Procurement: Issues and Analysis: Governing Law and Jurisdiction

1. Overview

Procurement

The organised procurement of goods and/or services by companies can take many forms (involving a varying degree of formality), ranging from the purchase of goods and/or services by a procurement team for a single company through to complicated arrangements where centralised procurement is undertaken for a group of companies, often on a multi-jurisdictional or even global scale. For more information on group procurement models see Structures for Group Procurement Options and Sourcing Rationalisation, An Overview of Hogan Lovells Approach.

Depending on the nature of the goods and services being purchased and their intended use purchase agreements can sit at several levels of the supply chain. For example a purchase agreement for goods which are to be used by the purchasing company or a member of its group will sit at the end of the supply chain, whereas if goods are purchased for use in manufacturing or on-sale then the purchase agreement may sit on the penultimate level or even further up the supply chain.  The position of the purchase agreement in the supply chain should, if possible, be identified and taken into account during the contracting process.

Jurisdiction and governing law

Jurisdiction and governing law clauses are required, and an arbitration clause is often appropriate, whenever there is a cross-border element in a contract, for example where the supplier and the purchaser are based in different jurisdictions.  

Particular issues arise in the context of international procurement of goods and/or services. In particular:

• How to approach governing law and jurisdiction issues across both individual contracts and, where the procurement forms part of an international supply chain, a global network of contracts.
• The extent to which alternative solutions such as arbitration may be appropriate for the supply and purchase contract.

These issues, and considerations of a general nature, are explored below.

2. Global Issues

Governing Law: The governing law of a contract is key to understanding what a contract means, and what its legal effect is likely to be. A governing law clause allows the parties to specify the system of law that will apply to the interpretation of the contract and its effect if a dispute arises.  

Governing law clauses are also sometimes used to specify which law will apply to non-contractual obligations which are related to the contract (for example claims in tort for damage caused by defective products supplied under a supply and purchase contract).

In the absence of a governing law clause the courts hearing any dispute will have to first determine what law applies to the contract or any related non-contractual obligations before it can resolve the dispute, leading to extra expenditure of time and money for the parties and increased uncertainty.   The principles used to determine the governing law will depend on the court hearing the dispute:

• Courts in the EU will apply EU-wide rules to determine which law should apply to the contract and any connected non-contractual issues.  The rules are based primarily on the habitual residence of the supplier and are set out in the Rome I Regulation and the Rome II Regulation respectively.   
• Courts outside the EU will use their own rules to determine the applicable governing law. 

Jurisdiction: A governing law clause determines which substantive law will be applied to determine the rights and obligations of the parties under the contract and to resolve any disputes that may arise, but it does not deal with how or where the disputes will be resolved – this is the function of the jurisdiction clause.  

Quite simply the jurisdiction clause determines which courts will have the right to hear the dispute:

• If the parties don't specify which courts are to have jurisdiction, the EU courts will apply the basic rule that a defendant must be sued in the courts of his/its domicile subject to various exceptions and constraints.   
• Courts outside the EU will use their own rules to determine whether or they have jurisdiction.

Choosing which court is to have jurisdiction over the supply and purchase contract is a crucial decision, because some courts are much better at resolving commercial disputes than others, and some are easier for the parties to deal with, whether because of location, language or other factors.

A global panacea?

Governing law clauses and jurisdiction provisions clearly have an important role to play in any cross-border contract and an express choice of governing law and an express choice of jurisdiction will usually be recognised by most developed legal systems provided that the choices made by the contracting parties satisfy the individual requirements of the relevant legal system(s).  However they do have some limitations.

Potential limitations of governing law and jurisdiction clauses:

• They are always assessed by a court by reference to local principles of private international law;
• They may have only a limited impact on third parties and/or any non-contractual rights or obligations;
• Whatever system of law is chosen, certain principles of local law will always be applied, including the procedural law of the court trying the case and overriding principles of law of countries connected to the contract (e.g. rules contained in consumer protection legislation); and
• There is no guarantee that a court chosen to try a dispute will agree to do so, or that other courts will refuse to try the case.  

Arbitration: As an alternative to court jurisdiction, parties to a commercial contract can agree to have their disputes finally resolved by arbitration.  

3. Impact on Procurement Operations

Does the jurisdiction have to match the governing law? 

A perennial question when formulating contracts, particularly contracts with a cross-border element, is "does the jurisdiction have to match the governing law?"  For example, if the governing law in the contract is US law, do the US courts also have to be given jurisdiction over disputes which relate to the contract?  

