Abstract
Over multiple decades, debates, and research scholarships, there has been a conflict on whether the laws of the place of formation of contract or the laws of the place of performance of contract should be applied to a problem that arises from said contract. However, the discretion of the parties in this matter has been recognised several times under Indian and English Private International Law, which means the parties are deemed to select any law that could regulate their contract. Since there is a lack of codification in respect of international contracts, the Indian Judiciary relies on the precedent set in the case of Vita Food Product Inc. v. Unus Shipping Co. Ltd[1]. The Privy Council in this case held that parties to the contract had the autonomy to choose any governing law, regardless of whether the governing law had a connection to the contract or not. However, it should be ensured by both the parties that the choice made was bonafide, lawful and in adherence to public policy. Thus, under the Indian approach to Private International Law, the proper law of the contract is dictated by justice, equity, and good conscience. This paper aims to study the old and the modern theories of establishing the proper law of contract. It also studies the merits and demerits of each theory. The paper analyses the position of Proper law in India. Lastly, the paper also mentions the merits and demerits of the theory of proper law.
Keywords: Proper Law, contract, intention, performance, parties, conflict.
Introduction
The proper law of the contract is the system of law which the parties expressly or impliedly choose as the law governing their contract or, in the absence of such choice, the ‘system of law with which the contract has its closest and most real connection’.[2] It has been defined in the case of Coast Lines Ltd. v. Hudig & Veder Chartering N.V.[3] as “the system of law (e.g. Indian Law, English Law, or Italian Law) by which the parties to a contract intend to be governed and where such intention hasn’t been expressed or implied, the system of law with the which the transaction has the its closest and most real connection.” This common law principle comprises of three tiers: express choice, inferred choice and objective choice.
The principle has also been explained in the case of Mount Albert Borough Council v. Australasian Temperance & General Mutual Life Assurance Society[4] as “that law which the English court is to apply in determining the obligations under the contract. English law in deciding these matters has refused to treat as conclusive, rigid or arbitrary criteria such as lex loci contractus or lex loci solutionis, and has treated the matter as depending on the intentions of the parties to be ascertained in each case on a consideration of the terms of the contract, the situation of the parties, and generally on all surrounding facts. It may be that the parties have, in their agreement expressed what law they intend to govern, and in that case prima facie their intention will be effectuated by the court. But in most cases they do not do so. The parties may not have thought of the matter at all. Then the court has to impute an intention or to determine for the parties what the proper law is 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.”
From the above interpretations, it can be derived that because of its inherent complexity, what constitutes the proper law of contract is not very easy to know. One cannot choose a particular law as the proper law of contract at a glance. The difficulty arises from the fact that entrepreneurs representing their businesses from various corners of the world enter into contracts of different kinds, such as contracts for the sale of goods, contracts for the purchase of leases, employment contracts, contracts for the leasing of equipment, contracts for the consolidation of goods, etc. These contracts contain terms, requirements and multiple factors that are related to each other. These terms and conditions form the constitution of the contract, which will result in an action for claims in breach of any clause.
In the first place, and in relation to the determination of the proper law of the contract, no difficulties may occur between the parties to the contract, provided that each of them respects or fulfils its obligations under the contract. However there is an issue where one party to the contract breaches or fails to fulfil its own contractual duty. If both the parties to the contract are based in the same country, this may not pose to be a problem as the contract would be governed by the domestic law of that country, for eg., Indian Contract Act, 1972. The problem actually arises when both parties belong to different countries, for eg., India and Italy, and it is difficult to ascertain which country’s proper law, Indian or Italian, would govern the contract.
By looking at the location where the contract was made, the court will decide the relevant legislation. It can also investigate, from the intention of the parties, the place where the contract is to be conducted, the domicile, nationality or primary place of business of the parties; the condition of the subject matter, the country of the vessel, in the case of the charter party, etc. Old and classical theories, which were valid for some time until they were discarded and replaced by more flexible laws, reflect the contracting position, place of operation and purpose of the parties.
The proper law would apply either because it has been selected by the parties and the court has critically checked the option, or because it is the law most closely related to the contract. In the absence of clear proof to the contrary, the parties must be treated as having the aim of referring to the domestic rules and not to the conflicting rules of their chosen law, and the reference to the legal system must be related to the substantive principles of law and not to the conflicting rules of law.
Research Methodology
The research conducted for this paper is primarily doctrinal in nature. The research paper is partly descriptive, exploratory and analytical. Data has been collected from various secondary sources such as research papers, reports, books, articles, etc. There are also various studies available regarding this subject on the internet which have been referred in this paper. The limitation regarding the research carried out for this paper is that there is a lack of data collected from primary sources. However, a comprehensive study has been done of the available research papers, articles and case laws to draft an informative paper.
