The standard terms in a financial agreement contract are known as the “boilerplate”. They are the clauses – such as grossing up if there is a tax charge, or reasons for treating the contract as terminated – which protect one or other party and are so widely accepted that they are generally only lightly negotiated, if at all.
However, there are clauses in the boilerplate which can be confusing because they interlock. These cover choice of law, submission to the courts of a particular jurisdiction, and enforcement of judgements. Wrapped within, although not necessarily mentioned, is the issue of conflicts of laws. Provided these clauses don’t come up for negotiation, a banker shouldn’t need to understand them. But if they do become the subject of discussion – for instance, if a powerful borrower in an emerging market starts to haggle over their inclusion and meaning – you should be able to stand your ground.
Every agreement has to be governed by a system of law of a specific country. The choice of law clause says which. If the parties don’t choose, the court will decide. But that is unpredictable since it depends on knowing which court any dispute will be brought before, so it is better for the parties to decide. Otherwise their contractual obligations could mean different things depending on which law governs the agreement. Usually English or New York law is chosen, especially where the lenders are international banks and have the upper hand.
The reason for choosing an external system of law (ie, external to the borrower’s country or the project’s location) is to insulate the contract from local law. Otherwise there is a risk that the local law may change – for instance through the country going bust or revolution or resentment of foreigners – and the lending banks find themselves on the receiving end of a moratorium, exchange controls, forced reduction in interest rates, embargoes on the payment of foreign creditors, or expropriations. English courts will ignore all of these. Even if exchange controls are subsequently introduced which comply with the IMF Agreement under which IMF members agree to recognize each other’s exchange controls, the English courts will insist they do not apply. By contrast, the US courts apply the “act of state” doctrine under which New York courts will not necessarily overrule expropriations of assets within the territory of the expropriating state.
But choice of law (governing law) and choice of courts (jurisdiction) are different things. Governing law and jurisdiction are theoretically separate. “A court in one country will generally not decline to adjudicate on a contract just because a foreign system of law applies. But it is generally desirable that the forum should follow the governing law in order to confer a greater predictability,” says Philip Wood, head of banking and capital markets at Allen & Overy, whose six-volume Law and Practice of International Finance is regarded as definitive on the subject. Selecting the court can help with insulation (choosing an external law would be defeated if the case ended up in the courts of the borrower’s country). If the contract does not contain a submission clause, it may be more difficult to persuade a court that it had jurisdiction over the borrower. The court might hold it was a “forum non conveniens”.
In general, courts of all major commercial states will exercise jurisdiction where the borrower has agreed to submit to their jurisdiction or is incorporated locally or has a local branch. Otherwise the lending bank is dependent on the court exercising what is called its “long-arm jurisdiction”, which courts may do depending on a variable set of rules particular to each country, such as the borrower having assets there (applied by some countries and known as the “toothbrush” jurisdiction).
If the contract is litigated – and assuming the court chosen applies the selected law as desired – there is a further issue over whether the court’s judgement is enforceable elsewhere. There are two European Conventions (Brussels of 1968 and Lugano of 1988, covering the then EC and EFTA countries) which are relevant to Convention and non-Convention parties alike. “The Conventions effect fundamental changes to normal jurisdictional bases,” says Wood. They say that a party domiciled in one of the contracting states should be sued in that state. They also set out the states’ long-arm rules and provide for judgements in any state to be enforced in all the others. “The group of 18 contracting states therefore operates as a monolithic jurisdictional unit with the widest conceivable long-arm jurisdiction rules available to a creditor or debtor in a non-Convention state such as Japan or the US,” says Wood.
A critical point here is that of contracting out of the Convention, for instance to obtain insulation (where the lender is outside the Convention states and the borrower within one). But there have been cases on whether contracting out of the Conventions by selecting an exclusive alternative jurisdiction is allowed by them. Contracting out on a non-exclusive basis seems to work. Contracting out is advisable even in the case of non-Convention borrowers such as US and Japanese companies, in case they should move into a Convention state. But too much flexibility will be struck down by the courts as causing uncertainty. In a 1984 shipping case, the carrier kept the option of choosing forum and governing law in Tehran, Hamburg or London. Not so, said the (English) courts. Advocates of English law over New York law point out that, whereas the UK courts’ judgements are recognized in most commercial jurisdictions through a network of treaties including the European Conventions, the US does not have any treaties for the reciprocal recognition of US judgements.
The penalty for having a contract which is defective in any of these respects, is to be plunged into a looking-glass world which intrigues legal scholars and terrifies bankers. For instance, a number of issues can arise on which law is applicable to the interpretation of a jurisdiction clause (there have been cases on it). There is something called “dépeçage” which allows different parts of a contract to be governed by different governing laws (which might seem odd, but it caused a UK court case in 1989). There is something called “renvoi” which is about conflicts of laws and allows courts to shoot the question back to the courts of the country concerned. As Wood points out, “The governing law is the domestic law of the jurisdiction concerned, not its conflict of laws doctrines. There is no room for renvoi in the law of contract, otherwise one could go backwards and forwards like a yo-yo.”
