Is Your Choice-of-Law Clause Enforceable in Tennessee?

 In Blog, Litigation and Dispute Resolution

You’re involved in a dispute in a Tennessee court that transcends state boundaries.  For example, one party is located in New York, another in Tennessee, another in Georgia.  You researched each state’s laws. You win under Georgia law and lose under New York law.  You’ve got one problem:  the contract says the court must apply New York law.  Is all hope lost?

You’ve got one problem:  the contract says the court must apply New York law.  Is all hope lost?

The answer is generally, but not always.  The Tennessee Court of Appeals recently took up choice-of-law clauses again in Williams v. Smith, 2014 WL 6065818 (Tenn. Ct. App. Nov. 6, 2014).  The court reaffirmed that Tennessee follows the rule of lex loci contractus, which means a contract is governed by the law of the state where executed absent a choice-of-law clause.  If there is a choice-of-law clause, Tennessee courts will honor it if four requirements are met:

  • The choice-of-law clause was executed in good faith;
  • The state whose law is chosen bears a material connection to the transaction;
  • The basis for the choice of another state’s laws must be reasonable and not merely a sham or subterfuge; and
  • The law of the chosen state is not contrary to a fundamental policy of a state having a materially greater interest and whose law would otherwise govern.

The first three requirements address the same essential issue:  Did one of the parties insert the choice-of-law clause to avoid its obligations or impose an unfair burden on the other party?  For example, it would be inequitable for a contract to select a wholly unrelated state’s law simply because one party knows that law is unusually favorable.  This should rarely be in play.

The action is on the fourth requirement, which was at issue in Williams.  There, North Carolina residents were injured by a Tennessee citizen in a car crash in Tennessee.  The auto insurance policy covering the plaintiff’s vehicle selected Missouri law because the vehicle was usually in Missouri.  Absent the selection of Missouri law, North Carolina law would apply.  The choice mattered because, under a North Carolina statute, the Tennessee driver was underinsured, and North Carolina law would impose coverage.  Missouri has no such statute.

The plaintiffs tried to avoid the application of Missouri law under the fourth prong.  They argued that North Carolina has a great interest in regulating insurance and excluding coverage was contrary to this fundamental policy.  The court nonetheless applied Missouri law.  Its decision seemed to rest on two facts.  First, the car was usually operated in Missouri, not North Carolina, so Missouri was the site of the insurance risk.  Second, the insurer had not inserted Missouri law to take advantage of unequal bargaining power; to the contrary, the insured had the option of either a Missouri policy or a North Carolina policy, and chose the former.

The court in Williams also relied on a North Carolina case holding that courts in that state, when faced with the similar decision, will not decline to apply chosen foreign law unless it is “violates some prevalent conception of good morals or fundamental principle of natural justice.”  Insurance coverage did not sufficiently invoke issues of morality to meet the test.

We can draw several lessons from Williams:

  • Research how the state whose law would apply absent the clause defines the “public policy” test.  The comments to the Restatement (Second) Conflict of Laws provides that “[t]he forum will apply its own legal principles in determining whether a given policy is a fundamental one.” Yet in Williams, the court began its analysis by looking to how North Carolina courts treat this issue.
  • An on-point statute is arguably not enough.  States create policy through their legislatures, so statutes are evidence of a state’s public policy.  North Carolina’s statutes required coverage, and Missouri’s statutes did not.  (Query, though, why North Carolina’s minimum coverage limits should apply extraterritorially to a Tennessee citizen driving in Tennessee….)  Yet this statute was not enough in Williams to create a fundamental policy to override the choice of Missouri law.
  • Perform an interests analysis.  The Williams court emphasized that North Carolina did not have an interest in regulating insurance for a vehicle typically operated in Missouri.  But what about the countervailing interests?  What interest does Missouri have in overriding a North Carolina statute when North Carolina citizens are injured in Tennessee?  And what interest does Missouri have in protecting a Tennessee motorist and nationwide insurance company for an accident in Tennessee, simply because the vehicle is usually located in Missouri?

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