Legality of cross border contractual stipulations

Outsourcing contracts are, to a great extent, executed between the overseas subsidiary of the Indian outsourcing service provider and the overseas client. Where the contract is between the companies belonging to separate Nations, the first issue is to select the ‘proper law of a contract’. In the words of Dicey and Morris in The Conflict of Laws:

The term “proper law of a contract” means the law or laws, by which the parties intended or may fairly be presumed to have intended to submit themselves.

Conflict of laws is a body of law that governs multijurisdictional legal problems. Conflict of laws’ problem is the allocation of governance authority over transnational activity, i.e., an activity with multinational connections. As it is evident that the transnational activity has connections with more than one nation, the question arises as to which of those nations should exercise that authority?

Conflict of laws seeks to mitigate these problems by providing Rules for the orderly allocation of governance authority over transnational activity.

If the parties have explicitly chosen a law, which will govern the contract, i.e., Lex contractus, then, that law will prevail.

There is no statue in India, which permits the parties to choose the law applicable to their contract. Joint Venture Agreements are the only exception to this Rule. A Joint Venture agreement between the company from India and its foreign partners is subject to the approvals issued by the Foreign Investment Promotion Boardand hence subject to Indian Law.

On perusal of the various Indian Precedents, it is apparent that Indian Courts accept the principle of autonomy of parties and allows the contracting parties to choose the proper law of contract.

The basic Rule is that the choice of law by the parties expressed is unequivocal as to proper law of the contract, provided that it is legitimate and not opposed to the public policy.

Nonetheless, there are some limitations on the parties’ right to choose the Lex contractus. The choice of law specified by the parties must be ‘bona fide and legitimate’.

As per the Indian Courts, the selected law need not have a connection with the transaction, i.e., the parties may select the law of a third State. Although, it is a Rule that there must be a single proper law of contract, which governs all aspects of the underlying contract. There can be no separate Law for the initiation of a contract and another for interpretation of the contract.

CHOICE OF APPLICABLE LAW RULES IN THE LACK OF CONTRACTUAL STIPULATIONS

When no contractual clause is specified, English Courts would apply a presumption. The first presumption was that the lex loci contractus, i.e., the law of the place where the contract was made, was the proper law. Second, if the contract was made in one country and executed in another, the lex loci solutionis, i.e., the place of performance of the contract, will be presumed as the proper law of contract. The Hon’ble Supreme Court of India noted that there were presumptions that a proper law is the lex loci contractus or lex loci solutionis. Although,the Hon’ble Supreme Court of India laid down, where the courts of a certain country are chosen, the law applicable will be of the same country. That is to say, the intention of the parties will be presumed to apply Indian Law if the contract provided for the jurisdiction of the Bombay High Court, for instance.

The theory of presumed intention was later replaced in England, Germany and France with an objective test, the test of closest and most real connection of the transaction with a particular legal system. This ‘objective test’ was later applied in the United States in the absence of Choice of Law Clause.

The Hon’ble Supreme Court of India applied the test of the ‘closest and most real connection’, for the determination of the proper law in 1955 in its judgment of Delhi Cloth and General Mills Co Ltd v Harnam Singh (AIR 1955 SC 590). Afterwards, the Hon’ble Supreme Court of India applied the test of ‘substantial connection’ in 1992 in its landmark case, National Thermal Power Corpn v The Singer Company and Ors(AIR 1993 SC 998).

Where the parties have not expressly or impliedly selected the proper law of the contract, the courts impute an intension by applying the ‘closest and most real connection’ test for determiningit as a just and reasonable man. To be precise, the material factors of the determination of proper law of contract are the following:

1. The place where the contract was made, i.e., lex loci contractus;
2. Place where the relevant performance occurs, i.e., lex loci solutionis;
3. Place of domicile, residence or business of the parties;
4. National character of the Corporation and location of its principal place of business;
5. Subject matter of contract;
6. Fact that certain specification is valid under one law but void under another;
7. Generally all encompassing facts, which help to localize the contract.

SCOPE OF THE APPLICABLE LAW

As per the standard practice, the parties to a contract have to select only one law, i.e., a choice of law clause. The law selected by the parties must be appropriate for all the aspects of the contract. As noted by the Hon’ble Supreme Court India,in Sumitomo Heavy Industries Ltd v ONGC Ltd and Ors(AIR 1998 SC 825), the following four types of laws are potentially applicable to a contract:

• The proper law of the underlying contract, i.e., the law governing the contract, which creates the substantive rights and obligations of the parties, out of which the dispute has arisen.
• The proper law of the arbitration agreement, i.e., the law governing rights and obligations of the parties arising from their agreement to arbitrate and, in particular, their obligation to submit their disputes to arbitration.
• The proper law of the reference, i.e., the law governing the contract, which regulates the individual reference to arbitration. This is an agreement subsidiary to but separate from the arbitration agreement itself, coming into effect by the giving of a notice of arbitration from which point a new set of mutual obligations in relation to the conduct of reference arise.
• The curial law, i.e., the law governing the arbitration proceedings themselves, the manner in which the reference is to be conducted.

By: Navin Kumar Jaggi, Aashna Suri