Research Objectives
- To understand the meaning of the principle of Proper Law of Contracts.
- To understand how Proper Law of Contracts is determined.
- To understand the principle’s application in India.
Research Questions
- What are the theories and their merits/demerits behind determination of Proper Law of Contracts?
- How is the principle applied in India?
Hypothesis
- The modern approach to determining proper law of contract is more efficient than the old and classical theories.
Review of Literature
- Private International Law: Indian and English by Paras Diwan, 4th ed., Deep & Deep. 1998
- This book is the best starter book for all topics under Private International Law. In relation to international contracts, the book covers many different topics from international conventions of agency to position of such contracts in England and other commonwealth countries and position of proper law of contracts in India. The book studies the principle of proper law of contracts in depth with a wide variety of international as well as Indian case laws.
- Conflict of Laws by Jason Chuah & Alina Kaczorowska, 2nd ed., Cavendish Publishing Ltd.
- This book gives detailed information on a variety of private international law topics. In context of the research conducted by the researcher, the book explains international contracts, their ingredients, the issues and conflicts present in them in great detail. The book also deals with the principle of proper law of contracts effectively and with many relevant case laws. The writing style of the book is detailed, student-friendly and easy to understand.
- Reconsidering the Proper Law of Contract by Brooker Adele Marshall, UNSW Sydney, June 2012.
- This paper covers a wide range of topics under this subject. It talks about choice of law and its implications. It studies, in detail, the difference between express choice of law and implied choice of law. The paper also helps us understand the problem faced by courts in the absence of choice and proposes a solution for the same. The writing style is comprehensive and elegant.
- Determining The Proper Law Of Contract Under Private International Law by Anyanwu A. Emmanuel, Ahmadu Bello University, Zaria, 2005.
- This research paper studies the different approaches to determining the proper law in international contracts. The paper also lists out and explains what the important ingredients of international contracts are. The research paper has mentioned relevant case laws for each topic and has been written in complete detail.
Chapter 1: Old and Classical Theories of Determining the Proper Law of Contract
In order to resolve issues arising from international contract disputes, eminent jurists and writers have proposed different theories. While common law theories like consideration, offer and acceptance etc, are fairly easier to understand, these old and classical theories are more perplexing and intricate. This is because we are facing a situation where contracting parties from various countries are involved. And again, as there are different contracts, there is no single form of contract.
The two earliest theories that are mentioned in this chapter are Lex Loci Contractus (law of the place where the contract is made) and Lex Loci Solutionis (law of the place where the contract is performed). A third theory of Intention of Parties is applicable when the above given theories are unable to provide a solution for the multiplicity of issues in an international contract.
1.1. Lex Loci Contractus
The latin maxim lex loci contractus means the law of the place where the contract is made. An early promoter of this theory was Huber, who argued that contracts are entirely regulated by the lex loci contractus in terms of form and substance and that the lex loci contractus does not prevail if the parties to the contract have another position in mind. It can be said that Huber’s theory was the beginning of the quest for the proper law of contract; or rather it opened the door for this search. Robinson v. Bland was the first case to apply this theory, in which the court held that the general rule in such cases takes into account the place where the contract is made and not the place where the action is brought.
In the above case, the use of the word ‘place’ implies that contracts which may conform to the theory of lex loci contractus are those concluded between the parties in one locality, in a specific region or town or in a specified territory. However where contracting parties come from various countries, before the contract is signed, it would be difficult to decide the location where the contract is made.
1.1.1. Merits and Demerits of Lex Loci Contractus
The theory has many merits, even though it has its problems primarily arising from its rigidity. The theory of lex loci contractus results in certainty and precise forecasting of the law to regulate the transaction. The location of the contract is always straightforward and devoid of speculation.
The problems under this theory arise when two parties from different countries execute a contract in a completely different third country. In such scenarios, the country where the contract is executed is chosen as the place for determining the law of the contract. Further, the place of contracting may be fraudulently inserted in the contract to give validity to an otherwise invalid contract.
There may be factual ties with many countries in the contract components, each of which has a claim to be regarded. Injustice will result if the relevant law is the law of the place where the contract is made and has no factual connection with the contract.
