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Contract Tip: Why Governing Law and Jurisdiction is Important

Let’s suppose you have a small consulting business. Given the power of the Internet, you can be located in New Mexico, have a partner in California and a client in Illinois. You can work from home. You feel you do good work, and your reputation speaks for itself. You are busy. A friend told you to always have a contract in place for your clients, to make sure you get paid, but you don’t like how a complicated contract looks — you feel it tells your clients that you don’t trust them. So, you downloaded something simple off the Internet, and it’s worked well for you for the past few years.

Now, further imagine that for a variety of reasons, circumstances and excuses, you’ve managed to let one of your clients not pay you for a few months and the total amount due is “getting up there.” You’ve reached the point in the relationship where you feel you must put your foot down and stop performing services. However, the amount your client owes you is now significant. Let’s say $20,000. You’re afraid to completely stop performing services, because you know you definitely won’t get paid. You feel trapped. What do you do?

Does this sound familiar? Have you found yourself in this situation or feel you could be in that situation, if you’re not careful?

Unfortunately for our hypothetical above, it seems most simple contracts lack a Governing Law and Jurisdiction clause in the contract. Such a clause is usually found in the “Miscellaneous” provisions of more complicated contracts, and it seems many of the miscellaneous provisions are the first to go, when a non-lawyer is trying to simplify a contract.

What is Governing Law?

In our example above, I indicated you are in New Mexico, a partner is in California and the client is in Illinois. Which law is controlling? It’s important to know this question, because all three states have very different laws (and penalties) regarding breach of contract and defenses for a customer, including unfair trade practices. Without a specific statement, you have a complicated factual question that depends on where the business was solicited, performed, where the contract was signed and more. It could be anything but predictable.

“Governing Law”, also called “Choice of Law” in some contracts, defines which state’s law applies to the contract. It greatly simplifies interpretation of contracts, as well as reduces costs associated with fighting about it, if the difference could win or lose your case.

It can be simple, and read something like:

      Governing Law. This Agreement shall be governed by, construed and enforced in accordance with the laws of the State of New Mexico, without regard to the conflict of laws principles thereof.

Governing law isn’t the only thing to be worried about, you should also make sure there is “Jurisdiction” clause.

What is Jurisdiction?

Jurisdiction is very similar to governing law, in that it indicates what state controls the contract. However, instead of addressing which state’s laws apply, it indicates which courts apply.

This is very important.

Jurisdiction indicates where a lawsuit can be brought in regards to the contract. In our hypothetical above, if you live in New Mexico, do you really want to hire an attorney in Illinois to sue your client for the money owed to you? If you don’t want to hire an attorney, would you even know where to begin — in bringing a lawsuit yourself in another state, such as Illinois?

Jurisdiction, therefore, can greatly reduce costs and increase convenience if jurisdiction is in your favor. Likewise, if can significantly increase costs and decrease convenience if you’re forced to go to another state to sue (or if you’re sued). Jurisdiction is very important, and in most instances, you should do everything you can to make sure the jurisdiction doesn’t create a problem for you.

A jurisdiction clause will read something like the following:

      Jurisdiction. Parties agree that personal jurisdiction shall exist in the State of New Mexico and that the State of New Mexico shall have subject-matter jurisdiction over any issues arising from interpretation or enforcement of this Agreement. Any lawsuits arising out of this Agreement shall be brought in Bernalillo County, New Mexico.

Jurisdiction can be its own paragraph, or it can be contained in another paragraph, such as governing law.

Governing Law and Jurisdiction: What It All Means

Having the right language in your contract can literally mean the difference of being able to enforce your contract and getting paid, or not. Let’s run through the scenarios. Keeping the above hypothetical, you live in New Mexico and your client is in Illinois.

First scenario: there is no governing law or jurisdiction language in your contract. If not, these are open issues. Where can you sue? A lawyer in New Mexico may be willing to take your case, and he or she can certainly send a demand letter. What happens if your client ignores the demand letter? If your New Mexico attorney files a lawsuit in New Mexico, it may not be enforceable as against someone in Illinois. You can hire an attorney in Illinois, though. See next scenario.

Second scenario: there is a governing law and jurisdictional clause, but they favor your Illinois’ client. You would not be able to sue in New Mexico. A New Mexico lawyer would NOT be able to file a lawsuit in New Mexico (under most circumstances — there are possible limitations to this, but arcane and unlikely in most scenarios). You would need to find and hire an attorney in Illinois. You’d need to pay a retainer. You may even need to travel to Illinois to provide depositions and there is no guarantee a judge in Illinois wouldn’t require you to by physically present during any hearings and certainly during trial. In other words, this could become expensive — quickly. And, what this means is, even if you’re owed $10,000, $20,000 or even $30,000, suing in another state may be prohibitively expensive. You could spend more on attorneys fees, travel and suing, then what you’re originally owed (Read why attorneys fees language in a contract can be a lifesaver).

Finally, the third (and final) scenario: there is a governing law and jurisdiction clause, and they favor you in New Mexico. You can hire a local attorney to write a demand letter (with the authority to follow through with enforcing the demand). The odds of your Illinois client responding favorably are higher, because the Illinois client doesn’t want to find themselves in their own “second scenario” as I described above. If your Illinois client doesn’t respond to the demand letter, your New Mexico attorney can file a lawsuit locally — and have it enforced as against the Illinois client (if there is a favorable jurisdiction clause). You don’t have to travel. Court fees and costs with suing are (potentially and significantly) lower. Because of this, it’s less expensive trying to get your $20,000 paid.

In summary, governing law and jurisdiction can have a profound impact on how “enforceable” your contract is, depending on the monies owed and the dispute between the parties.

Law 4 Small Business, P.C. (L4SB). A little law now can save a lot later. A Slingshot company.

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