postimage

    10:31 PM Marcus Teo (Centre for International Law, NUS)

    Floating/Invalid Choice of Law Clauses in Context: Shanghai Turbo Enterprises Ltd v Liu Ming [2018] SGHC 172

        

    Introduction

    When a contract’s choice of law clause is invalid, what happens to the main contract, or any jurisdiction clause therein? In Shanghai Turbo Enterprises Ltd v Liu Ming [2018] SGHC 172 (“Shanghai Turbo”), the Singapore High Court (“the Court”) noted that an invalid choice of law clause (1) will not impugn the formation of the main contract, but (2) will affect the validity of a proximate jurisdiction clause.

    This commentary unpacks and discusses the Court’s reasoning in support of those conclusions. It suggests that such reasoning permits a re-conceptualisation of choice of law clauses: from fundamental terms of the main contract, to fundamental terms contained in a separate dispute resolution agreement.

    Background

    Shanghai Turbo Enterprises Ltd (“ST”) is a Caymans Island-incorporated company set up in 2005 to be the ultimate parent company of the Chinese-incorporated Changzhou 3D Technological Complete Set Equipment Ltd (“Changzhou 3D”).

    ST brought claims against Liu, an erstwhile-Executive Director, whose father had built Changzhou 3D’s business before handing him the reins in 2005. ST alleged that Liu had breached duties owed under his contract of appointment (“the Agreement”), by failing to deliver up Changzhou 3D’s assets to ST, and by disclosing business opportunities and confidential information to a competitor.

    Clause 17 of the Agreement contained both a choice of law clause and a jurisdiction clause. It read:

    This Agreement shall be governed by the laws of Singapore/or People’s Republic of China and each of the parties hereto submits to the non-exclusive jurisdiction of the Courts of Singapore/or People’s Republic of China.”

    Since Liu was in China, ST sought leave to serve out of jurisdiction under Order 11 r 1(d)(iii), 1(d)(iv) or 1(r) of the Rules of Court.

    On r 1(d)(iii), which required the Agreement to be governed by Singapore law, the parties agreed that “clause 17 disclosed no valid express choice” of governing law, and that the objective proper law should govern the Agreement instead. However, they disagreed on what the objective proper law of the Agreement should be. ST argued for Singapore law; Liu, for Chinese law.

    On r 1(d)(iv) and 1(r), which required the Agreement to contain a Singapore jurisdiction clause, ST argued that Clause 17 conferred non-exclusive jurisdiction on both Singapore and Chinese courts. Liu, however, argued that Clause 17 was invalid, and thus no jurisdiction clause existed.

    The Court found a good arguable case that the objective proper law of the Agreement was Singapore law, and that therefore Order 11 r 1(d)(iii) was satisfied. It, however, found that Order 11 r 1(d)(iv) and 1(r) were inapplicable as the jurisdiction clause was determined to be invalid. Nevertheless, the Court set aside ST’s Order 11 writ on grounds that Singapore was not the natural forum, since most of the relevant connecting factors pointed to China, and since there was no cogent evidence that ST would be deprived of substantial justice in Chinese proceedings.

    This commentary focuses solely on the Court’s discussion of the effect of a choice of law clause’s invalidity on the main contract and any proximate jurisdiction clause.

    Commentary

    1. Choice of Law Clauses and Contract Formation

    On r 1(d)(iii), the Court found a good arguable case that the proper law of the Agreement was Singapore law. Crucial to that conclusion was its finding that, although the choice of law clause contained in Clause 17 “provide[d] for a “floating” proper law” which is “unenforceable” since a contract’s proper law is “fundamental to questions relating to the formation [and] validity…of a contract”, its invalidity did not call into question the Agreement’s formation. It thus followed that the objective proper law of the Agreement could be applied (Shanghai Turbo, [42], [30] & [33]). The reasoning behind the Court’s decision here suggests that contract formation and the validity of a choice of law clause are separate issues.

    1. Pro-intention vs pro-validation theories of contract formation

    The Court’s reasoning on the effect of invalid choice of law clauses is best understood in the context of existing judicial and academic discussion on the impact of an invalid and/or “floating” choice of law clause on a contract’s formation and governing law.

