Contracts with foreign elements & Autonomy of the will

In cases where we want to conclude a contract that contains foreign elements, the question arises as to which applicable law shall we choose. Thanks to the principle of autonomy of will in contract law, the parties are allowed to choose the law governing their contractual relationship. Just as the law governing obligations provides contractual parties with the freedom to decide whether to conclude a contract and how to regulate the provisions within the agreement, within the limits of imperative legal provisions, so does international private law as well, along with adding an additional type of freedom – the freedom to decide which law shall apply to their contract. 

The Rome Convention on the governing law for contractual obligations set out the principle of autonomy of will by enabling contracting parties with a high degree of freedom in terms of the choice of applicable law. The choice in question must be made in an explicit manner, but also in a tacit way if the choice of applicable law results from the content of the contract. The Convention allows the parties to determine the applicable law for the entire contract or only for one part of the contract. 

Regulation No. 593/2008 on the law applicable to contractual obligations (‘Rome I’) represents a unification of conflict of law norms on contractual obligations that replaced the initial Rome Convention on EU soil. Article 3 of the Regulation indicates the principle of autonomy of will in determining the governing law of the contract; the same was confirmed in the case of Intercontainer Interfrigo SC (ICF) v Balkende Oosthuizen BC, in accordance with Article 3 of the Rome Convention. Namely, the free choice of governing law takes precedence over other rules. 

The applicable law clause assumes the role of a link, that is, interpreted as an independent agreement in relation to the main substantive contract to which it refers. In this sense, the possible nullity of the choice of law agreement does not itself lead to the nullity of the main contract and vice versa.  

Is it possible to choose applicable law for all contracts with foreign elements? 

The will of the parties is the first point of binding, which is confirmed in Article 19 of the Serbian Law on resolving conflict of law.  

The same article further stipulates that the parties cannot determine the governing law for contracts whose subject is immovable property, because the applicable law in that case is the law of the state on whose territory is the immovable property located. 

Furthermore, the Serbian Law on Public-Private Partnership acknowledged that, in disputes between parties arising on the basis of a public contract, Serbian law shall be applicable. As for certain international legal documents, we can highlight, for example, the Convention on the contract for international carriage of passengers and luggage by road (CVR) and the Convention on the contract for the international carriage of goods by road (CMR), which exclude the possibility of choosing a governing law for transport-related contracts. 

Conditions for choosing the applicable law 

There are three main elements that must be fulfilled for the choice of applicable law to be valid. Let’s take a look.

The contract contains a foreign element 

There is no choice of applicable law if the contract is not related to a foreign country with any of its elements. In general, the term ‘foreign element’ may refer to contracting parties, particular things as a subject matter of the contract, or an action. For example, imagine two domestic companies that carry out investment activities on the market of Azerbaijan. Regardless of the fact that these are two domestic legal entities, the main business activity is carried out abroad.  

Our Law doesn’t specify what degree of foreignness is sufficient to allow the application of Article 19, i.e., the free choice of applicable law. Anyhow, the contract must contain a foreign element in order for Article 19 to apply. 

The choice must be explicit 

An explicit choice of applicable law refers to the inclusion of a contractual clause on the choice of law. In that case, the parties have expressly attached their choice to the contract in writing (e.g. ‘this agreement is governed by…’This agreement and all disputes arising out of it or in connection with this agreement shall be governed by…’). 

A tacit choice of applicable law refers to the situation when such a clause doesn’t exist, but based on other provisions of the contract, one can get an impression of which law the parties had in mind as the governing law.  

The choice must be allowed 

When determining the applicable law, the question arises whether it is the law of one state, several state, or if there is a possibility of choosing a non-state law?  

For example, the Rome I Regulation specifies that applicable law refers to the law of a certain state. Therefore, it laid down a narrower freedom of choice than in international arbitration. Legislations that take upon the 1985 UNCITRAL Model Law on International Commercial Arbitration, allow parties to choose as applicable not only the law of a certain country, yet also general legal rules (generally, this refers to non-state and international sources of law). 

Although it was disputed among a number of domestic authors whether, based on Article 19 of the Serbian law, the parties are enabled to choose the governing law for a part of the agreement or foresee several governing laws for different parts of the same agreement, the provision itself speaks in a singular form. In other words, this indicates a restrictive interpretation. 

Many other legal documents have supported the position that a partial choice is legally valid, namely that the parties can choose several governing laws for divergent parts of the contract if the contract itself is divisible. Splitting the contract in this manner is permitted, but it is not allowed to foresee that two different laws will simultaneously apply to the entire agreement. 

Applying multiple laws to one agreement is called Contract Splitting or Statute Splitting in international private law.

What if the parties do not choose a governing law? 

In recent legislation, the theory of characteristic obligation prevails. A broad number of countries have accepted this doctrine, such as, for example, Switzerland, Poland, Hungary, Austria and our country as well. Article 20 of the Serbian Law enumerates various types of contracts and the method of determining the applicable law, namely the characteristic obligation for each contract. For example, for a technology transfer agreement, the law of the place where the seat of the technology recipient was located at the time of the conclusion of the contract applies. A large number of contracts are listed, but of course, there are many other unnamed contractual relationships that are not covered by this provision. 

Theories such as Proper Law and Center of Gravity are also applied in practice. 

The Proper Law theory determined the governing law according to the criterion of the closest connection of the contract with some legal order. The Center of Gravity theory represents the basis for determining the applicable law for various contracts with an international element. According to this particular theory, the applicable law is established by the elements of a certain agreement that gravitate towards one state. Given that the characteristic obligations is not an easy task when it comes to complex contracts, it is necessary to check out the center of a contractual relationship, namely the center of gravity. 

Example: Consortium Agreement 

A consortium agreement is an agreement of autonomous commercial law created in the business practice of cooperation and joint execution of investment-related work. Two or more business entities, individuals or organizations combine their resources, knowledge and capacities to achieve a common objective. Hence, the goal of such an agreement is to achieve certain cooperation, project implementation or similar. The rules for determining the applicable law as far as this contract is concerned are neither present in the Serbian Law nor in the above-mentioned international sources. However, it is a type of contract whose subject is usually based on cross-border cooperation. 

In these types of contractual relationships, parties often decide consensually on a choice of governing law. As an aid in the selection, the contracting parties have at their disposal various model contracts, such as, for example, the Model Contract of the International Chamber of Commerce (ICC), the Model Contract of the EU and so on. One of the basic recommendations to the parties is to choose the applicable law that is sufficiently flexible and close in terms of the terminology used in the text of the contract and desirable legal institutes.  

Given that in many circumstances it amounts to a complex contract in which it could potentially be difficult to determine the characteristic obligation, it should be examined to which legal system the contract has the closest connection. During such examination, all relevant factors should be taken into account, such as the seat of the contracting parties, the place of the conclusion of the contract, the place where the negotiations were held, the currency of payment and the language of the contract.