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The Governing Law Provision Doesn’t Always Govern

Spring 2020

Understanding the Limitations and Exceptions


It is standard practice for parties to a contract to agree to the application of a certain state and/or jurisdiction’s law, otherwise known as a “choice of law” or “governing law” provision, and/or a forum selection clause of a contract. However, various jurisdictions are finding an increasing number of exceptions that may invalidate governing law and/or forum selection clauses, potentially resulting in ramifications for which any lender and/or lessor in the equipment leasing and secured lending industry may have never bargained. The categories below are not meant to be comprehensive but rather touch on a few of these exceptions as they may apply to your business.

Jury Waivers
Do not rely on governing law clauses to escape the policy concerns of states where litigation must be instituted. Although California generally favors contractual forum selection clauses that are entered into freely and voluntarily, it has deemed pre-dispute contractual jury waivers inherently unenforceable. Georgia similarly holds pre-litigation waivers of the right to trial by jury to be unenforceable. A recent California decision (Handoush v. Lease Fin. Group, LLC, 41 Cal.App.5th 729, 254 Cal.Rptr.3d 461 (Ct. App. 2019)) further expanded this principle, effectively nullifying the contract’s New York choice of law and jurisdiction clauses and invalidating an otherwise enforceable pre-dispute jury waiver provision under New York law. In the Handoush case, the California Court of Appeal held that a California resident’s right to a jury trial cannot be waived in pre-dispute contracts on the ground that “California Courts will refuse to defer to the selected forum if to do so would substantially diminish the rights of California residents in a way that violates our state’s public policy.” Drafting loan and lease documents with this in mind in affected jurisdictions is crucial.  

Usury Laws
Public policy concerns have also come into play when a state’s usury laws (i.e., the charging of interest beyond the rate permitted by a given state’s law) are considered vis-à-vis a choice of law provision where the parties are residents of different states. In such instances, governing law provisions have been disregarded when the rate permitted by the chosen states exceeds the rate allowed in an otherwise applicable state. For example, New York courts have refused to apply a contractual choice of law where such a provision violates fundamental New York public policy as it pertains to its usury limits. By contrast, other state courts have held that where a state chosen by the parties to govern their contractual rights has a substantial relationship to the parties and/or the transaction, that state’s laws should be applied therein.

Lender Licensing
States and local governments regulate business operations within their own state, including those that pertain to licensing requirements to enable a business to engage in certain activities. For example, California’s well-known Finance Lender Law requires finance lenders (i.e., any person or entity engaged in the business of making consumer or commercial loans in California) to obtain a license from the Commissioner of Corporations, with certain exceptions. See also Boland, B. (2020, February 18) Lender Alert: Commercial Finance Disclosure Legislation In New York Merits Watching [Moritt Hock Blog] and Garver, B. (2020, January 22) Lender Alert: Commercial Finance Licensing Legislation In New York Merits Watching [Moritt Hock Blog]. A choice of law provision in a consumer or commercial loan agreement choosing another state’s law may be deemed unenforceable, notwithstanding a “substantial relationship” to that jurisdiction, if it violates a fundamental policy of a state that has a greater interest in the parties’ transaction and is subject to certain lender licensing requirements.

Confession of Judgment
While many states have enacted statutes rendering confession of judgment or “cognovit” clauses void, other states have authorized their courts to enter confessed judgments so long as the creditor complies with certain substantive and procedural requirements.

Jurisdictions are finding an increasing number of exceptions that may invalidate governing law and/or forum selection clauses.


What if a party wishes to enforce a confession of judgment in a selected forum and/or against a party who is a resident of a jurisdiction where confessions of judgment are prohibited? The Full Faith and Credit Clause of the U.S. Constitution requires states to honor judgments that are validly entered by a court of competent jurisdiction in another state. As such, a governing law and/or forum selection clause may remain enforceable, as states cannot necessarily shield their residents from confessed judgments entered into in other states, even if otherwise prohibited in their state.

Notwithstanding, it should be noted that confessions of judgment are becoming increasingly regulated, both on state and federal levels. For example, a recent amendment to Section 3218 of the New York Civil Practice Law and Rules provides that a confession of judgment obtained against any individual and/or entity that was not a resident of New York at the time of its execution, shall be deemed unenforceable, with retroactive application. Moreover, the U.S. House Financial Services Committee recently approved a proposed bill—the Small Business Lending Fairness Act—that would outright ban confessions of judgment in business loans in an effort to protect small businesses from predatory lenders who abuse the use of confessions of judgment as a means to seize their assets.

A Governing Law Provision Without a Matching Forum Selection Clause
While a state’s substantive law may govern the parties’ rights in a given case, the general rule is that the procedural law of the forum state usually applies, including, but not limited to, the forum state’s statute of limitations. For example, the Delaware Superior Court has applied Delaware’s three-year statute of limitations to fraudulent inducement claims that arose from a contract governed by New York choice of law provision (where the applicable statute of limitations was six years), based on the fact that a statute of limitations is considered a procedural, rather than substantive, part of the law. Parties can work around this nuance by either having their contractual choice of law provision specify that the chosen state’s statutes of limitations also govern the parties’ agreement, or having a matching forum selection clause, so that the forum state’s procedural laws are governed by the same jurisdiction as the chosen state’s substantive laws.

Conclusion
The foregoing discussion leaves contracts vulnerable to some uncertainty regarding the rights and remedies that may be available and enforceable to the parties thereto, depending on which state’s law is ultimately deemed to govern any disputes that may arise. Commercial lenders and other businesses should carefully consider these possible consequences and choose as their governing law and forum a state whose law is well developed in an effort to achieve more certainty on these issues.

 

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