May 6, 1998

Memorandum

To: Members, American Law Institute

From: William J. Woodward, Jr. 

Re: Motion to Delete Section 2B-107(a) from Draft UCC Article 2B

 

The April 1998 Draft UCC Article 2B § 2B-107(a) states as follows:

The parties in their agreement may choose the applicable law. However, in a consumer transaction, the choice is not enforceable to the extent it varies a rule that cannot be varied by agreement under the law of the jurisdiction whose law would apply in the absence of the agreement.

I hereby move that Draft UCC § 2B-107(a) be deleted in its entirety and that the revision (if any) of the UCC’s contractual choice of law provision be resolved by the Article 1 Drafting Committee which is currently working on the problem.

Current law is contained in UCC § 1-105 which provides in part:

[W]hen a transaction bears a reasonable relationship to this state and also to another state or nation, the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties. [emphasis supplied]

The Draft provision deletes the "reasonable relationship" limit on the parties’ ability to choose applicable law in their contract. This is a dramatic change from currently applicable law within the United States, is unsupportable in policy, and is unnecessary in this context. In the domestic setting, the change implicates core issues both of federalism and of the power of law-making bodies to control those ordinarily subject to duly-enacted law.

The issues, unfortunately, are complex. A summary of reasons for the motion will be followed by a short Memorandum and a comparison chart.

Summary of reasons for the Motion:

· The UCC Article 1 Drafting Committee is struggling with contractual Choice of Law for all contracts within the UCC. No single issue has taken more of that Drafting Committee’s time and the Committee has not finally resolved the issues. Nothing in any supporting Article 2B documentation suggests that those subject to Article 2B are any different than other interstate businesses that must confront our Federal system on a daily basis. As recognized by Section 2B-107(b)(1), the parties could choose the law of the vendor’s jurisdiction, one that currently has a "reasonable relationship" with the transaction as required by UCC § 1-105. The Article 2B Draft should defer to the result reached in the Article 1 redrafting process.

· The newly-enacted Choice of Law provisions of Articles 4A and 5, dealing with very large transactions among very sophisticated repeat-players, form no precedent for unlimited choice in this context where repeat-player vendors will be dealing with one-time players in millions of everyday transactions.

· There is no exception for the millions of small and medium-sized transactions to be conducted with non-consumers. Because a choice of law clause is, essentially, the incorporation into the contract of a foreign legal encyclopedia, there will be no meaningful assent by non-drafters except in very large transactions. That foreign legal rules will be brought into form contracts through Article 2B’s assent provisions (which are very generous to drafters) exacerbates the assent problems with the provision.

· There are no exceptions for entirely intrastate transactions. Thus, the intent is, among other things, to permit two Pennsylvania entities to escape Pennsylvania’s mandatory law by selecting the law of Nebraska. The second sentence of the Draft quoted above makes it clear that the intent is to permit non-consumers to avoid (via a choice of law clause) legal provisions they could not otherwise avoid by direct agreement.

· The parties are not limited to choosing either domestic law or a single jurisdiction’s law to govern the whole of their transaction. By picking and choosing law to govern various aspects of one transaction, the creative drafter could create a law to govern its contract that exists nowhere. This "freedom" aggravates an already severe problem of assent.

· Because a forum will apply its own choice of law rules, the proposed rule creates significant externalities for non-enacting states. Thus, if two Pennsylvania citizens choose the law of Nebraska to avoid Pennsylvania’s mandatory rules and litigate their case in an enacting jurisdiction, the fact that Pennsylvania has not enacted the unlimited choice rule (or, put differently, has not ‘empowered’ its citizens or others to avoid Pennsylvania’s mandatory rules) will be irrelevant. The Full Faith and Credit Clause will probably require Pennsylvania courts to enforce the judgment that comes from the enacting state’s court.