1.2. Lex Loci Solutionis
The fulfillment of obligations by the parties to the contract is one of the main aspects of any contract. The time of performance is often specified in the contract and it must be adhered to by all parties. Likewise, the mode of performance is also defined in the agreement. It is necessary to do the thing to be achieved in the manner prescribed, otherwise there is no performance. But if there are many ways in which a contract may be enforced, and if there is no stipulation to the contrary, the form that is the least burdensome to the defendant can be followed.[5] A secondary and again inflexible position of performance theory was replaced by the key place of contracting. The only alternative is to accept the position of performance as the proper law of the contract, where the law of the place cannot be decided. Where both parties have to satisfy their contractual obligations in the same country, the legal structure of that country is most likely to be regarded by the court as the proper law of the contract.
In the well-known judgment of Lord Esher in Chatenay v. Brazilian Submarin Telegraph Co[6]., which has always been regarded as the principal authority for the doctrine, the lex loci solutionis law was followed. In this case, X, a Brazilian citizen residing in Brazil, executes in Brazil a warrant for the purchase and sale of securities in the Portuguese language and in the manner specified by Brazilian law in favor of A a stock broker operating in London. To the degree that the power of attorney is meant to be exercised in England (in any case, as far as third parties are concerned), it is regulated by English law as lex loci solutionis. Where both parties in the same country have to satisfy their contractual obligations, it is very likely that the court will treat that country’s legal system as the one with which the contract is most closely associated. This is assumed to be the functional sense to be attached in terms of the current evolution of the law, as there is serious disagreement as to the correct law to be regulated. In the above case, the law of the place of performance would therefore be given great weight as the proper law of the contract, especially where the contract is made in one country but is to be executed entirely in another.
1.2.1 Merits and Demerits of Lex Loci Solutionis
The lex loci solutionis eliminates the intrinsic issues associated with the law of the contracting position. For example, when an Indian signs a contract with a UAE individual for the shipment of crude oil from the UAE to India using Indian shipping and payment in Indian currency, India is undoubtedly the place of performance and that transaction is governed by its rule. However if the contract was concluded in the UAE, UAE law applying the lex loci contractus rule would undoubtedly be the governing law. Therefore if the parties select India as the place of performance, the lex loci solutionis rule applies and Italian law is the contract’s governing law, thereby replacing Nigeria’s law as the lex loci contract. The theory’s additional merit is that it is based on a substantive relation between the contract and its governing law.
The problem it raises is that if the contract is bilateral and each party from its own country is to perform, then it would be difficult to determine which law of the country reflects the law of the place of performance.
1.3. Intention of the Parties to Contract
The theories of lex loci contractus and lex loci solutionis posed certain problems when the situation pertaining the contract proved to be complicated. Therefore, the classical approach of intention of the parties was made. Willes, J., formulated the doctrine. In Lloyd v. Guibert’s case, he said:
“It is necessary to consider by what general law the parties intended that the transaction should be governed, or rather to what general law it is just to presume that they have submitted themselves.”
However this theory was not devoid of issues of its own. The question here arises as to whether the proper law should be determined as intended by the parties or as to the law which reasonable men would have intended to choose in the position of such parties.
1.3.1 Merits and Demerits of Intention Theory
The parties to the contract are free to provide, without external influence, the terms and conditions which will bind them. The parties’ intent creates a contract between the parties that is binding and enforceable. Where a contract is concluded and no rights and corresponding obligations or obligations are imposed, the question of the law governing it does not arise. For parties to have unrestricted freedom to make their contract produces convenience and certainty. Parties understand their rights and responsibilities in vivid terms. The proper law of the contract chosen by the parties requires the court to amicably settle any conflict resulting from the contract without further investigation, saving the expense of litigation and delay of trial at the same time.
The demerits are that it becomes impossible to choose the governing law by the court when parties do not choose the governing law. In selecting the governing rule, the court can be inclined to follow a subjective view. Again the outcome of such a test could not yield good results.
Except for the terms and conditions of the contract, the aim principle does not offer space for external consideration or circumstances. The consequence is the selection of a law which unless that law is objectively decided, does not have any relation with the contract. By choosing a law for the sole purpose of validating an illegal contract, parties can capriciously exercise their rights.
Chapter 2: Modern Approach of Determining the Proper Law of Contract
Unlike previous theories, the determination of the proper law of the contract was left to the courts, whether by looking at the position where the contract was made or where it was performed or by looking at the intention of the contracting parties. Through expressly specifying it in the contract itself the Modern Approach helps the parties to decide the option of law. The option must however, be taken in good faith by both parties and without violating the rights of either party to the contract.
It also means that if the parties do not expressly select the governing rule, their purpose is to be inferred from the terms and essence of the contract; and where there is no explicit or implied option of the proper law, the parties’ intention is to be ascertained from the circumstances surrounding the contract. This method has been tested, recognized and accepted as the only way to deal with disagreements resulting from the new dynamics of international contracts rather than the lex loci contractus, lex loci solutionis and purpose theories’ static and mechanical approach.
