The Doctrine of Proper Law of Contract

Until the middle of the 19th century, the courts applied the law of the place where the contract was made, the lex loci contractus, to decide whether the given contract was valid. Unfortunately, it was open to abuse and at the same time produced difficulties in cases where the contract required each party to perform its obligations in a different country. As a result, English common law developed a test to determine which system of private law would be used to construe the contract. The test determined what is known the proper law of the contract. Therefore, the Doctrine of Proper Law emerged. Until 1991 the flexible rule in England which governed most issues was known as the ‘proper law of contract’. This rule was the system of law by reference to which a contract was made. In the absence of choice the parties had the power to select the law which was to govern their contract. This is the principle of party autonomy, where there is an express selection of the proper law. In a Conflicts lawsuit, one or more state laws will be relevant to the decision-making process. In cases where the laws have substantive differences, the choice of which law to apply will produce a different judgment. Therefore, each state produces a set of rules to guide the choice of law. One of the most significant rules which the law applied in any given situation was the proper law. This is the law which seems to have the closest and most real connection to the facts of the case.

The choice between conflicting rules of more than one jurisdictions is developed in four areas of law. The capacity of the parties to a contract, the availability and nature of the remedy, the formal validity and the substansive validity. The determination of the validity of a contract has been dealt by three principal rules. The lex loci contractus, the lex loci solutionis and the party autonomy rule. The validity is determined by the law of the place where the contact was made. Therefore, in such a case the key factor is the place. A commentator, Adkinds, referred to the principle of lex loci contractus which was defined by the courts to be the presumed content of the parties to contract with reference to local law. Hence, the rule has been examined in several early cases. Generally, it was presented as an unuseful rule. [1] The doctrine of the lex loci contractus was qualified in the middle of the eighteenth century. However, the decisions in Chatenay [2] and Lloyd [3] reduced the importance of the lex loci contractus and the doctrine was finally displaced. It is doughttful whether this doctrine even served as a presumption in contemporary law. [4]

To begin with, the proper law of the contract was the main system of law applied to decide the validity of most aspects to the contract including its formation, validity, interpretation, and performance. However, this did not denied the power of the parties to agree that different aspects of the contract shall be governed by different systems of law. In the absence of such express terms the court had not divided the proper law unless under certain circumstances. Hence, very important was the general rule of the lex fori which applied the provisions of the proper law as it is when the contract is to be performed.

Taking an overview of the proper law of contract, parties were free to enter into whatever agreement for whatever choice of law they liked. As a result, this injected an element of certainty. Express choice and implied choice were valid and conclusive. However, there was an issue when the courts had to construe a contract to ascertain choice. In situations where there was no choice made, then the proper law of contract was emerging. Originally, the proper law of contract was to ascertain the presumed intention of the parties by construing the contract. However, this led to confusion. Therefore, in Boissevain v Weil [5] the goal was to identify the system of law with which the transaction has its closest connection or most real connection.

Historically, the expression “the proper law” was peculiar to the law of England. Literally, the term simply denoted the appropriate legal system without answering the important question of how you find that system or how you identify it. The conflict of laws was concerned whether that system can be more closely defined and whether they could eliminate general phrases and find a specific formula. However, one comes to the result to the conflict of laws where the term “the proper law” is most generally known and is given the widest and most significant scope. It is in this context that in the early part of the century Westlake defined it as the law of the country with which the contract has its most real connection. [6] In 1940, John Morris, embraced and adopted this formula, when together with Cheshire he published an article entitled The Proper Law of the Contract. [7] Mainly, he devoted to a criticism of Vita Food Products Inc. v. Unus Shipping Co. Ltd [8] , a decision rendered by Lord Wright on behalf of a Judicial Committee including Lords Atkin, Russell of Killowen, Macmillan and Porter.

By 1950, it was generally established in England by decisions of the House of Lords as well as in France, Germany and Switzerland, and other countries, that an express choice of law by parties was valid and conclusive. The same applied to an implied choice, affected through a jurisdiction clause. However, the problem was whether in the absence of an express or implied choice the presumed intention of the parties had to be ascertained by construing the contract. In 1949, Lord Denning stated that the question whether the contract to repay is valid depends on the proper law of the contract, and that depends not so much on the place where it was made or on the intention of the parties as on the place with which it has the most substantial connection. [9] In 1951, Viscount Simonds accepted this formulation.

In 1961, Lord Denning introduced a limitation in that and he seemed to suggest a merger between implied choice and proper law. Lord Denning said that in the absence of an express clause the test is simply with what country the transaction has the closest and most real connection [10] and the point became even more confused. The issue was solved by Lord Diplock in Amin Rasheed Shipping Corp. v Kuwait Insurance Co. [11] , where he described the proper law of a contract as the substantive law of the country which the parties have chosen as that by which their mutually legally enforceable rights are to be ascertained. [12]

However, it is quite clear that John Morris’s distinction between express selection, implied selection, the closest and most real connection, is correct if the last-mentioned solution means that in the words of Lord Wright, the court has to impute an intention or to determine for the parties what is the proper law which, as just and reasonable persons, they ought to or would have intended if they had thought about the question when they made the contract. [13] As a result, England had an embracing subjective formula which, broadly, was covering almost all questions arising in the life of a contract. Therefore, we must not be misled into thinking that the acceptance of a form of words solves all problems.