The short answer is "no", however, it makes sense, all things being equal, for disputes to be tried in the country whose law governs the relevant contract or other civil wrong, and for parties to be prevented from 'forum shopping' – that is, starting proceedings in any courts that are likely to look favourably on their claim, regardless of whether they have a real connection with the case. 

Do all contracts in a group procurement arrangement need the same governing law and jurisdiction? 

A primary concern where one company is procuring goods and/or services for its group, which must be dealt with clearly and explicitly in the various contracts which make up the group procurement arrangements, is ensuring that the governing law and jurisdiction clauses in those documents work in harmony.

Ideally, all agreements in a procurement arrangement should contain the same court jurisdiction (or alternatively, arbitration) and governing law provisions where there is an international element, so that every dispute can be tried in one place under one system of law.  However, this is rarely practical, so alternative strategies are sometimes adopted to achieve substantially the same result, while allowing individual contracting entities to opt for local courts and law if this is best for them.  These strategies include:

• the use of simplified or 'lowest common denominator' contract wording that works, and has basically the same effect, under almost any system of law; and
• entering into a 'master' or 'framework' agreement which allows for rebates to be paid at a higher level of the supply chain in which the group procurement arrangement forms sits to compensate for inconsistencies of outcome resulting from different contracts entered into a lower level of the chain.  

Certainty regarding the location of legal proceedings can also be achieved, or at least promoted, by setting up transactions in specific ways.  For example, making a payment or performing some other contractual obligation in (or through) a certain jurisdiction can lead to the courts of that jurisdiction trying a dispute under the relevant contract, depending on their own rules of private international law.  Similarly, a court might be willing to try a dispute because one of the parties is based within its territorial jurisdiction or does business there.  So it may be worthwhile ensuring in the contract that payments are made in one country rather than another, and choosing or setting up a company in a specific jurisdiction to enter into the contract, in preference to other/existing companies in a group. 

4. Thinking Ahead

Identifying the most appropriate court jurisdiction or arbitration clause for an agreement is all about looking ahead, not only to where it is practical for any dispute to be tried, but also to how and where any resulting judgment or award may have to be enforced.  Fundamental here is the question of whether a company is taking a defensive or more aggressive position in relation to any possible dispute.  If it expects to be sued, then enforcement is not a big issue and its home jurisdiction is often best.  But if it expects to sue a counterparty, enforcement of a judgment or award can be problematic across borders. 

Exclusive, non-exclusive or hybrid jurisdiction? 

Since assets can be acquired, dissipated or in some cases moved around, it is not always easy to know where a counterparty's principal assets will be at the moment a judgment or award needs to be enforced.  Therefore, where a company adopts an aggressive position, it may be best to use a non-exclusive court jurisdiction clause rather than the more usual exclusive type.  This does, however, give rise to a degree of uncertainty, and allow the counterparty to engage in forum shopping (see above).  

Even if the counterparty is the natural defendant in any proceedings, it might nevertheless issue proceedings, rather than waiting to be sued, by asking the court for a declaration that it has no liability (sometimes called 'negative declaratory relief'). To deal with this problem, it may be advisable to enter into a hybrid jurisdiction clause.  

"One-sided" or "asymmetrical" clauses which confine one party to suing in a named court but allows the other flexibility to go to another court if it so chooses, such as the hybrid clause mentioned above, should be used with care, though, because while they are taken at face value in some jurisdictions (such as England and Wales), they are not respected in others, largely as a result of a recent ruling of the French Supreme Court (Cour de Cassation) in the Rothschild case.  This has raised questions in several EU/EFTA jurisdictions concerning the effectiveness of these clauses, and also caused uncertainty elsewhere.  Until the EU's Court of Justice clears up the confusion, which is not likely to happen soon, contracts in a group procurement arrangement that have a connection with France or other French-speaking jurisdictions within the EU and EFTA should not include an asymmetrical clause, and such a clause should be used with caution in most other jurisdictions too.  

The issue of enforcement is less significant for arbitration clauses when compared with jurisdiction clauses.  As noted above, one of the key advantages of arbitration is the ability to enforce the award internationally pursuant to the New York Convention.  A list of the 140+ countries that have signed and ratified the New York Convention, thereby agreeing to give effect to and enforce arbitration agreements and foreign arbitral awards, can be found at Status: Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958).

In contrast, the number of countries that have made reciprocal arrangements with other countries for cross-border enforcement of court judgments is far more limited. 

5. Global Trends

Hogan Lovells’ leading Litigation and Arbitration practice surveyed 146 senior lawyers and executives across 18 industries from the world’s largest multinational corporations to determine how cross-border disputes have affected the legal landscape. The survey’s most revealing findings involve location. 