    In Amin Rasheed v Kuwait Insurance [1984] 1 AC 50, Lord Diplock stated that “contracts are incapable of existing in a legal vacuum…[and]… are…devoid of all legal effect unless they were made by reference to some system of private law” (at 65), because an agreement on parties’ rights and obligations inter se cannot be determined without reference to a single legal system to give “precise meaning” to bare contractual terms (at 61). In that case, the absence of a choice of law created no “legal vacuum”; the objective proper law simply applied (at 69). However, Lord Diplock was unclear on one point: could a “legal vacuum” theoretically ever arise, if parties’ actual intentions compel it? Are parties’ actual intentions, or the need to uphold contractual validity within objectively-determined reasonable limits, the paramount concern in contract formation?

    Today, contract choice of law principles seem to balance pro-intention and pro-validation approaches to contract formation. A pro-intention instinct prevails at the contract choice of law rule’s first and second stages, which gives primacy to parties’ actual (express or implied) intentions as to the which law governs their contract (i.e. the law under which their contract is formed). Conversely, a pro-validation ethos underlines the choice-of-law rule’s third stage: where parties’ actual intentions cannot be ascertained, the objective proper law is to be applied instead (Pacific Recreation Pte Ltd v S Y Technology Inc [2008] 2 SLR(R) 491 (“Pacific Recreation”), ([36]).

    However, the appropriate balance between parties’ intentions and contract formation, in the specific relationship of the contract choice of law rule’s first stage to its third, remains largely unexplored. The question is: should courts apply the objective proper law only when parties’ actual intentions cannot be ascertained, such that an actual but invalid choice of law will lead to a “legal vacuum” and a non-existent main contract – or should they do so when parties’ actual intentions either cannot be ascertained, or lead to an invalid choice of law, such that neither situation will call the main contract’s formation into question?

    A pro-intention approach would endorse the former position. Since parties’ intentions are decisive on the proper law, their actual choice of law implicitly excludes other laws’ applicability (Adrian Briggs, Agreements on Jurisdiction and Choice of Law (OUP, 2008) (“Briggs”), [11.25]-[11.30]). Thus, when parties’ actual choice is invalid, the contract is left in a “legal vacuum”, rendering it non-existent. This is because applying the objective proper law here would be to ignore parties’ true consensus ad idem, creating a contract neither intended (FA Mann, “The Proper Law of the Contract” (1950) 3:1 Int'l LQ 60, 69) – although without an actual choice, parties “did not address their minds to the question of [the governing law]”, and thus the objective proper law’s application will not defeat any intentions (Pacific Recreation, [47]). Similarly, when parties evince “a positive intention at the outset that there was to be no proper law…it may be doubted whether a contract had been formed at all” (Halsbury’s Laws of Singapore Vol 6(2) (LexisNexis, 2013) (“Halsbury’s”), [75.356], emphasis added). Thus, under a pro-intention approach, the validity of parties’ actual choice of law, and the main contract’s formation, are the same issue.

    Conversely, a pro-validation approach would take the latter position. Since certainty of agreement is paramount, when the actual choice is invalid, the objective proper law fills the gap, no “legal vacuum” ever arises, and the main contract’s formation is unquestioned. While it cannot be denied that contracts gain binding force from parties’ intentions, courts in truth search for objectively-ascertainable manifestations of parties’ consensus ad idem, rather than the actual existence thereof, and are guided in their quest by the expectations of reasonable businessmen (JHC Morris, “The Proper Law of a Contract: A Reply” (1950) 3:2 Int'l LQ 197, 198-200). Similarly, choices of law found to be invalid for not being “bona fide or legal” do not lead to the invalidity of the entire contract, but instead result in the application of the objective proper law of the contract (Tan Yock Lin, “Good Faith Choice of a Law to Govern a Contract” [2014] SJLS 307 (“Tan”), 312). Thus, under a pro-validation approach, the main contract’s formation will not be an issue even if the express choice of law clause is found to be invalid.

    1. The position in Shanghai Turbo

    In Shanghai Turbo, the Court found that the Agreement’s choice of law clause was invalid. Yet, no issue of the main contract’s formation was raised, much less discussed by the Court, clearly evincing its pro-validation approach.