Furthermore, one of the most controversial issues in the area of English contract law was the intention of the parties which was identified by the courts. English law in order to identify an action as a contact looks at the intention of the parties. This is the forst element of the formation of the contracts that it is examined by the courts. However, the most difficult aspect of identifying the intention of the parties……………………………………… is a term used to describe the idea of intention as commonly understood – the internal motivation of an individual. It is simple common sense that this will be very difficult to prove to the standard expected by a court of law: in matters relating to contract (and indeed any context outside of the criminal law) this standard of proof is the balance of probablities, or whether one can be more than 50% sure (on balance) that the evidence produced proves the conclusions that are being sought to be drawn from it. Clearly it is very difficult to be this sure of the internal psychological workings of another human being.By contrast, the notion of objective intention is used to describe the idea that one can infer the parties’ intentions from their actions. In other words, the question that is asked to determine objective intention is not “what was going on inside the heads of the parties” but “what a reasonable, ordinary observer of their behaviour would think their intention was”. The position of this hypothetical external observer is, in effect, that of a court trying to determine the intentions of the parties and it is therefore this objective conception of intention which is used as the legal test. A case which illustrates this idea nicely is that of Smith v. Hughes [14] . This is a case of the ninentheenth century where the objective intention applied.

Moreover, the case of Amin Rasheed expressed the two views which determine the proper law of a contract. Those views are the subjective one and the objective one. The subjectivist view is part of Lord Diplock’s view in which he said that English conflict rules accord to the parties to a contract a wide liberty to choose the law by which their contract is to be governed. [15] From this, it would appear that a subjectivist view prevails where the parties have expressly chosen the law to govern their agreement, or, at least, the proper law can be inferred or implied. On the other hand, the objectivist view was expressed by Lord Wilberforce in the same case, where in the absence of a choice of law he said that it is necessary to seek the system of law with which the contract has its closest and most real connection. [16] It is clear from the above that neither view is generally applicable.

In order to ascertain the proper law, first we need to take the subjectivist approach, where the parties have expressly chosen a law to govern their agreement. In Vita Food Products Inc. v Unus Shipping Co. Ltd., Lord Wright said that provided the intention expressed is bona fide and legal, and provided there is no reason for avoiding the choice on grounds of public policy’ the intention of the parties as to the choice of law prevails. [17] Three points with respect to the parties’ choice of law are. First, they can choose a law which has no obvious connection with the contract and still be bona fide and legal. Second, if the choice of law was made for the specific purpose of avoiding the consequence of the illegality then it is not bona fide and legal. Thirdly, there is no reported English case in which a choice of law clause has been struck down by the courts.

In common law the most well established area of choice of law is the contract choice of law. The issue of whether the choice of law rules for contract should be codified was of high concern. The codification could bring the advantage of accessibility to the law and an opportunity to put all together to an instrument. On the other hand, the existence of the danger of loss of flexibility it shouldn’t have been underestimated. Generally, the common law choices of law rules have worked well. However, it is underlined that the three stages followed in order to determine the proper laws of contract produce issues that need to be considered. [18]

However, when there is no express nor implied choice of law then the court has to impute an intention or to determine for the parties the proper law which, as just and reasonable persons, they ought to or would have intended if they had thought about the question when they made the contract. [19] The factors which help the court determine the proper laws of the contract are those with which the transaction had its closest and most real connection. [20]

In the situation where the contract does not contain an express selection of law to be applied to the contract, the court may take into consideration some other factors in order to determine whether the parties have impliedly agreed the system of private law that would apply to disputes. There are some situations which show implied choice by the parties. Those can be the selection of jurisdiction of court of which proceedings would be brought, arbitration clauses, references to regulations of a particular country, the currency in which sums are to be paid under the contract or the form of the documents. Also, the language used in a contractual document give guidance as to whether the parties have impliedly agreed to a system of law to govern the contract.

In the absence such express or implied agreements, English common law will determine the proper law of the contract to be the system of private law which the transaction has the closest and most real connection. This is an objective test to be ascertained by all the circumstances of the case. Amongst the factors that a court will consider in determining the system of law that has the closest and most real connection are the place of the contract was made, the place of performance of the obligations arising under the contract, the place of incorporation of the incorporated entities to the contract, place where any security to taken, and whether the contract is associated with another contract that does contain a choice of law. That system of law is known as the lex contractus, namely the law used to resolve substantive disputes between the parties in respect to the particular contract, and will apply from the time that the contract was formed. In rare cases, it may be appropriate for a court to order that more than one system of law applies to a contract, where the nature and type of obligations are distinct and severable from the remainder of the obligations.

Concluding, at the emergence of the doctrine of the proper law of contract it became apparent that there was recognition of party autonomy and a selection of proper law. However, it is important to say that neither Dicey’s subjective position nor Westlake’s objective position prevailed absolutely. Thus, it is appropriate to mention that the law dealing with determination of proper law of contract has borrowed from both positions. The situations where the parties to a contract have expressly stipulated that a particular law is to govern the contract that law is considered to be the proper law of the contract. In Vita this was reaffirmed by the Privy Council. After an express choice of law by the parties the extent to which the courts can give effect to this choice must be determined. Basically, it must be in good faith and legal. Further, a situation may arise where the parties have not expressly indicated a choice of law, In this situation it is highly possible for the parties to have made an implied selection of law. However, in the event that the parties’ intention, express or implied cannot be ascertained, the close and real connection test must be determined in order to identify the proper law of the contract.