What is Governing Law in Contracts?

What Is Governing Law?

Governing law is a contractual clause specifying which legal system will be used to interpret and enforce the agreement. This clause is important because different jurisdictions have varying laws that can significantly impact the rights and obligations of the parties involved.

How Does Governing Law Work?

Typically, governing law is specified within a "Choice of Law" or "Governing Law" clause in an agreement's Terms and Conditions section. For example, a Governing Law clause might state:

"This Agreement shall be governed by and construed in accordance with the laws of the State of California." 

This means that any legal issues arising from the agreement will be subject to California state law, regardless of where the parties are located.

Importance of Governing Law in Contract Terms

In cases where a legal dispute occurs, the governing law determines the applicable legal framework for resolving the dispute. This could involve:

1. Litigation

If the matter goes to court, the governing law will dictate which court has jurisdiction and what procedural rules apply.

2. Arbitration

If the agreement includes an arbitration clause, the governing law will still be relevant in interpreting the arbitration agreement and any resulting award.  

3. Contract Interpretation

Different jurisdictions have varying approaches to contract interpretation. The governing law will determine how the agreement is interpreted, including how the ambiguities are resolved.

4. Choice Law

Parties can often choose the governing law that best suits their interests. This is usually referred to as choice law, provided that the choice is not deemed contrary to public policy or against the law of a jurisdiction with a more significant relationship to the contract.

How to Choose Governing Law

Selecting the appropriate governing law for your agreement requires careful legal consideration. Here are some factors legal professionals might look at when making this decision:

1. Jurisdiction of the Parties

Often, parties choose the laws of the country or state where one or both parties are located. This may simplify the legal process and reduce logistical hurdles.

2. Nature of the Agreement

Certain laws may be more favorable for specific types of agreements. For example, intellectual property contracts might benefit from jurisdictions with robust IP laws.

3. Enforceability

A legal team might also ensure that the chosen governing law will be recognized and enforceable in all relevant jurisdictions.

4. Neutral Jurisdiction

In some cases, parties from different countries may agree on a neutral jurisdiction to avoid the agreement favoring one side over the other.

Governing Law vs. Jurisdiction

While governing law determines which legal system applies to the agreement, jurisdiction refers to the location where disputes will be resolved. For example, a terms and conditions clause may specify that the governing law of a contract is that of California, but disputes must be resolved in the courts of Delaware. These clauses often work hand-in-hand but are not interchangeable.

Risks of Not Specifying Governing Law

The risks of not including a Governing Law clause in your agreements can lead to significant legal complications if a dispute arises. Companies often negotiate this clause in their contracts to safeguard themselves from these risks.

1. Legal Uncertainty:

Parties may disagree on which legal framework should apply.

2. Increased Costs:

Determining applicable law during a dispute can be time-consuming and costly.

3. Unfavorable Outcomes:

Without a specified governing law, courts may apply laws that are less favorable to one party.

Managing Governing Law Clauses with Contract Lifecycle Management Software

Companies managing their contracts manually may face hurdles in efficiency, security, and even contract language accuracy. The challenges of manual management may range from versioning issues and inability to track changes across contracts to time spent on manual, repetitive tasks, unsecured communication methods, and lost insights buried in department siloes. Taken together, they may lead to greater noncompliance risks and lost revenue. In governing law, the risks of noncompliance may mean legal disputes or unfavorable outcomes.

This is where having a centralized contract management software can help. The benefits of using CLM software range from automated clause detection and workflow automation to having a digital, single source of all your contracts in one place. Advanced AI-powered platforms enable companies to go further and automatically detect risks of non-compliant contracts or help you negotiate a better one, and readily integrate with the enterprise systems you already use, such as Microsoft 360, SAP, or Salesforce. Feature offerings depend on the software.

Automated Clause Identification:

Using AI and machine learning, the software can automatically identify and extract governing law clauses from contracts, saving significant time and reducing the risk of human error. Advanced software offerings allow contract professionals to call up this information with a simple chat.

Single Source of Truth:

Storing all contracts within a central repository allows for easy retrieval and analysis of governing law clauses across all agreements. This provides a single source of truth for all contractual obligations.

Workflow Automation:

Automating contract workflows ensures that governing law provisions are consistently reviewed and approved at each stage of the contract lifecycle. This minimizes the risk of inconsistencies or overlooked clauses.

Automated Compliance Checks:

The software helps companies comply with relevant legal regulations and reduce the risk of legal disputes by ensuring the consistent application of governing law across all contracts.

Real-time Alerts and Notifications:

The software can trigger alerts and notifications based on changes in governing law or potential conflicts in governing laws. This proactive approach allows for timely intervention and minimizes potential legal risks.

Data-driven Insights:

The software provides valuable data and insights into trends and potential risks hidden in your contracts. This information can inform strategic decision-making and improve overall contract management processes.

Integrations:

The software can seamlessly integrate with various systems companies already use, such as Customer Relationship Management (CRM) systems, Enterprise Resource Planning (ERP) systems, and day-to-day systems such as Microsoft 365 Suite. For instance, customer information from Salesforce can automatically populate relevant fields in a new contract. Similarly, contract data can be seamlessly shared with ERP systems for accurate procure-to-pay data.

The Icertis Difference

Are you looking for a contract management platform that does all the above and more? Today, more than a third of the Fortune 100 trust the Icertis Contract Intelligence platform to transform the contract lifecycle management at their organizations. From automated contract analysis to risk assessment, Icertis uses AI to empower you to extract valuable insights from your contracts, reduce risks, and ensure compliance. Start your journey to better contract outcomes with Icertis Contract Intelligence. Request a demo to learn more.

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