    That the Court considered the choice of law clause invalid because it interpreted the clause as a “floating” choice of law clause makes no difference to the implications of its reasoning. In fact, such an interpretation was arguably erroneous: Clause 17 simply contained a non-“floating” but invalid choice of law clause. Absent a mechanism to crystallise the proper law, Clause 17’s plain wording arguably represented parties’ positive intentions for an effective choice of law from the outset. Further, a “floating” choice of law clause would not have been commercially sensible given the Agreement’s purpose: such clauses sacrifice certainty on contractual obligations for flexibility to adhere to the law of the place of contractual performance, and only make sense when performance will likely occur in several jurisdictions (as in both The Armar [1980] 2 Lloyd’s Rep 450 and The Iran Vojdan [1984] 2 Lloyd’s Rep 380 (“The Iran Vojdan”), where the carrier of cargo negotiated to have his rights governed by the place where he happens to be). On the facts, the place of contractual performance (that is, China; Shanghai Turbo, [37]) was certain from the outset.

    Even accepting the Court’s finding that the contractual choice of law clause was “floating”, the Court’s reasoning was nevertheless underlined by a pro-validation approach. “Floating” choice of law clauses paradigmatically state that some event after the contract’s formation shall determine its governing law. Admittedly, in practice a “floating” choice of law clause will never lead to a finding that the main contract was not formed (Tan, 320-322); that contract will be considered formed under the objective proper law (Halsbury’s, [75.356]). However, the reasoning necessary to reach that conclusion will differ depending on the approach adopted.

    Under a pro-intention approach, a “floating” choice of law clause threatens to bring the main contract’s very formation into issue: since it holds the governing law in abeyance, a “legal vacuum” exists at the time of formation. However, a “legal vacuum” is avoided by conceptually dividing that contract’s potential lifespan into two periods: existence before the “floating” choice of law crystallises, and existence after. Where a contract states that it “shall be governed by X law, but may be governed by Y or Z law if either party so opts”, existence in the first period would be supported by X law. Existence in the second period would likewise be supported – under Y or Z law, if X law allows for a post-formation variation-of-governing law; but under X law, if X law precluded such change (The Iran Vojdan, 384-385).

    More commonly, a contract will simply state that it “may be governed by Y or Z law if either party so opts”, but the outcome should be the same. Since the potential for crystallisation itself implies two periods in that contract’s lifespan, and since parties’ silence on the governing law for the contract’s first period shows that they “did not address their minds” to the issue, applying the objective proper law then does not defeat their intentions (Peter Nygh, Autonomy in International Contracts, (Clarendon Press, 1999) (“Nygh”), 99). Thus, many of the commonly encountered “floating” choice of law clauses are not true choice of law clauses, but are really post-formation variation-of-governing law clauses. Even under a pro-intention approach, the invalidity of a post-formation variation-of-governing law clause will not automatically trigger an inquiry as to whether the main contract has been validly formed.

    Under a pro-validation approach, however, such complex logic is unnecessary. That parties’ actual choice of law may be invalid (because it “floats” or otherwise) is irrelevant to the main contract’s formation, which is a non-issue even if the choice of law clause is invalid. Hence, courts may simply apply the objective proper law at the third stage of the contract choice of law rule.

    Though under both approaches the objective proper law must be determined, the pro-intention approach can do so only because there was no actual choice of law for the first period of the contract’s existence, while the pro-validation approach may do so even when an actual choice of law exists but is invalid. Since the Court noted “that clause 17 indicated that parties had applied their minds to the choice of law but had made no valid express choice” (Shanghai Turbo, [33], emphasis added), before applying the objective proper law, its reasoning was clearly pro-validation.

    One might question whether the Court limited itself to Clause 17’s validity because both ST and Liu considered the Agreement’s existence a non-issue (Shanghai Turbo, [26]). However, as aforementioned, under a pro-intention approach an express choice of law clause’s validity and the Agreement’s formation are the same issue – by questioning the former, parties must question the latter as well. Thus, the Court’s very finding that no issue of contract formation arose proves its pro-validation approach.

    The Court’s pro-validation approach, that the invalidity of the choice of law clause does not affect the formation of the main contract, is surely commercially sensible. Actual disagreements on the meaning of clearly-worded contracts in practice arise only at the peripheries, and parties do not reasonably expect such disagreements to mean that their contract was never formed – indeed, they are likely to already have performed and relied on the contract in good faith (Tan, 319-320).

    However, the Court’s pro-validation approach sits uneasily with its statement that “[t]he proper law is…fundamental to…the formation, validity, interpretation and performance of a contract”. That statement was not merely tangential to the Court’s reasoning, either — on it rested the Court’s entire conclusion that a “floating” choice of law clause can never be valid (Shanghai Turbo, [30], citing The Iran Vojdan at 385).

