Governing Law in Contracts: What It Is and Why It Matters

The Applicable Lawh2/Jurisdiction is ranked 27th in the Top 30 Most Negotiated Terms globally. It’s not just legal housekeeping; it’s a critical risk management tool that defines your “rules of engagement.”

For legal and compliance teams managing contract portfolios across jurisdictions, understanding governing law determines how every clause in your contract will be interpreted, which remedies are available, and whether your carefully negotiated terms will actually hold up in court.

What is a Governing Law Clause?

A governing law clause is a contract provision that selects the law to govern the contract and claims relating to the contract. Think of it as choosing the rulebook before the game starts.

The core function is straightforward: this clause allows parties to “choose their law” through what’s formally known as “Choice of Law.” The purpose of a choice of law clause is to provide a level of certainty about what laws will govern.

The parties to a contract can agree to have one state interpret the agreement even if one or both sides live or do business in another state. Two California tech companies can choose Delaware law. A London-based firm and a Singapore vendor can agree on New York law. The geographic location of the parties doesn’t dictate the choice; the contract does.

Why This Matters to Compliance Teams:

A foundational principle is that contracting parties already have a pre-existing, independent legal obligation to comply with Applicable Laws, regardless of what is stated in the contract.

• A party should not be required to perform an express obligation within a contract if that action would be prohibited under Applicable Laws.
• Each party is responsible and liable for its respective costs, fines, and expenses associated with complying with or failing to comply with Applicable Laws related to its business and operations, unless the contract expressly states otherwise.
• If a party fails to comply with Applicable Laws, this can constitute a breach of contract and trigger specified rights and remedies, especially if the failure damages the other party or causes the other party to violate Applicable Laws.
• The party responsible for the violation should bear the cost of any fines or penalties, which should be considered direct damages. However, reputational impacts on a party due to a violation of Applicable Laws by the counterparty are generally deemed consequential damage.
• Contracts should include a mechanism for adjustment if Applicable Laws change during the term and materially impact a party’s costs or performance.

Governing Law vs. Jurisdiction: Clearing the Confusion

These terms appear together so often that people treat them as synonyms. They’re not.

Governing Law: The rulebook (e.g., “We will play by New York rules”).
Jurisdiction (Venue): The referee and stadium (e.g., “We will argue in a London court”).

Jurisdiction refers to the geographical limits of a court’s authority, which is not necessarily the same as national boundaries. You can apply New York law to a contract, but agree to resolve disputes in California courts.

Read also: Contract Dispute Guide: Clauses & Resolution Tips

Is this common? No. Parties will usually want consistency between their governing law clause and jurisdiction clause, so if disputes are to be resolved in the English courts, it makes sense to choose English law. When they don’t align, you end up with California judges becoming experts in New York law, increasing costs, and introducing the risk that the court will incorrectly apply foreign law.

The choice of applicable law is particularly significant in Alternative Dispute Resolution (ADR) mechanisms like arbitration, as the chosen law often determines the procedural law followed.

Historically, the entire idea of a contract relies on the assumption of a possibility for enforcement.

In relational contracts, parties may agree contractually that the shared vision and guiding principles of the relationship shall be used to fill in the blanks when the contract language is ambiguous or silent. For a contract lawyer relying on “Entire Agreement” clauses, where the goal is to ensure contract obligations are exhausted by the written word, this inclusion of principles to interpret silence may seem risky, but it significantly decreases the risk of opportunism when complexity exists.

Why Governing Law is Critical for Commercial Agreements

1. Predictability

You know how terms like “indemnity,” “negligence,” or “material breach” will be interpreted. Delaware contract law is well developed and largely mirrors the general principles of contract law taught in law school, with no big surprises and no hidden rules that affect whether a contract will be enforced.

2. Cost Reduction

Choice-of-law contract clauses reduce the cost of dispute resolution by making it unnecessary for the court to conduct a choice-of-law analysis should a dispute wind up in litigation. Without a governing law clause, you’re paying lawyers to argue about which law applies before you even get to the merits of your case.

3. Standardization

Allows legal teams to use a single set of playbooks across regions where possible. When you know all your SaaS contracts will be governed by Delaware law, you can build templates, train your team, and develop clause libraries that work consistently.

4. AI and Regulation

Legal professionals acknowledge the risks associated with advanced technology, particularly AI inaccuracy. 83% of the legal industry reports they would be more open to using AI tools in the workplace if proper regulations were adopted to guide their use. Concerns include AI hallucination potentially causing the model to misstate or make up a new law entirely.