Companies report that they are routinely challenged by certain geographical locations and jurisdictions. 

The countries where they have most frequently had to manage cross-border disputes in the past two years are China, England, France, Germany, and the United States. Companies say the most challenging markets are the United States, China, Brazil, and India.

The difficulties that businesses and their lawyers routinely face when they find themselves in court, especially in those four countries, can seem daunting: getting familiar with overseas rules; managing differences in legal systems and often unexplored interfaces between them; and overcoming issues involving long distances and different time zones, cultures, and languages. 

The greatest challenge by far, though, is locating quality local counsel, especially in these difficult regions. It must be said that cross-border disputes are not always a bad thing. Yes, handled badly, they can be difficult and expensive to navigate. Yet, skilfully managed, they can provide extraordinary opportunities to protect or promote a company’s market position. In a globalized economy, cross-border disputes are becoming ever more complicated, taking companies into disputes and courts in countries they could never have anticipated. Furthermore, regulatory agencies are subjecting corporate transactions to closer scrutiny and mounting coordinated enforcement actions across multiple jurisdictions. 

Lawyers who work in the international arena are blazing new trails in courts in countries where they have never had to handle such complex disputes. To reassure boards of directors and chief executives about the legal risks of pursuing business opportunities in emerging markets, senior in-house counsel are having to develop new and complex global dispute management skills. 

They are finding new and proactive ways to prepare for cross-border clashes before there is even a spark of trouble. A majority of survey respondents — even those who had not yet cemented an approach to managing complex international disputes — said they viewed a cross-border litigation strategy as imperative. “This report confirmed a lot of what I’ve seen happening in the marketplace,” says Michael Davison, a partner in Hogan Lovells’ London office and co-head of the global Litigation and Arbitration practice. “What I took from it is great concern about risks posed by international business disputes. The world is becoming increasingly more litigious.”

Indeed, survey participants in a wide range of industries voiced this sentiment. For almost one-half of our respondents, cross-border disputes have become more frequent in the past two years. They reported that 90 per cent of these disputes involved two or three foreign countries, although some cases involved as many as 50 jurisdictions. And just over one-half of those surveyed said they expected an increase in cross-border disputes in the next two years.

According to our respondents, such disputes accounted for almost one-third of their legal caseloads. And 45 per cent said board scrutiny of cross-border disputes is intensifying. Directors worry about what these disputes mean for corporate reputations and what the cost and exposure to risk mean for their business models.

Customers were the main source of cross-border disputes all over the world. Other sources, including suppliers, regulatory entities, and competitors, varied by region. The most common disputes involved commercial or contractual issues. Eighteen per cent of respondents reported intellectual property issues as an area of law under which cross-border disputes had occurred at their organizations, 10 per cent had encountered competition and antitrust disputes, and 8 per cent cited product liability issues.

Much of the news related to cross-border disputes is positive. Respondents are learning to control costs and reduce the time and energy sucked up by cross-border disputes with new methods. 

Some are turning to a single firm with a global network of offices to manage the litigation — an approach that allows general counsel to focus on the strategy. And many are implementing new measures such as early case evaluation and a deliberate strategy for settling disputes. Companies are taking a more proactive approach, writing efficient and effective arbitration procedures into contracts or selecting friendlier governing law jurisdictions. Others have increased their internal cross- border expertise, bringing in lawyers with technical experience or especially strong project or case management skills. 

A number of companies are building stronger relationships with international law firms. And many are focusing on resolving disputes more quickly — even if it means settling instead of fighting to the bitter end. “The cross-border dispute problem does not have a cookie-cutter solution,” says Megan Dixon, a Hogan Lovells partner and head of the San Francisco and Silicon Valley offices. “Going forward, I expect to see either constant or even higher numbers of cross-border disputes due simply to the shrinking global market phenomenon of which we are all so acutely aware. But what I hope will happen concurrent with that trend is a decrease in the number of disputes caused by failure to anticipate or address easily resolved issues in advance. Part of the overall solution will be improved coordination among regulators and lawmakers across the globe so that the inherent differences in law or practice do not result in unnecessary confusion, delay, or conflict as our world economy continues to overlap and interact in new and more expansive ways.” 

The world economy is not yet as flat and uniformly global as we might wish. But will a rising tide of cross-border disputes deter entrepreneurs or international corporations from continuing to expand into uncomfortable legal environments? No. After all, the countries whose legal systems our survey respondents highlighted as being the most difficult — the United States, China, Brazil, and India — also offer some of the world’s most exciting economic opportunities. To successfully access these markets, companies and their advisors will have to work together to overcome the legal challenges standing in their way.