The first case to open the door of the modern approach to the proper law theory is P. & O. Steam Navigation Co. v. Shand[7], the Plaintiff, who had been appointed the Chief Justice of Mauritius, took a ticket in England for his passage from Southampton to Alexandria and from Suez to Mauritius on Board the defendant’s steamships. An exemption clause excluded the defendant’s liability for loss of or damage to passengers’ luggage. The plaintiff’s luggage was lost in Egypt.
The Supreme Court of Mauritius held that the contract was governed by French law (which prevailed at Mauritius) and that by that law the defendants were liable in spite of the exemption clause.
The Privy Council reversed this decision by laying down the general rule that English law is the proper law of the contract. he holding of their Lordships opened the door for further inquiries into the proper law of contract and its further principles. They arrived at this decision based on the following objective test:
- the parties did not disclose the governing law of the contract – the steamships were British ships
- the ticket was bought in England
- the payment was in pounds sterling
- the place of contracting was England
- the contract was not entered in Mauritius.
It could be deduced from the external factors referred to above that the greater part of the performance was to be carried out on board two English ships bringing their country with them for this reason (the flag of the ship) and that the application of English law must have been intended by both parties to be the law of the place where the contract was concluded. Therefore, English law is the proper law of this arrangement and the court did not follow the old and static theory of the law of the place of contracting in its selection, but looked at the circumstances surrounding it.
The application of the lex loci contract to a more versatile principle – the proper law of the contract – was brought down by this ruling. There is ample evidence from the issues that led to this judgment that the decision of the Supreme Court of Mauritius was anchored on lex loci solutionis, the rule of the place of performance rather than the place where the contract was concluded; thus the decision was fairly based on the strict approach of the theory of lex loci solutionis, which was not decided by the House of Lords.
Given the full importance of what the new approach is all about, we will now move on to see how this approach has been implemented by the courts over the years in conflicts concerning international contracts. In resolving these issues, the courts look at the contract of the parties from these perspectives namely:
2.1. Express Selection of the Parties
It is now an appropriate and accepted concept that the parties are free to express or choose the law to control their agreement. When the intention of the parties to the contract is expressed in words with respect to the law regulating their contract, this expressed intention usually defines the proper law of the contract. Parties have the right to compromise on what is their contract’s governing statute. Where they select the rule, when the facts are well balanced, they relieve the courts of the daunting task of deciding it. Thus, encouraging them to do so injects some clarity into the doctrine of proper law.
2.1.1. Limitation to the Selection of the Proper Law
Once the parties have expressly chosen a country’s law to control their transaction, whether or not that law has a substantive relation to the contract is not very relevant given that the law chosen is bonafide and legitimate, i.e. that it was not chosen at the expense of the other party for the benefit of one party. Or in order to prevent a statute banning the subject matter of the contract, the parties did not select it.
2.2. Implied Selection of the Proper Law
It is not in all circumstances the parties to a contract expressly want or choose the law governing their agreement. Where a declaration that the governing law of this contract is English law makes an express selection visible, the courts have little trouble deciding the proper law of the contract. However there is an issue where the intention of the parties is not expressly demonstrated in the contract. Where the purpose of the parties to a contract is not articulated in words with respect to the law regulating the contract, their intention is to be inferred from the terms and nature of the contract and from the general circumstances of the case, and the proper law of the contract is decided by that inferred intention.
2.3. Closest and Most Real Connection
Where the intention of the parties to the contract is not articulated and cannot be inferred from the circumstances with regard to the law governing the contract, the contract is regulated by the system of law with which the agreement has its nearest and most genuine relation. The fair man’s objective test is where the judge, placing himself in this position, decides the correct rule for the parties. He seeks not to determine the non-existent motive of the parties themselves, but how the issue would have been addressed by a just and fair individual.
Chapter 3: Merits and Demerits of Proper Law
As suggested by text writers and judges, the doctrine of the proper law of the contract is one of the most outstanding contributions to the friendly settlement of international contract disputes between parties from different countries. It is also possible that if the doctrine had not been invented, the courts would have had to establish new conflict rules for the settlement of contract disputes.
The doctrine of proper law contains all-embracing or general formulas regulating all kinds of questions that may occur in connection with a contract; the creation, validity, understanding and discharge of the contract are all regulated by the same law, subject to a variety of exceptions. It is open to the parties to accept that one element of the contract is regulated by the law of one country i.e. the law of the place of procurement and the law of another country i.e. the law of the place of results.
The rights and duties of all parties to the contract shall be regulated by the same statute, thus abolishing the lex loci contractus and lex loci solutionis static and mechanical theories. Their request results in unfairness that has been taken care of by the proper contract law.
