M&A Vocabulary – Understanding the Experts: “Choice of Law Clauses”

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

In the context of M&A transactions, it is common for them to involve circumstances that span multiple countries (and thus legal systems) in whole or in part. For example, buyers and sellers may be based in different countries, or parts of a company or subsidiaries of a group being acquired may be spread across several countries. This creates so-called legal “connecting factors,” which, according to the complex rules of private international law in individual jurisdictions, then answer the question of which law applies to the interpretation of a contract. The answer to this question can determine the enforceability of a contractual claim, as each legal system interprets contractual provisions differently and may set different limits on the parties’ contractual arrangements.

In this respect, it is common and advisable to agree on a choice of law clause in contracts with international elements. The parties deliberately and expressly agree on the national law applicable to the provisions of a contract in order to avoid being subject to the complex rules of private international law (and their time-consuming and costly enforcement) and thus to avoid potential uncertainties regarding the interpretation of the contract.

Can the parties freely agree on the applicable law?

In the vast majority of legal systems, parties are free to choose the law applicable to their contractual relationship. Nevertheless, it is advisable to check this on a case-by-case basis, as this freedom is restricted in some non-European countries, particularly in connection with M&A transactions. Such a restriction can lead to an unexpected jurisdiction of local courts and the applicability of local law determined by the law of a country, which in turn can cause unexpected effects regarding contract interpretation. European legal systems also recognize certain circumstances that are not subject to the parties’ free choice of law: for example, certain antitrust claims or claims in the field of intellectual 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 country or because there are specific and customary agreements within a market or industry. It makes sense to coordinate the choice of law clause and the jurisdiction clause to avoid a regular court in Country A having to apply the unfamiliar laws of Country B, which regularly leads to complications and the need for expensive legal opinions. Finally, there may also be technical reasons for a choice of law, for example, if a complex transaction requires the “Trust” or “Escrow” policy in a specific form that only a certain legal system recognizes. Beyond these practical considerations, only a detailed examination of the individual case will answer the question of which law is most favorable for which party in which scenario.

Which aspects of choice of law clauses should be considered?

As with all contractual clauses, care should be taken here to ensure the wording is as precise as possible. For instance, an actually applicable law should be chosen—for example, not the law of the United States, but the law of the State of New York. In addition, the choice of law clause should also address whether the choice of law is limited exclusively to the enforcement of contractual claims or also includes, for example, tort claims related to the contractual relationship (e.g., any duties of care during contract negotiations).

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