Soft Law as Governing Law

International commercial, financial, and other business transactions increasingly are conducted under ‘soft law’ rules—effectively, non-state rules that may be aspirational or reflect best practices but are not yet legally enforceable. Some argue that the traditional regulatory system is gradually being replaced by soft law. Part of soft law’s attraction is that it does not need governmental validation or consent, thereby providing rules of conduct when treaty-making fails.

Soft law’s unenforceability, however, creates uncertainty. To increase predictability, my recent Article argues for an innovative use of soft law: as a set of rules to choose as all or part of the governing ‘law’ of business contracts. If respected, this use of soft law would be transformational, making the soft law enforceable against the parties and providing a flexible and practical alternative to treaty-making.

Whether parties should have the contractual right to choose soft law as governing law is, as discussed below, largely an issue of first impression. This Article analyzes that right using language that should be accessible to most legal scholars and lawyers, avoiding the opaque choice-of-law jargon that has amassed over time.

Historically, the contractual right to choose soft law as governing law has been narrowly restricted to arbitration. The Uniform Commercial Code (‘UCC’) provides the closest US non-arbitration precedent, allowing parties to vary its provisions by choosing soft law promulgated by intergovernmental authorities such as UNCITRAL or Unidroit or to trade codes such as the Uniform Customs and Practice for Documentary Credits. The Hague Principles on Choice of Law in International Commercial Contracts also favor the right of parties to choose ‘rules’ of soft law ‘that are generally accepted on an international, supranational or regional level as a neutral and balanced set of rules’. These precedents are very limited, however. The UCC language ambiguously, at best, covers choice of law, and the Hague Principles are themselves expressed only as non-binding soft law. Furthermore, these precedents strictly limit the sources of the soft law. (The Rome I Regulation, setting EU conflict-of-laws rules, originally proposed allowing contracting parties to choose certain limited, internationally recognized, soft-law rules as governing law; however, that proposal was not ultimately adopted.)

The analysis starts by examining the fundamental underpinnings of choice of law, which focus on party autonomy. It also examines the right to choose soft law under the broader lens of freedom of contracting. Finally, it asks whether governmental interests in ensuring legitimate enforcement should limit the right to choose soft law. That analysis concludes that sophisticated parties to business contracts should have the right to choose soft law as all or part of their governing law if several conditions are met: (a) the choice of soft law does not create significant externalities, or the social benefits of that choice are likely to exceed those externalities; (b) the soft law is clear and accessible; and (c) the soft law has legitimacy by virtue of being either generally accepted, promulgated by a respected independent and unbiased organization, or manifestly fair.

The Article then considers an alternative analytical framework: incorporating the soft law merely by reference into a business contract. This incorporation by reference is not a choice-of-law rule but, rather, a shorthand ‘cutting and pasting’ drafting technique. The Article finds that sophisticated parties to business contracts should have the right to incorporate soft law by reference into their contracts if the same conditions for choosing soft law as governing law are met—other than the condition requiring that the soft law has legitimacy.

It therefore should be easier to incorporate soft law by reference into a contract than to choose that soft law as the contract’s governing law. In theory, though, because incorporation by reference is subject to applicable mandatory rules of local law, it would not be as effective as choice of law. The Article shows, however, that choice of law is itself subject to ‘overriding’ mandatory rules of local law—and there often is little difference between those categories. Furthermore, for reputational and other reasons, parties to business contracts may not want to disobey either category of mandatory rules.

Finally, the Article applies its choice-of-law and incorporation-by-reference frameworks to a sovereign-debt-restructuring Model Law promulgated by an independent, non-partisan think tank, as an example of soft law. The application shows that incorporating the Model Law by reference into a new sovereign debt contract should not only be as effective as, but also potentially easier to implement than, choosing the Model Law as governing law of the contract. However, incorporating the Model Law by reference into an existing sovereign debt contract could be problematic because the Model Law’s ‘supermajority’ voting would contravene contracts that require unanimity to change key terms such as principal amount, interest rate, and maturities. Although ultimately a matter of contract interpretation, amending that unanimity requirement to incorporate the Model Law by reference would likely require a unanimous vote of the contracting parties. In contrast, the parties to an existing sovereign debt contract arguably should be able to choose the Model Law as part of the contract’s governing law by whatever requisite majority (ie, non-unanimous) vote ordinarily allows amendment of the governing law.

Steven L. Schwarcz is the Stanley A. Star Professor of Law & Business at the Duke University School of Law, and a Senior Fellow at the Centre for International Governance Innovation (CIGI).