law provision in a cross-border commercial contract may not be the juiciest part of the contract. And many believe it is a boilerplate provision, and it is often overlooked. However, the choice of the law governing the commercial contract could have a material impact on the outcome of a dispute relating to such contract.
Greater certainty provides greater confidence
In a commercial context, laws and regulations provide certainty (or, at least a greater certainty) as to what activities may be undertaken by, and the rights and obligations of, a person, company, partnership or other legal entity in relation to a commercial transaction. For example, promulgations of The Hong Kong Limited Partnership Fund Ordinance (the LPFO) and the Variable Capital Companies Act 2018 (the VCC Act) have fueled significant increase in fund establishments in, and capital inflows to, Hong Kong and Singapore, respectively, in recent years. Prior to the LPFO and the VCC Act becoming effective, Hong Kong and Singapore did not have a bespoke fund formation statute and domestic corporate fund vehicle, respectively.
Separately, while there is a growing acceptance of digital assets, I would argue that, with the adoption of new laws and regulations (such as the Digital Asset Market Clarity Act) would provide further clarity (yes, pun intended) as to how digital assets, and transactions and rights related thereto, are regulated (such as whether a digital asset is a security or commodity and what laws and regulations apply to it). A greater certainty of laws should provide further confidence to parties engaging in commercial transactions that are subject to such laws.
When choosing a law that governs a commercial contract, the same logic should apply. What law provides the best certainty as to the intended interpretation of the terms of such commercial contract, a party’s rights and obligations thereunder, remedies and enforcement?
Well, let’s remove some of the easy items off the table. For major cross-border commercial agreements, the most common governing law choices are New York law and English law. This is because those laws, in general, provide the best certainty of intended outcome in a commercial contract dispute as further described below.
Another case is a commercial transaction where one party has a greater leverage over the other party. In such a case, it is highly likely that the former’s choice of governing law will prevail. For example, if a small-sized manufacturer of widgets is entering into a supply agreement for the first time with Apple, it will very likely have to sign a template supply agreement prepared by Apple with an already chosen governing law.
In other cases of cross-border commercial contacts that involve parties with similar levels of leverage, how do you choose the governing law from hundreds of possible choices?
Common law vs civil law
National legal systems today are generally based on common law or civil law. Some national legal systems are based on religious law or a combination common law, civil law and/or religious law. For the purposes of this article, discussions of such national legal systems will be excluded. Common law countries include the U.S., England and Wales, Hong Kong and Singapore. Civil law countries include France, Germany, the PRC, Japan and Korea.
A key difference between common law and civil law systems is that a common law system follows the doctrine of judicial precedent (stare decisis). Broadly, lower courts are generally bound by relevant decisions of higher courts, and a prior court decision must be followed or given sufficient weight in later cases involving same or very similar facts or legal issues. Therefore, a common law system with a rich history of precedent cases on commercial issues would provide a greater certainty as to the intended interpretation of the terms of a commercial contract, a party’s rights and obligations thereunder, remedies and enforcement. For this reason, among others, New York law and English law are the most common governing law choices in cross-border commercial contracts. Traditionally, New York law was chosen for US-centric transactions and English law for non-US-centric international transactions. In recent years, however, that line has begun to blur.
For a cross-border commercial contact involving a party or parties incorporated or resident in Asia, should New York law or English law be the default choice? That depends. In addition to choosing the governing law, one will need to consider the forum (i.e. a court or arbitration, and the chosen place/seat) for the dispute resolution and the enforcement strategy (i.e. where the counterparty and its assets are based and whether the resulting court judgement or arbitral award can be enforced there). In addition, if the commercial transaction involves taking security over certain assets of a party, the choice of governing law will depend on the type of assets and where those assets are located, among other things. This is a completely different ball game and beyond the scope of this article.
A key factor in choosing the place of forum for a dispute resolution and, in turn, the governing law, is cost. For example, if all parties to a cross-border commercial contract are incorporated or resident in Asia, the cost of resolving a dispute in New York City or London would be much higher as compared to doing so in Asia, such as in Hong Kong or Singapore. In addition, if the chosen court or the arbitrator is not competent to preside or arbitrate over the chosen governing law, there may be additional cost of hiring a legal expert of the chosen governing law. For example, if the parties choose Hong Kong to resolve a contract dispute and the chosen governing law is New York law, a New York law expert may need to be appointed.
Hong Kong and Singapore laws are on the rise
Hong Kong and Singapore are leading common-law jurisdictions in Asia. Their roles as financial and commercial centres, together with their developed bodies of commercial case law, have contributed to wider use of Hong Kong law and Singapore law in cross-border commercial contracts in the region. If majority of the parties to a cross-border commercial contracts are incorporated or resident in Asia and/or familiar with Hong Kong or Singapore law, such law could be a sound alternative the default choice of New York law or English law as the governing law of a commercial contract.
Forum and enforcement
As for the forum for a dispute resolution and enforcement strategy, each of these topics warrants its own article. But here are few rules of thumb to consider:
a court vs an arbitration: arbitration may offer confidentiality, procedural flexibility and specialist decision-makers. A court litigation may be preferable where a dispute requires urgent judicial remedies, public precedent or the participation of multiple parties that are not bound by the same arbitration agreement. Unlike a court case, an arbitration award does not create a binding precedent.
enforcement: a court judgement or an arbitration award from one jurisdiction does not mean that it is automatically enforceable in another relevant jurisdiction (such as where the counterparty is incorporated or their assets are located). One should form a strategy based on multilateral or bilateral treaty, reciprocity or relevant procedural laws on recognition and enforcement of a foreign court judgement or arbitration award. Hong Kong and the PRC have a reciprocal recognition and enforcement of judgement in civil and commercial matters. A point to note for this reciprocity is that the commercial contract must specify that a Hong Kong or PRC court has exclusive jurisdiction over any dispute arising from that commercial contract.
John Lee, Registered Foreign Lawyer
John is a highly experienced capital markets and finance lawyer with more than two decades advising on complex, cross‑border financing transactions across Asia, including Korea, Hong Kong, the PRC, the Philippines, Thailand, Indonesia and Mongolia. Learn more about John here.
