Drafting A Choice of Law Provision

Consider All Aspects & State Revisions

Annual Funding Source Issue

Drafting a choice of law provision is not as easy as it seems if you assume the Uniform Universal Code (UCC) is ‘universal’ in all states. But it isn’t. Therefore, one needs to be extra vigilant in writing these provisions to ensure the outcome isn’t different from what was intended.

A choice of law provision is used in a lease or contract to determine the state or jurisdiction whose laws will govern if litigation arises between the lease parties. At first glance, when drafting or administering a commercial lease, it is easy to ask, “What is the real value of a ‘choice of law’ provision” if contractual rules are to be uniform under the “universal” Uniform Commercial Code (UCC)? A lessor should be able to achieve the same result in a contractual dispute regardless of the state in which litigation may be filed.

While states have adopted the UCC, they have not uniformly adopted all provisions of the UCC, nor do the various states uniformly interpret its terms. States tend to revise and edit sections and provisions of the UCC thus varying the outcome of any litigation. In drafting a choice of law provision in a lease one should consider a number of factors, including proximity to the court, the reputation of the judges in the particular legal area, the likely type of available jurors, and differences in the states governing leasing law and procedure.

Given the importance a choice of law provision will have on the outcome of possible litigation, it is surprising that the UCC provides, at best, minimal guidance on the subject. Case law over the years has developed the best guidance for drafting choice of law provisions in a commercial lease. The real source of direction in drafting a choice of law provision is, therefore, case law. Rules developed by case law have engendered a strong public policy in favor of allowing and enforcing choice of law provisions.

Case law provides our roadmap. This article will add comments on important rules of the road. If a choice of law provision is not procured by fraud and is not a violation of public policy, then courts will apply the law of the state designated in the lease if the selected forum bears sufficient contacts with the transaction. The law allows, in this instance, for contractual freedom. Three important aspects of a choice of law provisions are: the “reasonable relation” of the choice of law provision to the lease parties or to the state in which the suit is to be brought; the “conspicuousness” of the choice of law provision in the lease; and whether or not the provision places an inconvenience on the party seeking to avoid the provision.

Most of my “relations” are unreasonable. By that, I mean a good number of my cousins are a bunch of clowns. But the law is not referring to my kin when it talks about a “reasonable relationship.” The law of the state chosen in a choice of law provision must have some “business relation” to the lease parties or to the subject of the lease. The relationship need not be substantial or formal but requires some everyday relevance.

Accordingly, a choice of law provision will be deemed to have a reasonable relationship to the transaction if the headquarters of one party to the lease is within the state selected. In contrast, if the provision bears no relationship at all to the jurisdiction selected, such a choice of law provision will not be upheld.

Assume a choice of law provision requires that all lawsuits be brought in Utah, but Party A resides in New York City and Party B resides in Portland, OR, with the leased equipment to be manufactured and distributed from Denver. Courts likely will not uphold a choice of law provision of this nature (Utah), because of the lack of relationship with the forum selected. On the other hand, if the choice of law provision designated either, New York, Oregon or Colorado, then the provision would be deemed to have a reasonable relationship to the transaction— each of these states either has some connection to the lease parties or is connected to the subject of the lease.

The conspicuousness of a choice of law provision is another issue that will determine whether the provision will be upheld. The rationale behind making sure that a choice of law provision is conspicuous is to prevent fraud and to insure that a party to a lease agreement is not compelled to fight a lawsuit in a jurisdiction utterly unrelated to the lease. A choice of law provision that clearly indicates within the lease agreement which jurisdiction’s law is to be applied will be upheld.

Case law has provided an example of what would constitute “clearly indicated.” A choice of law printed in large cap letters has been deemed to be conspicuous, although it should also be noted that the court also mentioned that use of large cap letters was more than necessary. Parties entering into a commercial lease are considered to be more sophisticated than a consumer, thus, the steps to insure that a choice of law provision is sufficiently explicit for a consumer may not be needed when a businessperson is involved.

While the law allows for freedom of contract, and while lessors might want to gain any business advantage they can when drawing up a contract, courts will not validate a choice of law provision that would be manifestly inconvenient for the party seeking to avoid the provision. Finding that application of a choice of law provision would be unreasonable takes more than a mere claim of inconvenience by the party seeking to avoid the provision. Courts have ruled that the fact a litigation party has to travel will not, by itself, be deemed a legal inconvenience.

For example, Party A conducts business in North Carolina while Party B conducts business in New York. A choice of law provision, which requires that all lawsuits be brought in the state of New York included in the lease agreement will be upheld, because although Party A must travel to New York the fact that there is traveling involved does not bar the application of the choice of law provision.

As a final note, just because the drafters of the UCC effectively overlooked choice of law issues, does not mean you should or that a judge will. When drafting a choice of law provision in a commercial lease pay attention to the road map. Failure to follow the rules of the road could send you on a litigatious journey to Iowa, when you wanted to go to New York.