This does not in any way imply that it does not have demerits of its own. In the scenario where the parties have not chosen the proper law, the courts will impose one on them by applying the objective rule of balancing the contract factual situations between one system of law and another. This is stripping the parties of their right to freedom of contract, since the parties have no option but to accept whatever law the court has chosen at the end.
If the parties have selected the law to rule their contract and the objective test is passed by that law, however it is a law that invalidates the contract of the parties, the court will continue to enforce the law regardless of its invalidating effect. If they were supposed to refer to the contract in question, English courts and even courts in other countries simply apply invalidating laws, however ridiculous this might sound.
Chapter 4: Position of Proper Law of Contract in India
Although there is no statute regulating the option of contract law in India, the courts, when deciding the proper law of contracts, apply the principles of common law. The Privy Council has acknowledged that the law regulating a contract must be the one preferred by the contracting parties.[8]
However, in the case of British Indian Steam Navigation Co. Ltd. v. Shanmughamvilas Cashew Industries[9], it was held that the law chosen to govern a contract must have some connection to the contract so being entered into. Furthermore the courts in India have repeatedly confirmed that the parties to the contract enter into a contractual clause whereby they choose a neutral court and submit to its jurisdiction to settle any possible dispute which may arise between the parties. However if the parties do not choose any governing law or a neutral court to adjudicate their disputes, then a governing law will be chosen as the law that has the most real connection to the contract.[10]
Indian courts are therefore likely to follow the principles of common law adopted by the English courts and based on the decisions set out by the Indian courts. However the Indian Courts have very specifically laid down the governing law with regards to such particular contracts. The governing rule is held to be the law of the location where the bank’s branch resides in the case of banking contracts.[11] The parties are free to choose the governing law with reference to shipping and sea-related contracts.[12]
Chapter 5: Conclusion
Since the advent of contracts themselves, the option of law when it comes to controlling contracts between two or more parties has been a matter of debate. The term proper law of contract was first described in the Coast Lines Case in the year 1972. In order to settle the conflicts under the option of law regulating contracts, the courts then introduced three strict theories. The position where the contract was made, the place where the contract was made, and the intention of the parties to the contract were discussed in these three theories. Each theory proved to have its own demerits, particularly in places where both parties to a contract were involved in foreign contracts, where it was entered into in another location and executed in another location, and where both parties came from various countries.
The modern approach has been adopted by the courts and legal experts around the world to address this issue, wherein the parties to a contract specifically make the decision to regulate law when entering into a contract. As a clause of its own, this option is entered into the contract. However the modern solution often has some limitations, so the express option made by both parties must be made with the free will of both parties to the contract. It must be bonafide in nature and not made at the expense of one of the parties to the contract to restrict the option of the governing law so chosen. In cases where the parties do not select the governing law, the intention of the parties is again tested in order to evaluate the implicit choice of law and, ultimately, the chosen law must have the closest actual relation to the contract itself. As per the study done, the hypothesis of the author is proven correct.
All this is not to suggest that in today’s world, the issue of proper contract law is still a legitimate one, as many courts around the world still adopt the old classic and static theories to decide the option of a contract’s governing law. The comeuppance of the new approach however has helped to mitigate possible and real tensions that have/could have arisen.
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[1] Vita Food Product Inc. v. Unus Shipping Co. Ltd, [1939] A.C. 277 (P.C.).
[2] Amin Rasheed Shipping Co v. Kuwait Insurance Co., [1984] AC 50, 69.
[3] Coast Lines Ltd. v. Hudig & Veder Chartering N.V., (1972) 2 Q.B. 34 (C.A.).
[4] Mount Albert Borough Council v. Australasian Temperance & General Mutual Life Assurance Society, (1938) A.C. 224, 240.
[5] Lord Chorley & O.C. Giles, Slaters Merchantile Law 102 (Pitman Publishing Ltd., London 1977).
[6] Chatenay v. Brazilian Submarin Telegraph Co, (1891) 1 Q.B. p. 82-83.
[7] P. & O. Steam Navigation Co. v. Shand, (1865) Moo. P.C.N.S. 272.
[8] State Aided Bank of Travancore Ltd. v. Dhrit Ram, AIR 1942 PC 6.
[9] British Indian Steam Navigation Co. Ltd. v. Shanmughamvilas Cashew Industries, (1990) 3 SCC 481.
[10] Delhi Cloth and General Mills Co. ltd. v. Harnam Singh, AIR 2003 SC 1177.
[11] Id.
[12] Nicholas Schivas v. Nemazi, AIR 1952 Cal. 85.
