Our Contract Says Disputes Go to Another State. Does That Clause Hold Up?

Three different clauses that get confused

Contracts usually bundle three separate choices into one "governing law and disputes" paragraph, and Texas treats each differently.

• Choice of law. Which state's law the court will apply. A Texas court can apply Delaware law, and often does.
• Forum selection. Which state's (or country's) courts will hear the case. This is the clause that moves the lawsuit.
• Venue. Which county within Texas. Texas has its own statute on when a county can be chosen by contract.

Reading the clause closely tells you which of the three you are dealing with, and whether the language is mandatory ("shall be brought exclusively in") or permissive ("may be brought in"). A permissive clause consents to a forum without excluding others; only a mandatory clause forces the case out of Texas.

Forum-selection clauses: presumptively enforceable

The Texas Supreme Court set the rule in In re AIU Insurance Co. in 2004, enforcing a clause that required an insurance coverage dispute to be litigated in New York and holding that mandamus relief is available when a trial court refuses to enforce such a clause, because an appeal after trial in the wrong forum is an inadequate remedy. A forum-selection clause is presumed valid, and the party resisting it carries a heavy burden to show one of a few things:

• the clause was the product of fraud or overreaching directed at the clause itself, not merely at the contract;
• enforcement would be unreasonable and unjust;
• enforcement would contravene a strong public policy of the forum where the suit was filed; or
• the chosen forum would be so seriously inconvenient that the party is for practical purposes deprived of its day in court.

Inconvenience alone rarely works. The cost of litigating in another state was foreseeable when the clause was signed, and Texas courts hold parties to that bargain. A clause in a signed contract between businesses, even a form contract, is enforced in the great majority of cases. Where the dispute involves claims that are not strictly contractual, such as fraud or tortious interference, the question becomes whether those claims fall within the clause's wording, and courts read language like "any dispute arising out of or relating to this agreement" broadly.

The mirror image also holds: a clause selecting Texas courts will be enforced against an out-of-state party, which resolves the jurisdiction question discussed in suing an out-of-state company in a Texas court.

Choice-of-law clauses: honored with two exceptions

Texas follows section 187 of the Restatement (Second) of Conflict of Laws, which the Texas Supreme Court adopted in DeSantis v. Wackenhut Corp. in 1990. The parties' chosen law governs unless either the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the choice, or applying the chosen law would be contrary to a fundamental policy of a state that has a materially greater interest in the issue and whose law would otherwise apply. DeSantis itself is the classic example of the second exception: a Florida choice-of-law clause in a Texas employee's non-compete was not enforced, because Texas policy on non-competes was fundamental and Texas had the greater interest in a Texas employee working for a Texas operation.

In ordinary commercial disputes the exceptions seldom apply. Delaware law in an LLC agreement, New York law in a financing agreement, or the law of a supplier's home state in a distribution contract will be applied by a Texas court. The exceptions come up in non-competes, consumer matters, insurance, and clauses that would strip a party of a statutory right Texas considers fundamental.

Large transactions: Business and Commerce Code chapter 271

For qualified transactions, defined in section 271.001 as those in which a party pays, receives, lends or borrows consideration or credit with an aggregate value of at least $1 million, the Legislature strengthened the parties' choice. Under section 271.005, the chosen law governs if the parties agreed in writing and the transaction bears a reasonable relation to that jurisdiction, regardless of whether applying that law is contrary to a fundamental or public policy of Texas or any other state. The chapter carves out several matters, including issues another statute assigns to a particular law and construction contracts governed by chapter 272.

Venue clauses within Texas: the $1 million rule

Picking a Texas county by contract is a different matter. Texas venue is governed by statute, and Civil Practice and Remedies Code section 15.020 allows a written agreement to fix venue only in a "major transaction," meaning a written agreement under which a party pays or receives consideration with an aggregate stated value of $1 million or more, excluding personal, family or household transactions and personal injury settlements. In a major transaction, a suit must be brought in the agreed county, and may not be brought in a county the parties agreed to exclude. Below that threshold, a venue clause is generally not enforceable on its own, and the ordinary venue rules apply, which are explained in where a business can file suit under the Texas venue rules. Section 15.020 does not apply where the agreement was unconscionable when made or where venue is fixed by another statute.

Construction contracts: Texas keeps them home

Business and Commerce Code section 272.001 applies to construction contracts concerning real property in Texas and voids, as against public policy, any provision that makes the contract subject to another state's law, requires litigation in another state's courts, or requires arbitration in another state. Where a venue provision is void under the section, the suit must be brought in Texas in the county where the property is located unless the parties stipulate otherwise after the dispute arises. Section 272.002 excludes a few categories, including entity governing agreements and certain lending and property management arrangements. For a Texas contractor working for an out-of-state owner on a Texas project, this statute often overrides the owner's form contract entirely.

Example

Suppose a Dallas marketing agency signs a services agreement with a California technology company. The agreement says California law governs and that "any action arising out of or relating to this agreement shall be brought exclusively in the state or federal courts located in Santa Clara County, California." The company stops paying and the agency wants to sue in Dallas County. The clause is mandatory and covers the claim, the agency signed it, and the cost of litigating in California was foreseeable. Under AIU the Dallas court will almost certainly dismiss in favor of the California forum, and the agency's choices are to sue there or negotiate. California law will likely govern the contract claim too, since California has a substantial relationship to the company. Had the agreement instead been a construction contract for a Texas building, section 272.001 would void both the California law and the California forum, and the case would stay in the Texas county where the property sits.

Arbitration clauses are their own category

A clause requiring arbitration is enforced under the Federal Arbitration Act or the Texas Arbitration Act, with their own rules about validity and scope. An arbitration clause that names a seat in another state operates much like a forum-selection clause, but the analysis runs through arbitration law. That subject is covered in whether the arbitration clause in your contract is enforceable in Texas.

What to do with the clause in front of you

• Classify it: law, forum or venue, and mandatory or permissive.
• Check the dollar value of the transaction against the one-million-dollar thresholds in chapter 271 and section 15.020, and check whether chapter 272 applies.
• Ask whether the claims you want to bring fall inside the clause's wording, and whether any claim or party is outside it.
• Weigh the cost of fighting the clause against the cost of simply litigating where it says. Resisting a forum clause usually fails and adds a round of motions and possibly a mandamus proceeding before the merits begin.
• If you are the drafting party, decide these points before signing. A one-line clause fixing Texas law and Dallas County courts, in a transaction above the major-transaction threshold, is enforceable and saves the whole argument.

Where a case is heard and what law applies often decide its value before any fact is proved, so these clauses deserve attention at the contract stage and again on the first day of a dispute. Tina Wysk represents Dallas businesses in contract disputes involving forum, choice-of-law and venue clauses in Texas state and federal courts.