Client Alerts
August 28, 2018

Choice of Law and Your Construction Contract

Stites & Harbison Client Alert, August 28, 2018

What law governs your construction contract and the claims that may arise out of it?

Answering this question incorrectly could be very costly, and so can needless legal fights about which law should govern. Fortunately, careful drafting can help manage uncertainty and avoid the unexpected application of a law different than what you selected while negotiating your contract.

Commercial projects can involve owners, design professionals, contractors, subcontractors and suppliers based in different states, meaning that the laws of multiple different states may be implicated. At the same time, construction law varies widely from state to state, so that knowing which law applies is critical. For example, some states bar any contractual waiver of lien rights or of delay damages by a contractor, while other states permit such waivers. Key payment-related provisions, including “pay-if-paid” provisions and requirements for the timing of payments to and by contractors, may or may not be enforceable depending on which state’s law governs. And different states’ laws vary meaningfully with regard to issues like statutes of limitations, indemnity provisions and restrictions on awards of liquidated damages. In other words, the answer to basic questions like “How long do I have to file suit?” can differ significantly based on which state’s law is applied.

As a result, most construction contracts expressly address choice of law, whether or not the parties actually give these issues any real consideration. Indeed, in order to answer the question above, you may begin digging through the boilerplate at the back of your contract, where you may find a choice-of-law provision that reads: “This agreement shall be construed in accordance with the laws of the State of X.” It is tempting to think that you can comfortably rely on the laws of State X to govern all issues, disputes or claims that may arise from the project. Unfortunately, leaping to this conclusion could be a major mistake.

Why does the above choice-of-law clause fall short?

First, it is not a given that the parties’ choice of law will be given effect at all. Courts generally give weight to the parties’ selection of governing law, so long as it is not arbitrary. However, many states have passed statutes specific to construction that may negate the parties’ contractual choice of law. For example, for any project located in Texas, a Texas statute provides that if a construction contract contains a provision making the contract or any conflict arising under the contract subject to another state’s law, or providing that it will be resolved in litigation or arbitration in another state, the contractor or subcontractor performing the work may opt out of that provision in favor of Texas law. See Tex. Bus. & Com. Code Ann. § 272.001. If you are a Michigan-based general contractor with a Michigan choice-of-law provision in your subcontract for a Texas-based project, it will likely come as an unhappy surprise if a Texas court jettisons your bargained-for selection of Michigan law in favor of unfamiliar Texas law.

Second, the parties’ written choice of law may not encompass all of their claims and disputes. By its terms, the above choice-of-law clause only specifies the law that governs “construction” (that is, interpretation) of the contract itself. This provision will probably extend to all contract-based claims between the parties (although a better-drafted clause would make that clear). However, the provision is silent as to tort or statutory claims that do not arise from the contract, like negligence, fraud or a claim based on state statute for violation of the building code. Thus, even if the parties’ choice-of-law provision is enforced, a court might logically conclude that there is simply no indication that the parties agreed that the laws of State X would govern extra-contractual claims between them.

Third, inconsistent drafting within contract documents can generate further uncertainty about the governing law. For example, if a subcontract contains the above choice-of-law clause and the contract with the owner contains a provision selecting the law of another state, which state’s law governs claims between general contractor and subcontractor? What if the subcontract incorporates the general contract by reference? Similar conflicts can result from amendments or additions to contracts. By not giving adequate thought to the interplay between choice-of-law provisions in interrelated contract documents, the parties may invite a lengthy fight about the rules of their fight.

A final major source of uncertainty arises from the practical question of who will be interpreting the parties’ written choice of law. In the real world, the parties’ contractual selection of law and forum may be more likely to be honored in one forum than another. As noted above, if a subcontractor on a Texas-based project files suit in Texas state court against its Michigan-based general contractor, a Texas court appears likely to enforce the Texas statute favoring the subcontractor’s choice of law and forum over the subcontract provision selecting Michigan. But if the general contractor files first in Michigan state court, will the Michigan court follow Texas law? Or will the parties be compelled to arbitrate as agreed under the subcontract such that an arbitration panel will decide the question of which law governs?

As the above begins to illustrate, critical (and seemingly simple) questions like which statute of limitations applies can trigger a devilishly complex legal analysis for which the parties’ written choice of law may only provide a starting point. Fortunately, careful drafting can help assure that your written choice of law is, in most cases, also the ending point of the analysis. While not all of the above factors can be avoided by prior agreement, thoughtful advance planning can help minimize uncertainty about which law will govern (and about who will make that determination). With luck, a more complete and clearer agreement will head off any excursions into the treacherous terrain of choice of law. After all, if all parties know which law applies to all of the issues, that is one less issue to dispute.

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Construction Health Care - Construction Drafting, Reviewing & Negotiating Construction Contracts