What Is a Governing Law?

Plain-English Explanation

The "Governing Law" clause in a contract tells you which set of laws will be used to interpret the contract. This means that if there is a disagreement about what the contract means or how it should be followed, a specific location's laws will be used to figure it out.

This clause is important because laws can be different in different places. By agreeing on which laws will apply, both parties know what to expect if there is a problem. It helps to avoid confusion and makes it clearer how the contract will be understood.

Usually, the governing law is chosen based on where one of the parties is located or where the contract will mostly be carried out. Sometimes, it might be a place known for having clear and fair laws.

Why This Clause Exists

The Governing Law clause exists to provide clarity and predictability. When two parties from different places make a contract, they might be used to different legal systems. By agreeing on one set of laws, they both know what rules will apply if there's a dispute.

This clause also helps to save time and money. If there's a disagreement, knowing which laws apply can make it easier to resolve the issue without a long and costly legal battle. It sets the stage for how problems will be handled and can make the process smoother for everyone involved.

Common Risks to Watch For

• The clause may favor the laws of one party's location, which could be less familiar to the other party.
• It could be unclear if the chosen laws are very different from where the contract activities happen.
• The clause may not specify which court will handle disputes, leading to confusion.
• It could surprise parties if the chosen laws have unique or unexpected rules.
• The clause may not consider changes in the law after the contract is signed.

Example in Plain English

Imagine you sign a contract with a company based in another country. The Governing Law clause states that any disputes will be settled according to the laws of that country. Later, there's a disagreement about the contract terms. Because of the clause, you have to understand and follow that country's laws to resolve the issue. This means you might need to learn about their legal system or get help from someone who knows it well.

When This Clause Causes Issues

• When one party doesn't understand the laws of the chosen location, leading to confusion or mistakes.
• If the laws change in the chosen location, and the parties didn't plan for how to handle such changes.
• When the chosen laws are very different from where the contract activities are happening, causing unexpected challenges.

What to Do Before You Sign

• Ask whether the governing law is familiar to both parties.
• Consider if the laws of the chosen location are stable and unlikely to change soon.
• Find out if the governing law is different from where the contract activities will occur.
• Ask if the clause specifies which courts will handle disputes.
• Consider how changes in the law might affect the contract terms.