M&A Vocabulary – Understanding Experts: Choice of law clauses

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give or refresh a basic understanding of a term and provide some useful tips from our consultancy practice.

What are choice of law clauses and why are they important?

In the context of M&A transactions, it often happens that they reflect, in whole or in part, matters that extend to several countries (i.e. also jurisdictions). For example, the buyer and the seller may be based in different countries, or parts of companies or subsidiaries of a corporate group to be acquired, may be scattered over several countries. These circumstances give rise to the so-called legal "ties", which then, based on the complex Conflict of Laws rules in the individual jurisdictions, answer the question as to which law should be applied to interpret a contract. The answer to this question may be critical in respect of the enforceability of contractual claims, as each jurisdiction interprets contractual provisions differently and may set different limits to the contractual arrangements made between the parties.

In this respect, it is common and advisable to agree on a choice of law clause in contracts that have a foreign nexus. In doing so, the parties deliberately and expressly agree on the national law governing the contract in order not to be subject to the complex Conflict of Laws rules of private international law (and the time-consuming and costly enforcement of claims and rights under such rules) and thus avoid any uncertainties with regard to the interpretation of the contract.

Are the parties free to choose any law they want?

In most jurisdictions, the parties are free to choose the law they want to govern their contractual relationship. Nonetheless, it is advisable to check this on a case-by-case basis because especially in some non-European countries this freedom of choice is limited also in M&A transactions. Such limitation can lead to situations where, based on the law of a given country, local courts unexpectedly turn out to have jurisdiction over the contract and local law applies, which, in turn, can lead to unexpected implications for the interpretation of the contractual provisions. Also in European jurisdictions there are certain matters that are not subject to the parties' freedom of choice of law, e.g. certain claims arising from competition law or industrial property rights.

Is there a "right" and "wrong" choice of law?

In many cases, the choice of applicable law will be obvious because both parties are familiar with the legal system of a respective country or also because the market or the industry uses certain specific and customary agreements. It is advisable for the parties to align the choice of law and the jurisdiction clauses in order to avoid a situation where a court in country A has to apply the laws of country B that are unknown to it, which often leads to complications and the need for obtaining expensive legal opinions. Finally, there may also be technical reasons for incorporating a choice of law clause, e.g. if a complex transaction requires using the instruments of "trust" or "escrow" in a particular way that is known only under one particular jurisdiction. Beyond these practical aspects, only a close examination of the individual case will answer the question of which law is most favourable for a particular party in a particular scenario. 

What aspects of the choice of law clauses should be considered?

As in all contractual clauses, care should be taken to ensure that the wording is as precise as possible. Thus, the parties should choose a law that actually can be applied, e.g. not the law of the United States, but the law of the State of New York. In addition, the choice of law clause should address the question of whether the choice of law is limited exclusively to the enforcement of contractual claims or whether it includes, for example, tort claims that are connected to the contractual relationship (e.g. any duties of care during contractual negotiations).