How to Choose the Right Governing Law

1. Neutrality & Fairness

Why do parties often pick a “neutral” third ground? When parties select a non-domestic corporate law for their M&A transaction, stability, predictability, and certainty matter, driving them to choose popular Anglo-American laws such as those of England, Delaware, New York, and California.

In international transactions, English Law has become the dominant standard because neither party has a home-court advantage, and the jurisprudence is well-developed and predictable.

2. Industry Standards

Corporate/Startups: Often Delaware. More than 68% of the Fortune 500 companies are incorporated in Delaware. The state offers well-developed corporate case law and a business-friendly court system.

Finance: Often New York or London. Empirical studies in the early 21st century have found that the law of the state of New York is by far the most popular choice for choice of law clauses in American contracts, followed by either Delaware or California.

SaaS/Tech: Frequently California or Delaware, depending on the company’s incorporation state and negotiating leverage.

3. Physical Presence: The Nexus Requirement

For the choice of law and jurisdiction clause of a contract to be enforceable, there must be enough points of contact between the law and jurisdiction and one or both of the parties or the transaction involved.

However, some jurisdictions make this easier. New York offers businesses the possibility of applying New York law to their agreements when the consideration involved in the agreement is $250,000 or more, whether or not such a contract bears a reasonable relation to the state.

Jurisdictional Differences

The importance of specific contract terms varies significantly across different legal jurisdictions. Legal systems based on English/US/Common Law and French/Civil Law show noticeable similarities in their Most Important Terms, while jurisdictions like Indian, Russian, and Islamic laws place importance on different terms.

Regulatory Context and Case Studies: How to Manage Them with AI

Mary O’Carroll, Former Chief Community Officer at Ironclad, remarked on the perception of legal departments in the State of AI 2024 Report: “In the corporate legal department, everyone is swamped. Everyone is constantly telling us how buried they are, and there’s too much work to be done. And you’re a cost center, by nature, you can’t deny it. So, your incentive is always to get more done, faster.”

The need to navigate complex regulations like GDPR and CCPA demands that organizations choose CLM solutions that meet rigorous security and compliance standards of governing laws.

1. Regulatory-Driven Contract Simplification

Increased regulation and government intervention are driving major businesses to simplify their contracts. The GDPR requires organizations to process personal data in a manner that ensures its security, including protection against unauthorized or unlawful processing. Under the CPRA, businesses must establish written contracts with service providers, contractors, and third parties, clearly outlining the permitted uses of personal data and prohibiting unauthorized actions.

The amendment of the EU’s Unfair Contract Terms Directive and updates to the Australian Consumer Law, designed to strengthen SME protection, have forced organizations (including those in the mining industry) to simplify contracts and revisit risk policies to comply with these new requirements.

2. M&A Due Diligence and Compliance

The complexity of managing legal assets can be mitigated by technology. In one instance, a legal department utilized AI-enabled CLM during a large, complex merger and acquisitions transaction to complete due diligence in nine days, leading to the discovery of $20 million in title defects.

3. Real-Time Risk Assessment

A corporate lawyer used AI-enabled CLM to proactively address risk questions during a real estate meeting, reviewing the contract in real time and analyzing the event of default clause to provide an immediate, data-driven answer.

4. Force Majeure and Compliance

A commercial contract manager in the oil and gas industry used a CLM when a severe winter storm caused prolonged power outages, creating a force majeure event. They were able to quickly generate specific queries related to the storm to determine where they had clear force majeure rights and which agreements they could interrupt without penalty, ensuring compliance while mitigating risk exposure.

5. Responding to Inflation/Regulatory Changes

Facing supply chain issues and inflation, a company used AI-enabled CLM to quickly identify which contracts contained price escalation clauses. This allowed the legal team to efficiently assert their contractual right to raise prices or understand where renegotiation was required, saving potentially thousands of hours of manual review across their contract repository.

In essence, while lawyers are not data scientists, technological solutions like AI-enabled CLM systems, trained by legal and data science experts, are transforming legal departments into sources of intelligence by enabling faster, more efficient compliance, risk mitigation, and strategic decision-making in an increasingly complex global legal landscape.

Risks of Not Specifying Governing Law

Gaston Alvarado, Sourcing Director at Lincoln Electric, highlighted internal difficulties: “I believe that a significant challenge for any organization, whether in procurement or any other area, is the continuous improvement mentality. This culture or behavior heavily depends on the leader.”

1. Conflict of Laws Analysis

When the issue comes up in the absence of a choice of law provision in the contract under dispute, the court will apply its own choice of law rules, which themselves vary from state to state, to select which jurisdiction’s law applies.