    The problem is this: should not a lack of valid consensus ad idem on “fundamental” issues threaten a contract’s formation? It is well-established today that courts should adopt a broad “internationalist” approach when characterising issues arising out of choice of law disputes (Raiffeisen Zentralbank v Five Star Trading [2001] EWCA Civ 68, [26]), Further, comparative perspectives on contract formation show that parties’ objectively-determined intentions are generally insufficient for formation if parties shared a subjective intention on “fundamental”/“essential” issues which cannot be achieved, and if there are significant discrepancies between those objective and subjective intentions (Martin Hogg, Promises and Contract Law: Comparative Perspectives (CUP, 2011), 242-243, 246-247, 250, 254 & 255). Thus, if a choice of law is “fundamental” to the main contract, should not questioning the validity of an actual choice of law necessarily call into question the main contract’s formation as well?

    1. Choice of Law Clauses, Jurisdiction Clauses and Separability

    An explanation, perhaps, might be to consider a choice of law not a fundamental term of the main contract, but a fundamental term of another agreement concerning parties’ provisions for dispute settlement, related to but separable from the main contract (Briggs [3.49] & [10.40]).

    The Court’s treatment of r 1(d)(iv) and 1(r) stops short of such a conclusion – but only just. There, the Court found that since Clause 17 was invalid in its entirety, no jurisdiction clause existed at all. It reached this conclusion on two alternative grounds. First, it found that since both jurisdiction and choice of law clauses were “contained in the same clause” and connected with the word “and”, they were “intimately linked”, and the former “could not be severed” from the latter but instead “stands or falls with [it]” (Shanghai Turbo, [40] & [45]-[46]). Second, even if severance were available, Clause 17’s jurisdiction clause was disjunctive (because it read “Singapore/or People’s Republic of China”), and thus would be unworkably uncertain, since it created a “floating” jurisdiction clause with no election mechanism (Shanghai Turbo, [47]-[50]).

    Concerning the Court’s second ground: respectfully, Clause 17’s jurisdiction clause was not unworkably uncertain. “Floating” jurisdiction clauses are not uncommon (see The Jian He [1999] 3 SLR(R) 432), and the principle of effective interpretation should save ambiguously-worded jurisdiction clauses by implying a “commercially logical” election mechanism (Insigma v Alstom [2009] 3 SLR(R) 936 (“Insigma”), [31]-[33]): namely, that parties choose by commencing proceedings in Singapore/China. Indeed, that Clause 17’s jurisdiction clause was expressly labelled “non-exclusive” shows that parties did not consider that commencing proceedings in one jurisdiction should bar proceedings in the other; such an election mechanism would still “result in [litigation]…within the[ir] contemplation”  (Insigma, [31]).

     

    Thus, the Court’s conclusion that Clause 17’s jurisdiction clause was invalid presumably rested substantially on the first ground of decision: that Clause 17’s jurisdiction clause was not severable from the invalid choice of law clause. Indeed, the Court seemed to consider this its central ground of decision on that issue (Shanghai Turbo, [40]).

    In finding that Clause 17’s jurisdiction clause could not be so severed, the Court’s was heavily influenced by Bingham J’s conclusions in The Iran Vojdan, that jurisdiction clauses “parasitic” on invalid choice of law clauses should also be invalid. The clause in The Iran Vojdan reads as follows:

    “The contract of carriage…and all disputes arising hereunder…shall…in the option of the carrier to be declared by him on the merchant's request be governed (i) either by Iranian law…with exclusive jurisdiction of the Courts in Teheran Iran; (ii) or by German law…with exclusive jurisdiction of the Courts in Hamburg…; (iii) or by English law…with exclusive jurisdiction of the Courts in London”

    Two features of the Iran Vojdan clause arguably made severance impossible. First, the choice of jurisdiction provision was integrated into what was predominantly a choice of law clause. Severance of the choice of law portion would have rendered the remaining choice of jurisdiction portions ungrammatical and therefore inoperable. Second, the clause was expressly designated “exclusive”, denying an interpretation of Tehran, Hamburg and London as non-exclusive forums. As the clause in Iran Vojdan required parties to make an “exclusive” choice of jurisdiction, and since it would only be commercially-sensible to exercise both that choice and the choice of law together, the two clauses were arguably inextricably linked.

    Those two features were not present in Clause 17. In the case of Clause 17, severance of the “floating” choice of law clause would have left a grammatically-sound and thus workable jurisdiction clause in place. Further, because the term “non-exclusive” was expressly used, parties would never have needed to make an exclusive choice of jurisdiction, and therefore the jurisdiction clause need not have operated in tandem with any decision to crystallise the “floating” choice of law. Indeed, it seems the only reason why severance was denied is that both clauses were in Clause 17, and were linked by the word “and”.

