This article offers an overview of choice of law clauses, their enforceability, and their importance. Furthermore, this article outlines some state-specific laws that equipment finance lessors and lenders should account for when selecting a contract’s choice of law clause.

Choice of Law Clause: An Overview

A choice of law clause is a provision in a contract that designates which jurisdiction’s laws will govern in the event of a legal dispute regarding most contractual matters. This clause is a critical component of contractual agreements, especially in transactions that span multiple jurisdictions. The importance of a choice of law clause cannot be overstated. For one, it provides greater legal certainty. Parties can better anticipate their likely rights and obligations under a contract if they know which jurisdiction's laws will apply. Additionally, a choice of law clause assists with risk management. By selecting a jurisdiction with well-understood and predictable legal principles, parties can manage legal risks more effectively. A choice of law clause may also promote cost efficiencies. Avoiding disputes over which jurisdiction’s laws apply can save time and legal expenses. 

Importance of Having a “Nexus”

The concept of a “nexus” is fundamental in determining the enforceability of a choice of law clause. A nexus refers to a substantial connection between the parties, the subject matter of the contract, and the chosen jurisdiction. Courts generally uphold choice of law clauses if there is a substantial connection between the chosen jurisdiction and the parties or the transaction. However, if the chosen law is deemed to have no substantial relation or violates public policy, a court may refuse to enforce the clause.

Noteworthy Nexus Exceptions

Certain states have enacted laws allowing parties to choose the governing law for their contract, regardless of any connection to that state. A well-known nexus exception is § 5-1401 of New York’s General Obligations Law (GOL), which provides that a choice of law provision in a commercial agreement designating New York law is valid, even if the agreement has no reasonable relation to New York, provided that the transaction is valued at $250,000.00 or more. Because of this and the perception that disputes governed by New York law tend to have more predictable outcomes, many sophisticated parties and high-value commercial agreements include New York governing law clauses.

State-Specific Law Considerations

While choice of law clauses provide a framework for legal predictability, various state-specific laws can influence how contracts are enforced. Here are some critical considerations for equipment lessors and lenders to keep in mind:

Usury

Usury laws set the maximum interest rates that can be charged on loans, safeguarding borrowers from excessively high rates. These laws differ widely from state to state. A choice of law clause that selects a state with permissive usury laws may be contested if there is no substantial connection to that state and for public policy reasons. This prevents lenders from bypassing stricter laws by simply choosing a more favorable jurisdiction without a legitimate basis.

Auto-Renewal Statutes

Auto-renewal statutes govern the conditions under which leases can automatically be renewed. These laws are designed to primarily protect consumers. However, there are a handful of states (including New York, Wisconsin, Rhode Island, and Vermont) that have enacted auto-renewal statutes aimed at commercial transactions. These laws aim to strike a balance between the lessor’s desire for auto-renewals and the necessity of informed consent, thereby safeguarding commercial entities from potential exploitation. It is important to consult the applicable laws for specific state requirements.

Jury Waiver Clauses

Jury waiver clauses are provisions in which parties agree to waive their right to a jury trial in the event of a dispute, opting instead for a trial in which only the judge will decide the outcome. The enforceability of these clauses varies by state. For instance, some states like California, North Carolina, Georgia, and Arkansas will not enforce such provisions and some other states are skeptical of such waivers, due to concerns about fairness and voluntariness. Conversely, other states may enforce these clauses more readily. When drafting a choice of law clause that includes a jury waiver provision, it is vital to ensure the selected jurisdiction supports such waivers to avoid potential invalidation.

The UCC Considerations

The Uniform Commercial Code (UCC) is a comprehensive set of model laws governing commercial transactions in the United States. Before the 2022 UCC amendments, most states had enacted a fairly uniform version of the UCC, except Louisiana which did not adopt Articles 2 or 2A. However, since the 2022 amendments, only half of the states have enacted the amendments or a portion of them. This staggered enactment has resulted in a lack of UCC uniformity among the states. When a choice of law clause designates a state that has not adopted specific UCC provisions, it may impact the contractual terms related to commercial transactions.

The UCC also includes rules on governing law. While the UCC generally allows parties to choose which law will govern most commercial issues, some UCC provisions override these choices for certain matters, like the classification of a transaction as a lease or secured financing, and the perfection and priority of security interests. Therefore, it is essential to know which state's UCC version applies to understand the rights and interests in commercial transactions.

Enhanced Disclosure Laws

Highlighted by the introduction and passage of California SB 1235, there is a movement by various state legislatures to create consumer-like enhanced finance disclosure requirements for commercial transactions. While the bills and enacted laws differ, the purpose of the proposed rules and enacted laws focus on requiring commercial financing companies to provide clear and consistent disclosures with the focus most often on protecting small business owners. For more information on the status of these enhanced disclosure laws and their applicability, please refer to ELFA’s Interactive State Lender License & Disclosure Map. 

State-Specific Anomalies

In addition to the considerations listed above, there are several jurisdictions that have state laws that are quite distinctive. For example, in Kentucky, there is a unique guaranty statute, KRS 371.065, that requires creditors to state the maximum amount and termination date of a guaranty. Another example is North Dakota where there is a state law that prohibits enforcement of a contractual agreement to pay attorneys’ fees in a promissory note, security agreement or other evidence of debt in case of default or other proceeding to enforce the debt. Creditors’ awareness of these state-specific laws is crucial before agreeing to allow such jurisdiction’s laws to govern a transaction.

Conclusion

A choice of law clause is a pivotal element in contract law, providing clarity and predictability in legal disputes by designating which jurisdiction’s laws will govern the contract. The importance of having a nexus between the selected jurisdiction and the transaction cannot be overstated, as it ensures the chosen jurisdiction has a legitimate interest in the agreement. Understanding state-specific law considerations is essential for parties drafting or entering into equipment lease and loan contracts. These considerations highlight the complexity and variability of state laws, and critically important, emphasize the need for careful legal planning and consultation to ensure the enforceability and fairness of contractual agreements.

In essence, while choice of law clauses offers a mechanism to manage legal risk and enhance contractual certainty, crafting them with a keen awareness of the relevant legal landscape is paramount. By doing so, parties can better navigate the complexities of multi-jurisdictional transactions and uphold the integrity of their agreements.