This messy legal process uses the “closest connection test.” Courts look at where the contract was signed, where it’s being performed, where the parties are located, and a dozen other factors. The outcome? Unpredictable and expensive.

Read also: Novation of Contract: A Simple Guide with Examples

2. Unforeseen Statutes

You might inadvertently be subject to consumer protection laws of a foreign jurisdiction that are stricter than your own. The Delaware Court of Chancery acknowledged that under the applicable California statute, the non-compete would be enforceable to protect acquired goodwill, but reasoned that the covenant in the employment agreement was directed to a different employer interest.

Even with a Delaware choice-of-law clause, California’s strong public policy against non-competes can override your chosen governing law if California has a materially greater interest in the matter.

Examples of Governing Law Clauses

1. Standard Pro-Company Clause (Favoring Your Home State)

This Agreement shall be governed by and construed in accordance with the laws  

of the State of [Your State], without giving effect to any choice or conflict  

of law provision or rule.

2. The “Delaware” Standard (For Corporate/SaaS)

This Agreement shall be governed by the laws of the State of Delaware, USA,  

excluding its conflict of laws principles. The parties agree, consent, and waive  

contest to the exclusive jurisdiction and venue of the federal or state courts  

of Delaware for all disputes arising out of or relating to this Agreement.

3. The International/Neutral Clause (English Law and Arbitration)

This Agreement shall be governed by and construed in accordance with the laws  

of England and Wales. Any dispute arising out of or in connection with this  

Agreement shall be referred to and finally resolved by arbitration under the  

Rules of the London Court of International Arbitration, which are deemed  

to be incorporated by reference into this clause.

Managing Governing Law at Scale with HyperStart CLM

Legal teams must continually balance the need for enforceable obligations with the need for flexibility when handling breaches or disputes. Legal must distinguish between breaches that cannot be compromised, such as those related to anti-trust and bribery or compliance with laws, and those that can be handled more collaboratively (e.g., missed SLAs).

Competitors rarely discuss the operational challenge of managing governing law variations across thousands of contracts. HyperStart will win by positioning Governing Law not just as a legal clause, but as a standardization lever that impacts deal velocity.

The Repository Problem

How do you know which of your 5,000 legacy contracts are governed by French law vs. NY law? Organizations implementing AI-powered CLM report transformative results, 

Without AI-powered contract management, you’re manually reading thousands of contracts or relying on inconsistent metadata that was entered years ago by people who’ve since left the company.

Shria T., AVP – Legal, Mid-Market (51-1000 emp.)

1. “[HyperStart] gives a central repository for all our contracts.”
2. “The Tool’s AI extraction feature helps to capture the key points from all the contracts… This makes the work a lot easier.”
3. “The AI extraction is one of the best compared to its peers.”

Read also: A Contract Review Checklist to Protect from Legal Risks

Clause Libraries

Giving sales teams pre-approved “fallback” clauses (e.g., “If they reject NY, offer Delaware”) speeds up negotiation without calling legal every time. A survey reveals that 65% of legal departments now utilize AI-powered contract management solutions, which marks a significant 14% point increase over the past two years.

Organizations leveraging AI in contract management have achieved 31% cost savings, proving that automation delivers tangible ROI. Forrester Research states that CLM solutions can reduce contract drafting and review time by up to 80%, significantly easing legal workloads.

Conclusion

Ryan O’Leary, Research Director for Privacy and Legal Technology at IDC, provided an optimistic view on technology: “Unlock the future of legal efficiency with AI-driven contract lifecycle management, transforming legal departments from cost centers to strategic business enablers.”

Governing law is the “operating system” of your contract. It determines how every clause will be interpreted, which remedies are available when things go wrong, and whether your carefully negotiated positions will actually be enforceable when tested.

But here’s what most legal teams miss: while drafting the right governing law clause is important, managing these clauses across your entire contract portfolio is what actually protects the business long-term.

If you have 500 contracts governed by Delaware law, 300 by New York law, 150 by English law, and another 200 scattered across various jurisdictions, you don’t have a contract management problem; you have a data problem. You need to know:

• Which contracts are governed by which laws
• Which jurisdictions create the most negotiation friction
• Where your risk exposure sits geographically
• When regulatory changes in specific jurisdictions require contract amendments

Legal teams that use the governing law clause as a standardization lever, backed by AI-powered contract lifecycle management, are free from boilerplate to focus on higher-order work.

The question is: do you actually know what’s in them, can you enforce consistency, and can you find them when they matter most?

That’s where modern CLM sets you apart.