Choice-of-Law Clauses and Marital Property Law
January 18, 2024
In a recent law review article, I criticized a unanimous decision of the Washington Supreme Court that enforced the choice-of-law clause in a contract to which only one spouse was a party to determine which jurisdiction’s law governed an issue relating to marital property. In this blog post, I first provide a concise account of this case. I then explain how and why the court got it wrong.
Shanghai Commercial Bank v. Chang
The facts of the case in question, Shanghai Commercial Bank v. Chang, are striking. It involved spouses who had lived in Washington State their entire married lives, a period of more than twenty years. The husband and his father signed documents for a loan from a Chinese bank to assist the father with some of his investment activities and debts in Hong Kong. The father lived in China, received the loan documents in China, and mailed them to the husband in Washington for signature. The wife did not sign any of the documents and was unaware that her husband had entered into the loan. The loan documents specified that they were to be governed by Hong Kong law.
After default on the loan, the bank obtained a nine-million-dollar judgment against the husband in a Hong Kong court. The wife was not a party to the Hong Kong lawsuit. The bank domesticated the judgment in Washington and sought to enforce it against the spouses’ community property. The spouses defended on the ground that the husband did not incur the debt for the benefit of the marital community and, therefore, under Washington community property law, the judgment could not be enforced against any of their community property. They argued that it could be enforced only against the husband’s separate property, which was limited to nonexistent.
The parties did not dispute the Hong Kong court’s ruling that the Hong Kong choice-of-law clause controlled as to the interpretation and validity of the contract. The only choice of law issue presented to the Washington Supreme Court was whether that same clause controlled the marital property issue and the court held that it did. The court then concluded that, because Hong Kong marital property law would allow recourse for the loan to all property of the spouses of types that would be community property under Washington law, the creditor could execute against all the couple’s community property even though Washington law would not have allowed recourse to any of that property.
In the article, I argue that the court’s decision was incorrect both under applicable Washington precedent, which follows the Restatement (Second) of Conflict of Laws, and as a matter of policy.
It was likely correct for the Hong Kong court to apply Hong Kong law to issues of interpretation and validity of the loan documents in the initial litigation, which resulted in the Hong Kong judgment. The Washington Supreme Court did not address those issues in its decision. It addressed only the issue of what property of the spouses was available to satisfy the judgment after it was domesticated in Washington. In doing so, it incorrectly applied the law of Hong Kong rather than applying the marital property laws of Washington.
The court erred in three important respects and, in doing so, it undermined some of the fundamental protection given to Washington residents under the state’s community property laws.
First, the court did not appear to recognize that it should analyze choice of law on an issue-by-issue basis and that different jurisdictions’ laws might govern different issues.
Second, the court based its decision on the rules laid down in section 187 of the Restatement relating to choice-of-law clauses without first considering whether one of the affected parties was a party to the contract containing the clause. The court should instead have looked to section 6 of the Restatement, which lists factors for courts to consider when there is neither a valid contractual choice of law nor a controlling statutory directive. As explained in the article, those factors would have pointed to Washington as the appropriate governing law.
Third, the court applied Hong Kong law to deny the wife the benefits of a fundamental policy of Washington’s community property laws, which are designed to protect the community property from contractual debts incurred by only one spouse without the consent of the other that do not benefit the marital community. Even if both spouses had been party to the loan documents, Washington courts, following sections 187 and 188 of the Restatement, should have concluded that Washington’s community property laws are a fundamental policy of the state, which cannot be contracted around where Washington has a materially greater interest in the determination than does the state whose law was chosen in the contract. The Washington courts have so ruled in other contexts, for example not allowing a contractual choice of law to avoid Washington’s usury statutes where they would otherwise apply.
The article contrasts the court’s ruling with the approach taken by courts in Arizona (another community property state). In cases with facts like those in Shanghai Commercial Bank, the Arizona courts regularly apply the marital property laws of the jurisdiction that is more favorable to the non-contracting spouse.
A better rule would posit that the marital property issue is governed by the law of the spouses’ current domicile except when the contracting spouse took on the debt while the spouses lived in another state and the spouses then moved to a new state and tried to use the new state’s marital property laws to avoid or reduce the recourse the creditor would have under the laws of the former domicile. This rule should apply even where both spouses are parties to the contract because (1) the marital property laws should be viewed as a fundamental policy of the domiciliary state, and (2) a different rule would create an unworkably chaotic situation for insolvent spouses who would have different states’ marital property laws governing the recourse available to different creditors. I take no position on whether other courts should adopt Arizona’s approach, which is more favorable to non-contracting spouses.