    Perhaps the Court was entitled to decide either way on the issue of severability. However, the doctrine of separability, which insulates dispute resolution clauses from challenges that may be brought against their main contracts’ validity, should have justified severance – if the doctrine of separability applied, only a lack of consensus ad idem on a jurisdiction clause’s specific subject-matter would invalidate it (Briggs, [3.15]-[3.18]). Admittedly, separability’s applicability appears only well-established for arbitration clauses, and in that context, by virtue of statute (Article 16(1) of the UNCITRAL Model Law on International Commercial Arbitration, read with International Arbitration Act (Cap 143A, 2002 Ed) s 3). However, its underlying policy of promoting party autonomy and reducing transaction costs is commercially desirable, and thus very much upheld as general common law policy (Briggs, [3.19], [3.35]-[3.41]), in particular by Singapore’s courts (see HSBC Institutional Trust Services v Toshin Development [2012] 4 SLR 738, [45]). There are thus no principled grounds for limiting separability’s operation only to arbitration clauses.

    Of course, the doctrine of separability is merely an interpretative presumption, displaceable by parties’ clear intentions (Premium Nafta Products Limited v Fili Shipping Company Limited [2007] UKHL 40, [12]-[13]). However, that two terms are in the same clause should not, without more, be sufficient to overcome the presumption. The explanation for the Court’s conclusion that “[b]y Singapore law, if the ‘floating’ choice of law sub-clause is invalid, the ‘floating’ jurisdiction sub-clause contained in the same clause falls” (Shanghai Turbo, [40]) is thus somewhat hard to discern.

    Nevertheless, a explanation for why separability should not generally operate between jurisdiction clauses and choice of law clauses, as it would between jurisdiction clauses and main contracts, does exist. This would be so if both choice of law clauses and jurisdiction clauses are considered part of a single dispute resolution agreement, separable from every contract which they are formally part of. Indeed, the Singapore Court of Appeal had previously expressed tentative support for the separability of a choice of law clause from the main contract, albeit in a different context (see CIMB Bank Bhd v Dresdner Kleinwort Ltd [2008] 4 SLR(R) 543, [33]).

    If the Court had adopted this explanation for its conclusion that jurisdiction and choice of law clauses in the “same clause” stand or fall together, no damage would have been done to the doctrine of separability. The Agreement would continue to exist under its objective proper law, but the jurisdiction clause would be invalid because a fundamental term of the separate dispute resolution agreement to which the jurisdiction clause was part of (namely, Clause 17’s choice of law clause) is invalid.

    Conclusion

    As aforementioned, the Court’s conclusions on Order 11 r 1(d)(iii), 1(d)(iv) and 1(r) were not essential to its decision to set aside ST’s Order 11 writ, given its conclusion that Singapore was not the natural forum.

    Nevertheless, the above discussion shows how the Court’s reasoning – that an invalid choice of law clause does not impugn the main contract’s formation but leads to the invalidity of jurisdiction clauses contained in the “same clause” as the main contract – permits a re-conceptualisation of choice of law clauses as forming part of a separate dispute resolution agreement.

    The ramifications of such a conceptualisation are considerable. Notably, it would explain why the invalidity of a choice of law clause does not in principle automatically trigger the invalidity of the entire contract, which incidentally happens to be a commercially desirable outcome as well. Further, conceptualising a choice of law clause as constituting a separate agreement from the main contract strengthens the argument for applying an express choice of law to issues of formation and validity of the main contract, so as to avoid the alternative: the logically-circular application of a putative proper law (Briggs, [3.63]-[3.64]; Nygh, 84).

    Given the brevity of the Court’s reasoning, Shanghai Turbo is not clear authority for the proposition that a choice of law clause may be considered a fundamental term of a separate dispute resolution agreement rather than the main agreement. As the case goes on appeal, clarification by the Court of Appeal on this area of law would certainly be welcome.

     

    * This blog entry may be cited as Marcus Teo, “Floating/Invalid Choice of Law Clauses in Context: Shanghai Turbo Enterprises Ltd v Liu Ming [2018] SGHC 172”  (23 October 2018) (http://www.singaporelawblog.sg/blog/article/220)

    ** A PDF version of this entry may be downloaded here 

     

Comment Section