·.The provision will substantially raise transaction and litigation costs at several levels:

·. Choice of law clauses will become common and will be perceived to yield competitive advantage. Drafters’ lawyers will therefore have to familiarize themselves with the law of all potential choices in order to help their clients select the "best" law.

·. Drafters will also be asked by clients to predict whether the chosen law will override particular mandatory provisions that might otherwise apply and will be exposed to potential liability if they guess wrong. The potential for wrong guesses goes up when the chosen law is "unrelated."

·. Form recipients will either have to expend resources to familiarize themselves with the law selected by the drafter or will take on risks of contracting that are not commercially ascertainable. In either case, the form recipient’s costs of contracting go up.

·. Litigators will sustain extra costs in learning and then proving to the forum the law of the foreign jurisdiction. For example, I discovered that Corel’s WordPerfect 8 Academic License purports to choose the law of the Republic of Ireland to control its dealings with all its non-Canadian customers. If that law is to control a routine lawsuit in the U.S., it will be relatively expensive to try it.

·. Judges will sustain extra research and, potentially, library costs as their libraries of domestic cases will no longer suffice to decide even routine cases.

·. Long-term damage will be inflicted on the common law system of precedent as more and more courts decide cases and pronounce the law of jurisdictions other than their own.

· To the extent international practice is a precedent, it may support the parties’ power to choose law in large international contracts where the diversity in potentially-applicable law creates more need for choosing law, and where a Constitution regulating the interaction of competing state governments is lacking. International practice does not support a policy of permitting the parties in an entirely domestic U.S. contract to choose the law of an unrelated state or nation to govern their contract. It also does not support a policy of exposing U.S. customers in routine, mass-produced contract settings, to foreign law chosen by non-domestic businesses.

· If a case can be made that unlimited choice of law (including mandatory law) is sound policy in some instances (e.g., perhaps, large, fully negotiated transactions or large, fully negotiated international transactions), developing a suitably narrow provision will require considerable effort. The Article 1 Drafting Committee is the appropriate entity for such an effort for the Uniform Commercial Code.

Memorandum in Support of the Motion:

The Article 2B Draft has created a rule validating any choice of law in a contract subject to Article 2B; as the Reporters’ notes make clear, the Draft rejects the "reasonable relationship" test of current UCC § 1-105. As those notes also make clear, outside of a narrow exception for consumer transactions, the rule enables the parties to a contract to reject (by choosing a different law) otherwise applicable mandatory law, that is, legal provisions they could not alter by contract if they sought to do so directly. It is clear from the Draft that there is no exception of any kind (outside the limited consumer exception) for intrastate contracts, for entirely domestic U. S. contracts, or for adhesion contracts drafted by vendors. The domestic or intrastate parties are not limited to choosing the law of an American jurisdiction or the law of one place for the whole contract. The main use of the provision will be in form contracts and there will be many millions of them.

A choice of law clause imports the entire jurisprudence of the chosen jurisdiction into the contract through a one-sentence provision. It is foolhardy to think that there could be anything approaching knowing assent by the non-drafter in any but very large contracts. The economics of small and medium sized transactions simply will not permit the non-drafter to discover the reason for the drafter’s particular choice, and how that drafter’s reason affects the value of the product. This problem is exacerbated in the Article 2B context through its extremely generous rules for finding assent to whatever a drafter happens to put into its form, into its carton, or onto its click-to-agree screen. The nature of choice of law clauses makes real assent unlikely except in the best of circumstances; Article 2B’s assent rules makes real assent to a choice of law clause a remote possibility.

While the Reporter’s notes suggest this is not a substantial change in the law, they hint at its startling break with our fundamental federal traditions. To quote the Reporter,

[E]ven the smallest business entity on the Internet is subject to the law of all fifty states and all countries in the world. Because that risk would have long term adverse effects on electronic commerce, this Section is one of the most important contributions of Article 2B to development of electronic commerce.

