PROPER OF CONTRACT

A contract is a backbone of trade at a domestic or an international level. In India, the Indian

Contract Act, 1872 (ICA) forms the governing and foundational law in terms of regulation of
all forms of contract, however, one must also appreciate that the business contract between
individuals, institutions, companies, etc. have also grown beyond the boundaries of the ICA.
When contracts transcend national boundaries, the legal regime of a single country
becomes inadequate to regulate and control the implications of the international contracts.

Thus, when parties to a contract are from different countries, at least two systems of law
impinge upon the transaction and the rules and guidelines of private international law come
into play. Hence, there are multiple international conventions such as the United Nations
Convention on Contracts for the International Sale of Goods (CISG), or the clauses of
International Arbitration that play their role in the formation as well as governance of
contracts in India. In this article, we explore the challenges of choice of laws in the context
of international commercial contract and then briefly look at the practices prevailing in India
regarding the principles governing the choices of law.

Private International Law & contracts

When parties to a contract reside in different countries, different problems pose themselves
such as what law one or both the parties should follow or in which country the claim is
justiciable and in what way. Conflict of laws or private international laws is a set of laws or
guidelines that determine which legal system or jurisdiction may apply in a dispute related
to contracts between parties. These rules typically apply when a dispute has a ‘foreign’
element. Thus, these laws and rules seek to reconcile the disparities among laws of different
countries. The conflict of laws may be seen at multiple levels, like, whether the court or the
forum has the power to decide the case presented before it, secondly, if the court or forum
has the jurisdiction, then which country’s law must be applied by the court or the forum to
decide the case, and thirdly, whether the courts have the ability to recognize and enforce a
judgment from a foreign forum or the court within its jurisdiction.

In a dispute related to contracts, as noted earlier, there may appear foreign elements, for
instance, in a case where an Indian businessman entered into a contract with its French
counterpart, and they decided that the goods will be delivered and paid for in the United
Kingdom. Consequently, however, one of the contracting parties breaches the contract, and
in an action brought in an Indian court, a question arises which country’s law should be
considered by the Court in deciding the case because laws of India, France and the UK might
be different in certain aspects. In that case, a general principle is that every international
contract (that is, a contract containing one or more foreign elements) has a governing law,
which is most often termed as the ‘proper law of the contract’.

The proper law of the contract, thus, helps in deciding the issues in a case. The parties have
the power to choose the proper law of the country with which the contract has the most
real connection. However, this may not entirely resolve the issue, because the idea of
proper law itself is ambiguous. It is possible that the law of a single country may not be
adequate to deal with the whole of the contract, since it may not deal with certain aspects
of the contract. Thus, some of the aspects may be subjected to one country’s law and some
aspects of the same contract may be subjected to other country’s law. Hence, the
application of proper law may itself become complicated for the courts and the forum.

Choice of the proper law

There has been a conflict persisting in the scholars whether the place of contracting or the
place of performance should be the criteria to determine which law should be applied to the
problem. But under Indian and English private international law the autonomy of the parties
in this matter has been recognized multiple times, which means the parties are deemed to
choose any law which could govern their contract. For international contracts, in the
absence of any domestic codification on that aspect, the Indian judiciary relies, for its
persuasive value, on the traditional common law position as enunciated in Vita Food
Product Inc v Unus Shipping Co.Ltd, wherein it was held by the Privy Council that the parties
were free to choose any governing law, irrespective of its connection with the contract,
provided that the choice was bonafide, legal and not contrary to public policy. Thus, The
proper law of the contract under the Indian private international law is determined on the
grounds of justice, equity, and good conscience.
It has also been observed that such a choice of the proper law of the contract may either be
express or implied. The choice may be considered express when the contract contains an
explicit provision of the specific governing law, in a situation of conflict. Thus, ideally, parties
of different nations are required to provide the provision for proper law. However, it may
not be possible in every case.

