Governing Law Red Flags: What to Watch Out For in Contracts

The governing law clause specifies which country’s or state’s laws will apply to the interpretation and enforcement of your contract. This decision can impact everything from how disputes are resolved to the remedies available to each party. Choosing the wrong jurisdiction—or failing to specify one—can introduce significant risks, including increased costs, legal uncertainty, and unenforceable contract terms.

• Unfamiliar or Unfavorable Jurisdictions: Selecting a governing law that is unfamiliar or historically biased against your interests can put you at a disadvantage.
• Ambiguous or Conflicting Clauses: If the governing law clause is vague, inconsistent, or conflicts with other parts of the contract, it can lead to disputes over which laws apply.
• Absence of a Governing Law Clause: Not specifying a governing law can result in lengthy and expensive legal battles to determine which jurisdiction’s laws should apply.
• Mandatory Foreign Laws: Clauses that require disputes to be resolved under foreign laws, especially those with complex or unpredictable legal systems, can increase risk and costs.
• Unenforceable or Illegal Choices: Choosing a governing law that is not recognized or enforceable in the relevant jurisdiction can render the contract void or difficult to enforce.

Be alert for these Governing Law warning signs when reviewing contracts:

• Clauses referencing jurisdictions with a reputation for slow or biased courts.
• Governing law choices that conflict with the location of the parties or the subject matter of the contract.
• Boilerplate clauses copied from unrelated agreements without considering the specific transaction or parties involved.
• References to outdated or repealed statutes.

Including a dangerous governing law clause can expose your business to:

• Unexpected legal costs and delays.
• Difficulty enforcing contract rights or collecting damages.
• Unfavorable dispute resolution forums.
• Loss of legal protections available in your home jurisdiction.

It’s essential to assess the governing law risks before signing any agreement.

• Consult with legal counsel familiar with the relevant jurisdictions.
• Use clear, specific language when drafting governing law clauses.
• Ensure the chosen law is enforceable and appropriate for the contract’s subject matter.
• Consider the location of the parties, the nature of the transaction, and potential dispute scenarios.
• Leverage AI contract risk scanners like Flag Red to automatically detect and flag problematic governing law clauses.