Zombie Choice-of-Law Clauses
November 21, 2022
When a contract is terminated, the provisions contained in that agreement generally cease to have any legal effect. Many U.S. courts have held, however, that contract provisions relating to dispute resolution continue to bind the parties even after the underlying contract ceases to be. In this post, I refer to such provisions as “zombie” clauses because they endure even after the main agreement ends. This post examines some of the legal issues presented by zombie choice-of-law clauses, in particular, and their relationship to the legal doctrine of separability.
Wahl Clipper Corp. v. Plaza Lama
To illustrate how zombie clauses come to be, it is helpful to examine the facts of a recent case decided by the Northern District of Illinois – Wahl Clipper Corp. c. Plaza Lama, S.A. Wahl Clipper Corporation (“Wahl”) is an Illinois-based company that sells hair clippers, hair trimmers, and shavers. Plaza Lama, S.A., (“Plaza”) is a company that operates department stores in the Dominican Republic. In January 1997, Wahl entered a Distributor Agreement (the “Agreement”) with Plaza whereby Plaza agreed to become the exclusive distributor of Wahl’s products in the Dominican Republic. The agreement contained a choice-of-law clause selecting the laws of Illinois and a non-exclusive forum selection clause selecting the courts in Illinois. The Agreement stated that it would automatically expire on December 31, 1997, unless the parties agreed in writing to renew it. The parties never renewed the agreement.
Over the next twenty-four years, Wahl continued to sell hair-trimming products to Plaza. It did so, however, on a non-exclusive, purchase-order/confirmation basis. None of these purchase orders contained choice-of-law clauses. In 2021, Plaza contacted Wahl to demand that it perform certain actions required under the Agreement. It also threatened to sue Wahl for damages in the Dominican Republic under a local statute that allows foreign companies to terminate distribution agreements with local companies only for “just cause.” In response, Wahl filed a declaratory judgment action in the Northern District of Illinois asking the court to find (1) that the Agreement expired in 1997, and (2) that the Dominican statute did not apply to the relationship between Wahl and Plaza. Although Plaza was properly served, it failed to answer or otherwise respond to the complaint. The district court entered a default judgment against Plaza on November 7, 2022.
Separability and Zombie Clauses
In its decision, the district court sought to determine whether the Illinois choice-of-law clause in the Agreement was enforceable against Plaza under Section 187 of the Restatement (Second) of Conflict of Laws. It held that the clause was enforceable, first, because the interest of the Dominican Republic in applying its law to the dispute was not materially greater than that of Illinois and, second, because applying Illinois law would not be contrary to a fundamental policy of the Dominican Republic. Although the court’s decision assumes that the Illinois choice-of-law clause was still in effect, the court never explained why this would be so since the Agreement had expired by its terms in 1997. Although contracts sometimes specify that certain provisions will survive after termination, the Agreement does not appear to contain a survival clause.
The legal concept of separability offers a potential explanation for the court’s decision. If one conceives of the choice-of-law clause as a separate, stand-alone agreement between the parties that is embedded in the main agreement, then the termination of the main contract should have no effect on the clause. The Supreme Court has long held, for example, that arbitration clauses are “separable” from contracts into which they are embedded. If a party seeks to invalidate an arbitration clause on the basis of fraud, it is not enough to show that the contract as a whole was induced by fraud. The resisting party must show that the arbitration clause was itself induced by fraud. The logic of separability has led a number of U.S. courts to conclude that arbitration clauses generally survive the termination of the contracts in which they are embedded. Because these clauses have an separate existence, so the argument goes, they continue to have legal effect even after the underlying agreement is terminated.
Some U.S. courts have applied this same logic to cases involving forum selection clauses. Since forum selection clauses constitute separate agreements between the parties, the courts reason, they may only be invalidated on the basis of fraud when the fraud relates specifically to the clause. This line of cases has attracted criticism. The practical consequences of applying the doctrine of separability to forum selection clauses is that these provisions continue to exist until the end of time. There are situations — including but not limited to cases involving contracts of adhesion between large corporations and individual consumers — where it may be unfair to grant this supercharged status to forum selection clauses.
One can apply the same logic of separability to choice-of-law clauses. If the choice-of-law clause is separable, it may continue to have legal effect even after the main agreement is terminated. On this account, the choice-of-law clause is not a “zombie” raised from the corpse of a dead contract. It had an independent existence from the very beginning. The Hague Principles on Choice of Law in International Commercial Contracts takes the position that choice-of-law clauses are separable from the main agreement in commercial contracts. Article 7.2 states that a choice-of-law agreement “possesses an autonomous character from the contract to which it applies.” Article 7.3 states that a “choice of law agreement is not affected by a claim that the main contract is invalid, non-existent or ineffective.” If the doctrine of separability is applied in the Wahl case, the district court’s decision enforcing the choice-of-law clause may be justified on the grounds that that clause was distinct and separate from the main agreement.
Party Intent and Public Policy
As noted above, it is common for sophisticated parties to draft agreements that contain survival clauses. These clauses specify that some (but not all) of the provisions in the contract shall survive the termination of the agreement. If a contract omits a survival clause, or if a choice-of-law clause is not specifically mentioned in a survival clause, then the court must decide whether the parties intended the clause to lapse upon termination of the underlying agreement.
Very few courts have considered whether it is appropriate to apply the doctrine of separability to choice-of-law clauses. The general sense among scholars to have written on this issue, however, is that parties generally want their choice-of-law clauses to endure beyond the termination of the contract. This approach probably reflects majoritarian preferences in the general run of cases. There are circumstances, however, where one may reasonably wonder whether the parties truly intended to have their choice-of-law clause live on forever. One might ask, for example, whether Plaza really intended for the Illinois choice-of-law clause in the Agreement to bind it even after it had entered into dozens of subsequent purchase orders that lacked any choice-of-law clause. It is also debatable whether most parties would want a very broad choice-of-law clause — one which governs any disputes arising out of the “relationship” between the parties — to supply the governing law for all future disputes between the parties… including those disputes that have absolutely no connection to the original contract. And when a contract contains a survival clause that omits any mention of the choice-of-law clause, it is fair to ask whether the parties really intended their choice-of-law clause to survive past the end of the agreement. If the parties intended this result, why didn’t they say so in their survival clause? While applying the doctrine of separability to choice-of-law clauses may be sensible as a general rule, in short, there are scenarios where the parties may well have intended a different result.
In the context of non-negotiated contracts of adhesion with consumers and employees, the courts should also carefully consider whether extending the life of the choice-of-law clause represents sound public policy. In such cases, the company drafting the contract had the unfettered ability to write a survival clause into the agreement prolonging the life of the choice-of-law clause beyond the end of the contract. If the company failed to do so, then the doctrine of contra proferentem suggests that the absence of such language should be construed against the drafter.
In a perfect world, the parties would always write language into their agreement specifying which clauses will survive termination of the contract. Such language makes the court’s job easy. When a contract lacks any language to this effect, then the general rule is that dispute resolution clauses survive the termination of the agreement. There are situations, however, where this outcome may not align with notions of party intent and sound public policy. In cases where the parties have entered into subsequent agreements on the same topic that omit any choice-of-law clause, for example, or where the clause is exceptionally broad, or where the survival clause makes no mention of the choice-of-law clause, the courts should think long and hard before deciding to zombify a choice-of-law clause and grant it eternal life.