Every commercial contract exists within a legal framework that determines how its provisions will be interpreted, what implied obligations it creates, and what remedies are available when it is breached. A governing law clause is the provision that designates which state’s law provides that framework. Most experienced contract drafters include one as a matter of course, but fewer think carefully about which state to choose and why. The selection has real consequences that can affect everything from how a court interprets ambiguous language to whether certain provisions of your contract are enforceable at all.
The phrase governing law clause is sometimes used interchangeably with choice of law clause or choice of governing law provision, but they all refer to the same concept: a contractual designation of the legal system that will supply the default rules, fill gaps in the agreement, and adjudicate disputes about what the contract means. A typical governing law clause reads something like: ‘This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without regard to its conflict of laws principles.’ That short sentence carries significant implications that most business owners, and even many lawyers, underappreciate.
What a Governing Law Clause Actually Controls
A governing law clause determines which state’s substantive law applies to the contract. This includes the rules of contract interpretation, the standards for determining whether a breach occurred, the measure of damages, the availability of specific performance and other equitable remedies, and the implied obligations the law reads into the contract beyond what the parties expressly agreed. In short, the governing law determines the legal backdrop against which everything in your agreement plays out.
Different states have developed meaningfully different legal rules on all of these topics. Some states impose implied duties of good faith and fair dealing more broadly than others. Some states have more creditor-friendly or more debtor-friendly interpretation rules. Some states have judicial traditions of interpreting commercial contracts strictly based on their text, while others permit more extensive consideration of extrinsic evidence about what the parties intended. These differences can determine the outcome of disputes on facts that are otherwise identical.
Governing law also determines whether specific types of contractual provisions are enforceable. Non-compete agreements are a prominent example: they are enforceable under various conditions in many states but essentially unenforceable in California. Liquidated damages clauses, limitation of liability provisions, indemnification clauses, and class action waivers are all assessed for enforceability under the rules of the governing state. Choosing the right state law can make the difference between a contract that holds up as written and one whose key provisions are struck down or modified by a court.
One thing a governing law clause typically does not control is procedural matters. Court procedures, filing deadlines, evidentiary rules, and the mechanics of litigation are governed by the law of the court where the dispute is heard, not the law designated in the contract. This is why governing law and choice of venue or forum selection are distinct concepts. Your contract can specify Delaware law while the dispute is litigated in federal court in Texas; in that case, the substantive law would be Delaware’s but the court procedures would follow federal and Texas procedural rules.
Why States Differ and Why It Matters
American contract law is primarily state law, not federal law. The Uniform Commercial Code has been adopted in some form in all fifty states and provides a common framework for contracts involving the sale of goods, but even UCC-governed transactions are subject to significant state-by-state variation in how courts interpret the code’s provisions. For service contracts, software agreements, licensing deals, and other commercial arrangements not governed by the UCC, the variation is even greater.
Delaware has become the most popular choice of governing law for sophisticated commercial contracts, particularly those involving corporate transactions, private equity, and complex business arrangements. Delaware has an extraordinarily well-developed body of commercial law, a specialized business court called the Court of Chancery with deep expertise in complex commercial matters, and a judicial culture that strongly respects the freedom of parties to contract on their own terms. Delaware courts are predictable, sophisticated, and generally reluctant to override the agreed terms of commercial agreements between sophisticated parties.
New York is similarly popular, particularly for financial contracts, credit agreements, real estate transactions, and high-value commercial dealings. New York has a long history of serving as the commercial capital of the United States, and its courts have developed an extensive body of commercial case law. New York courts are known for applying a strict, text-based approach to contract interpretation, relying heavily on the plain language of the agreement and generally declining to consider extrinsic evidence when the contract language is unambiguous. For parties who want certainty that their written agreement will be enforced as written, New York is often the preferred choice.
California’s law is quite different in character. California has strong public policy protections for employees and contractors, robust consumer protection doctrines, and a court system that is generally more willing to consider extrinsic evidence and public policy arguments when interpreting contracts. California is a difficult jurisdiction for non-compete agreements, certain limitation of liability provisions, and arbitration clauses that California courts view as unconscionable. Businesses contracting with California-based parties often face pressure to accept California governing law, but sophisticated out-of-state businesses frequently push back on this.
The Conflict of Laws Exception
Most governing law clauses include a phrase such as ‘without regard to its conflict of laws principles’ or ‘without giving effect to any choice of law or conflict of laws rules.’ This language is important and often not fully understood. Without this exception, if a court were asked to apply the chosen state’s law, it might first apply that state’s own conflict of laws rules, which could point back to another state’s law as the appropriate governing law. This result would defeat the purpose of the governing law clause by introducing the very uncertainty the clause was meant to eliminate.
By carving out conflict of laws principles, the parties are saying that they want the substantive law of the chosen state to apply directly, without the chosen state’s courts engaging in any further analysis of which state’s law would normally govern in the absence of a contractual designation. This is now standard drafting practice and is included in virtually all well-drafted governing law clauses. If you see a governing law clause in a contract that does not include this exclusion, it is worth noting as a potential drafting gap.
When Courts Override Your Choice
Governing law clauses are generally enforceable, but courts will override them in certain circumstances. The most important limitation is that a court will decline to apply the chosen state’s law if it would violate a fundamental public policy of the forum state. This most commonly arises when the chosen law permits something the forum state has declared contrary to its public policy, such as a non-compete that would be unenforceable under forum state law but enforceable under the chosen law.
Courts also consider whether the parties had a reasonable relationship to the chosen state at the time of contracting. The Restatement (Second) of Conflict of Laws, followed by many states, provides that a choice of law clause will be honored unless the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice. In practice, this limitation rarely invalidates governing law clauses in commercial contracts between sophisticated parties, because parties typically have some relationship to the chosen state or a reasonable business justification for the choice.
The timing of the challenge to governing law also matters. Courts are most willing to override governing law clauses when the challenging party can point to a specific statutory or public policy ground for overriding the parties’ choice. A general argument that the chosen state’s law produces a bad result for one party is not sufficient. The objection must be grounded in a specific rule or policy that the forum state has declared fundamental.
Making a Strategic Choice
When you are in a position to choose the governing law of a commercial contract, you are making a choice that affects every future dispute under that contract. The right choice depends on your priorities. If predictability and strict enforcement of the contract as written are paramount, New York or Delaware are strong choices. If your agreements involve corporate governance matters, Delaware is particularly appropriate. If your contracts involve technology licensing, intellectual property, or employment, the analysis becomes more nuanced and depends heavily on the nature of the restrictions you are trying to enforce.
When you are accepting rather than choosing the governing law, pay particular attention to the implications for the specific provisions in the contract that matter most to your business. If the contract contains a non-compete, check whether the chosen state enforces such provisions. If it contains a limitation of liability, check whether the chosen state has any special rules limiting such provisions. If it contains an arbitration clause, check whether the chosen state has any peculiarities in how it treats arbitration agreements. These are the most practically important consequences of the governing law choice, and they deserve careful attention regardless of whether you or your counterparty proposed the provision.