It appears that the intent is to address a core problem of state commercial law in the United States -- local control and the resulting conflicts among state regulatory and "mandatory" rules that results. Interstate banks, insurance companies, mail order houses, and corporations of all kinds are subject to multiple state laws and regulations and have staffs of lawyers constantly addressing compliance issues. Where compliance becomes too difficult or impossible, the usual solution, pursued by National Banks and other national enterprises is to seek preemptive federal legislation.

The problem of multiple state regulation that our interstate businesses must confront is a product of our Constitution and our penchant for state rather than federal commercial legislation. Truly uniform state commercial law has been elusive but it is our only solution short of federal legislation. Unlimited choice of law by contract is not an answer to this essentially political and Constitutional problem.

In any event, the assent and federalism issues raised by contractual choice of law are complex and are being studied by the Article 1 Drafting Committee. In entirely domestic situations, there is no reason to treat Article 2B drafters any differently than we treat all of our other businesses that sell or lease goods or lend money. The issues should be resolved by the Article 1 Committee for the Uniform Commercial Code generally.

Lack of Support for Legal Change:

Contrary to the assertions in the comments following the Draft provision, there is very little case or academic support for this major change in the law. There appears below a chart parsing the Reporter’s Notes assertions made to support for this novel provision.

 

Draft’s Notes

Comments

"Choice of law clauses are routine in commercial licenses and are important in how parties structure commercial deals."

True and they may be increasingly common in international transactions. But choice of law clauses among US citizens choosing unrelated state law are unreported in the cases. If the Reporters’ notes make an empirical assertion about unrelated choices as a matter of business practice in U.S. transactions, the supporting data are missing.

"The information economy accentuates that importance through expanded communications capabilities and, with respect to transactions in information, the fact that remote parties frequently engage in contract formation and performance through remote systems spanning two or more jurisdictions and not dependent on the physical location of either party or of the information itself."

True. But both vendors and vendees have locations. As Draft 2B-107(b)(1) makes clear, it is a simple matter for the drafting vendor to choose the law of its location (a "related" jurisdiction under UCC § 1-105) if it seeks certainty and (perhaps) minimal interstate regulation. In this respect, software vendors are no different from national mail order businesses, insurance companies, or banks.

[For mandatory law] "under the Restatement, the contract choice is presumed to be valid, subject to limited exceptions. Restatement (Second) of Conflict of Laws 187 ([the choice] may be invalid if not resolvable by contract and either there was no ‘reasonable basis’ for the choice of that state's law or ‘application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue.’)."

True as stated, but the implication is unsupported at least for domestic contracts. Presumably, the assertion is that if the contract chose an "unrelated" state law, there must have been a reason and that reason itself would supply a "reasonable basis" for sustaining it. No case is cited (or has been found) where "a better regulatory climate," "more latitude on unconscionability," "more hospitable courts," or any other supposed reason (or no other reason than "we chose it") for choosing unrelated law has been sustained.

"Article 2B rejects current Section 1-105 which allows choice of law only if the chosen state has a "reasonable relationship" to the transaction. This rule is more restrictive than the Restatement and the law of most states outside Section 1-105."

The rule in § 1-105 is nominally more restrictive. It is only more restrictive in this context if the Restatement and non-UCC state cases were to sustain the choice of "unrelated" law as having a "reasonable basis." There are no such cases cited and none have been found. No case cited by the Reporter had any challenge to the choice of law provision; in three of them, it is clear that the chosen law was "related" to the contract.

"[Section 1-105] reflects law that existed when the UCC was adopted five decades ago, but that has little merit in modern electronic transactions and does not fit with modern scholarship about choice of law as reflected in the Restatement (Second) and elsewhere."

True, UCC § 1-105 is old but its age may testify to its wisdom. A couple of scholars have advocated unlimited choice of law within the past 5 years. But before that, there is nothing supportive in the literature. There is nothing that could be called a "trend" in modern scholarship advocating unlimited choice of law by contract and, as indicated above, such a position is not reflected in the Restatement.