The law applicable to the contractual relationship

Marcello Mantelli
Lawyer in Milan and Turin



It is fundamental that the set of rules contained in the contract be accompanied by an indication of the applicable law that will rule what has not been provided for in the contract between the parties.

On this point we will examine the rules of EU and some international conventions that provide a common legal framework for economic operators in most countries of the world, with particular reference to the United Nations Convention on the International Sale of Goods (Wien, 1980).

The goal is to avoid operating in an uncertain legal framework.

Some necessary preliminary considerations

Before addressing the subject matter of this article, it is necessary to clarify a fundamental issue, namely, the need to clearly distinguish issues pertaining to applicable law from those pertaining to jurisdiction.

Often companies and in general, individuals doing business with foreign countries tend to confuse the two notions, with possible negative consequences on the success of the economic transaction.

The distinction is very clear:

-when it comes to applicable law, the question an economic operator must ask himself is: what will be the rules governing my contract?

-on the contrary, when it comes to jurisdiction the question will have to be: who will decide any disputes that may arise with the other party to the transaction, in relation to the contract am I about to finalize?

Indeed, it has occurred to me very frequently that traders tend to take for granted the fact that by choosing jurisdiction, that is, by submitting any disputes to the courts of a particular state, automatically the law applicable to the contract will be that which is proper to the legal system of that country and vice versa. This is not the case.

Therefore, it will be good to keep the two issues separate, so as to understand and correctly apply the principles regarding applicable law and jurisdiction.

The importance of identifying the applicable law

A very frequent mistake is to consider the issue of applicable law as a merely theoretical matter, almost secondary to the substance of the economic transaction. Nothing could be more wrong.

In fact, the choice of applicable law can have very drastic consequences from the point of view of the convenience of the economic transaction, as this example shows.

Imagine, in your capacity as an Italian exporter, that you have appointed a French company as your agent for France and had to negotiate a detailed contract that would allow you to secure the deal.

Once you came to face the choice of law applicable to the contract, your agent had requested that it be subjected to the French law, while you, for various reasons, had expressed a preference for Italian law.

In the end, both of you agreeing that you should not waste too much time on this issue, which was considered “marginal”, you decided not to settle the matter expressly.

After 3 years, you legitimately decide to terminate your relationship with the French agent and proceed to terminate the agency contract because your agent’s poor performance.

Well, the French agent will certainly ask you for an indemnity of customer equal to two years of commissions, according to French law (which will be applicable, as we shall see, in the absence of specific choice), with a good chance of having its claim recognized on the basis of majority case law.

Moreover, said commissions are due merely because the agent has lost, due to the termination and commissions he would have earned had the relationship continued.

On the contrary, if you consult a trusted attorney experienced in the field, you will learn that if Italian law had applied, the maximum indemnity payment that might have been due, only to the extent that the agent had developed a customer from which the principal continues to benefit after the termination of the contract, would have been equal to a maximum of one year’s commission, calculated on the basis of the annual average of the salaries collected by the agent over the last five years.

In conclusion, if you had insisted on the application of Italian law, you would have avoided paying a much higher indemnity to the agent (one year of commissions instead of the “French” two years, no small difference).

It is clear from this example that the choice of applicable law is far from a marginal issue.

The applicable law in the absence of a choice

In most cases, it is undoubtedly preferable to identify the law applicable to the contract by agreeing on a specific clause within it.

Very frequently, as mentioned above, it happens that the contract, especially if drafted without the assistance of an expert lawyer on the matter, does not stipulate anything, either because the parties did not fully understand the relevance of the issue, or because they were not able to agree on the point, leaving the issue hanging.

In this case, if a dispute arises with reference to the performance of the contract, it will be necessary to seek a solution in the so-called rules of private international law, applicable to the case at hand.

The rules of private international law (“so-called “conflict law” in Anglo-Saxon countries) are a set of rules contained within a legal system that make it possible to determine the law applicable to cases characterized by elements of foreignness with respect to the law of the country in question, for example a contract concluded with a foreign counterpart.

When it is common ground that jurisdiction belongs to the courts of a particular country, reference will have to be made to the rules of private international law and not to the law of that country.

Indeed, the application of a country’s private international law rules may lead to the application of foreign law.

If on the other hand, the contract provides nothing about jurisdiction, reference will have to be made to the private international law rules of the various potentially competent courts.

Finally, if the contract provides for arbitration, the parties will have to rely on the wide discretion left to the arbitrators, unless the choice of applicable law is express and unambiguous, which will make it difficult to make predictions with reasonable margin of certainty.

Having identified the applicable rules of private international law, one should, in general, finally be able to determine the law applicable to the particular case.

The criteria for identifying the applicable law in the absence of choice is provided by the rules of private international law, Rome I Regulation and the 1955 Aja Convention.

Each system of private international law offers different solutions with reference to the criteria used to identify the competent law in the absence of a choice by the parties.

The main ones, without claiming completeness, are:

-the place of conclusion of the contract;

-the law of the country with closest connection to the contract;

-the place of performance of the contract;

-the residence or domicile of the party performing the performance characteristic of the contract.

Then there are systems of private international law that provide, alongside general criteria, specific connecting criteria for individual types of contracts.

Among these systems is Regulation No. EC/593/2008 known as the Rome I Regulation, which has been in force since December 18, 2009, in all member states of the EU, with the sole exception of Denmark, which continues to apply the 1980 Rome convention (replaced in all other member states by the Rome I Regulation mentioned above).