On the other hand, when the contract does not contain any such explicit provision for the
proper law of contract, in that case, the principle as laid down by Lord Simonds in the case
of Bonython v. Commonwealth of Australia is referred which says that the proper law of the
contract is the system of law by reference to which the contract was made or that with
which the transaction has its closest and most real connection. The idea that the contract
was made with a reference to a certain system of law represents the implied choice of the
parties as the proper law governing the contract. The most prominent example of an
implied choice can be the choice of a governing forum by the parties, that is, the contract
contained a clause providing the court of the jurisdiction of a particular country. In
international commercial contracts, the arbitration clauses which stipulate the place for
arbitration may provide the choice of the proper law.

The validating laws

Similar to the idea of the implied choice of the proper law of the contract, where a contract
or a particular provision in the contract is valid under the law of one country but invalid
under the another country’s law, the court may infer the tacit choice of validating law on
the basis that the parties had intended their contract to valid from the beginning and not
void. For instance, in In re Missouri S.S. Co., there was an exemption clause in a contract
that was void under the law of Massachusetts, however, the same was valid in English law.
Thus, it was held that the English law was the proper law, as the parties must have intended
that their contract as well as the exemption clause in question must be valid. Thus, until
there appears anything contrary in the contract, the court will consider the proper law in
the law which validates, rather than invalidates the contract.

Restrictions on the power to choose the proper law:

There are many reasons for the power of choosing the proper law in the very beginning of
the contract, firstly, it gives the parties a feeling of certainty as to the governing law,
secondly, in domestic systems of law, the parties are largely free to choose the terms of
their contract for themselves, from which the power to choose the governing law
automatically follows as an apparent and rational expansion. However, there are some
limitations as well to the power of parties to choose the proper law such as:

Mandatory rules of domestic law- Some rules of the domestic law are not optional, but
mandatory, which means they are applicable irrespective of any agreement of the parties to
the contrary. For instance, the rules which render the contracts void on the ground of public
policy, etc. This is to say that if parties are allowed an unrestricted choice of the governing
law, there will be chances on evasion from mandatory rules of the country with which the
contract is most closely connected, whose purpose may be to protect the public interest or
to protect the interests of a particular class, such as employees or consumers. Moreover, in
the Vita Foods case, it was held by the court that the only general limitation on the choice of
the parties regarding the governing law is that it must be made with bonafide intention and
it must be legal.

The law of the country with which the contract is most closely connected- in some cases,
where the choice of proper law cannot be derived either expressly or impliedly from the
contract, then the law of the country with which the contract is most closely connected is
deemed the proper law. The court, in this regard, considers various factors such as the place
of making the contract, the place of performance of the contract, the connection of the
parties with the countries, the site of any immovable property which is the subject matter of
the contract, etc. However, it is sometimes hard to determine the close connection itself.

Convenience and business efficiency- When the interest of the parties is emphasized in the
contract, then the court evaluates the contract in terms of business efficiency and
convenience. For this, the court looks at multiple factors with varying relevance while
deciding these connections, for instance, the factors like the place of making the contract or
the place of performance may not be as important as the place where the parties carried
their business or where they reside in. Moreover, in relation to the interest of the parties,
the law of that country with whom the party belongs will usually be the accurate law.
However, it is still not easy to answer the question that the law of which party must be
preferred, in an international 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:

1. The capacity of the parties to a contract,

2. The availability and nature of the remedy,
3. The formal validity and
4. The substantive 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 unusual rule. The doctrine of the lex loci contractus
was qualified in the middle of the eighteenth century. However, the decisions in Chatenay
and Lloyd reduced the importance of the lex loci contractus and the doctrine was finally
displaced. It is doubtful whether this doctrine even served as a presumption in
contemporary law.

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. 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. 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 and the point became even more confused. The issue was solved by Lord
Diplock in Amin Rasheed Shipping Corp. v Kuwait Insurance Co. , 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.

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. 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 probabilities, 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. 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. 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. 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. 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.

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. 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.

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.