In 1987, a Texas court applying New York law awarded Pennzoil Company over $7 billion in actual damages and $1 billion in punitive damages in a lawsuit against Texaco, Inc. That case, which sent one of the world’s largest oil companies at the time into bankruptcy, is an example of the importance of choice of law. A key issue in the case was New York’s requirement that binding agreements, even if preliminary, carry a duty of good-faith performance. No such duty exists under Texas law. Would the result have been different if Texas law applied? Although the Pennzoil case is often criticized for incorrectly applying New York law, it nevertheless highlights how important choice-of-law issues are in high-stakes disputes.
The majority of international contracts contain alternative-dispute-resolution provisions, such as arbitration clauses, to provide greater certainty when resolving business disputes. Much has been written about the perceived benefits of arbitration and how to draft an effective arbitration clause that, among other things, eliminates the risk of potentially biased local courts and creates a more streamlined process to avoid expensive, prolonged litigation. Accordingly, this article will not retread old ground addressing any of those issues.
Instead, this article examines a contractual provision that receives less attention than the arbitration clause, but that is just as important: the choice-of-law clause. That provision determines what substantive law applies to a contract and any related dispute.