The system adopted by the Rome I regulation, reversing the system provided by the 1980 Rome Convention, provides, in the first instance, specific criteria for identifying the applicable law, for several contracts, such as sale, provision of services, franchising, distribution).

Where the above specific criteria are not applicable, the Rome I Regulation has recourse to the criterion of the residence of the party who is to perform the characteristic service, and finally, where none of these criteria is suitable for determining the applicable law, it establish that reference should be made to the law of the country with which the contract has the closest connection.

In contrast of most EU countries, Italy has adopted (as also in Denmark, Finland and France) the Aja Convention of June 15, 1955, on the applicable law to Sale of Articles of International character of Movable Corporal objects, which dictates rules that are partially different from those of the Rome I Regulation.

Consequently, the Italian court will be required to determine the law applicable to a contract of international sale of movable property on the basis of the criteria adopted by the Aja Convention instead of those adopted by the Rome I Regulation.

In particular, the 1955 Aja Convention provides that references should be made, in principle, to the law of the seller’s country of residence or, if the order is received from an office of the seller in another country, to the law of that country.

However, if the order is received by the seller himself or by his representative, agent or traveling salesman, in the buyer’s country, the law of the latter country will apply.

As you can see there is an appreciable difference with the Rome I Regulation, given that in many areas the transmission of orders through a seller’s agent operating in the buyer’s country is normal practice.

Thus, there will be many cases where, in the absence of choice, the Aja convention will lead to the application of the buyer’s law instead of the seller’s law.

It should be noted and should be remembered, that the application of the aforementioned Aja Convention, resulting in the identification of the applicable law in the seller’s or the buyer’s law, will lead for several cases to the same solution, and so the application of the United Nations Convention on Contracts for the International Sale of Goods signed in Wien on April 11, 1980, which has been ratified in Italy and is likewise in force in 94 European and non-European states, including, by way of example, most of the member states of the European Union, Russia, Switzerland, United states, China and Canada.

The Vienna Convention dictates a uniform regulation of international sales that becomes part of the domestic law of the adhering countries, which will thus have a dual set of rules on sales: that of the Convention applicable to international sales and the domestic law applicable to domestic sales.

The choice of applicable law

In the end, it is necessary to verify the criteria to be followed in choosing of the applicable law, examining the main alternatives, so as to highlight the pros and cons of each choice.

In a very general way, without claiming to indicate optimal solutions (which is not possible, given the need to examine the best adoptable solution on a case-by-case basis), the main options available to the parties who have to choose the law applicable to their contractual relationship are:

-choice of the law of one’s own country;

-choice of the law of the other party’s country;

-choice of the law of a third country;

-choice of so-called general principle of law.

Choosing the law of one’s own country allows one to refer to a generally better-known law and enables the seller to refer to a uniform law with reference to all ongoing contractual relationships with parties based in different countries.

However, this is not always an ideal choice. Consider the case where the choice of one’s own law leads to the application of rules advantageous to the other party. However, with the exception of the case mentioned, it is as a rule unadvisable to resort to the choice of the law of the counterparty’s country since it would give the latter the opportunity to operate within a known set of rules, especially in cases where it is objectively difficult for Italian exporter to know the foreign law applicable to the contractual relationship.

In cases where it is not possible to adopt different solutions, it will still be necessary to try at least to limit the impact of such legislation, for example, by invoking the general principles of law, the so-called Unidroit Principles.

In cases where the parties do not agree on the choice of either their own law or the other parties’ law, one may consider the possibility identifying as the applicable law, the law of a third country, as for example Switzerland, France or Engalnd.

The advantage of such a choice lies in the neutrality, to which it follows that neither contractual party will be in the favorable position of obtaining a contract governed by the law of its own country.

The evident disadvantage of such a solution is that neither party will normally be familiar with the law that will be applied, with risks weighing on the proper performance of the obligations arising from the contract and the success of the economic transaction.

By choosing this type of solution, it will be advisable to submit any disputes to arbitration, so that one can trust that the party who will be called upon to settle the dispute has a good knowledge of the applicable law.

The final solution to consider if it is difficult to reach an agreement with the other party is to submit the contract to the so-called lex mercatoria and general principles of law.

The expedient to consider in such cases is to make sure that the contract regulates in sufficient detail the rights and obligations of the counterparties and that disputes are submitted to arbitration.

In fact, such a solution appears advisable only in the context of international arbitration since the possibility of a domestic court agreeing to apply principles of law that are not contemplated in the domestic system under the rules of private international law is to be ruled out at present.

In conclusion, it emerges from this brief discussion how the issue of the choice of law applicable to the contractual relationship plays a central role in the context of negotiating a contract with a foreign counterparty.



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Marcello

Dear Aurelia, the information you have provided are not sufficient for an answer which is subject to a professional engagement. In any case, we should study the provisions of the contract and identify governing law of the contract.If it does not provide anything on governing law then conflict law shall apply (in the most part of the countries likely the governing law will be the law of the country where the agent is domiciled). best regards Marcello Mantelli

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Aurelia

I signed a contract with a fashion agency but there were no termination clauses in the contract and decided to withdraw it before one week after signature so sent them an email but after 14 days they sent me an email and asserted that because i didnt withdraw in legal deadlines i have to perform the contract and pay whole money.Noboday told me about any deadlines and nothing was in the contract!! Why did they claim such a thing?

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