Determine the applicable law to contractual obligations

Dr. Roberta Pál

Partner, Mihalics Law Firm

The case below provides guidance on the maze of applicable law in the absence of choice according to Hungarian practice

Background

In 2012, the parties signed an English-language contract in London, according to which the defendant owed the plaintiff USD 1,000,000 in cash and USD 1,500,000 in real estate as a result of their cooperation in the implementation of a real estate development project under the name “M” in Budapest. The parties agreed that by 2015 the defendant would transfer the cash to the plaintiff according to the schedule specified in the agreement and the ownership of certain Budapest located real estates selected by the plaintiff from the results of the “M” project. The defendant failed to perform his duties under the contract.

UK Courts declared lack of jurisdiction in the real estate claim

The plaintiff filed his claim at the Central District Court of London. The defendant brought an appeal before the Higher Regional Court, which on the one hand declared that it had no jurisdiction to adjudicate the parts of the plaintiff’s claim related to the transfer of the real estates, and on the other hand found the defendant to be in breach of contract in related to the cash transfer and ordered him to pay its debt.

Choice of law must be preliminary and express

Following the UK decisions, the USD 1,500,000 worth real estate claim was filed at the Hungarian court.

The defendant requested the court to dismiss the claim. He argued that the applicable law is the law of the UK because it should be considered an express choice of law that the parties have previously agreed to have their dispute heard at an English court using the English law. In addition, the application of English law is also justified because the contract was signed in London and drafted in English.

The Hungarian court the first had to decide whether it had jurisdiction and which law was applicable to adjudicate the case.

The court of first instance found that the defendant’s allegation about the choice of law had no basis since, as the choice of law must be preliminary and express, and it could not be “ex-post and implied”. The court held that under Article 4(1)(c) of Regulation (EC) No 593/2008 of the European Parliament and the Council (‘the Regulation’), a contract relating to a right in rem in an immovable property shall be governed by the law of the country where the property is situated, which in our case is Hungarian law.

Decision on second instance – ex-post and implied choice of law is permitted

According to the court of the second instance’s reasoning, the first instance was not wrong when it determined Hungarian law as applicable under Article 4(1)(c) of the Regulation. However, the court of the second instance pointed out that choice of law could be ex-post and implied since the so-called method of choosing a law has been recognized in private international law.

Supreme Court – no choice of law had been made by the parties

The Supreme Court made the following decision:

The provisions of Hungarian private international law in force at the time the dispute is settled shall apply to contractual obligations that do not fall within the scope of the Regulation. It was not disputed between the parties that their agreement fell within the scope of the Regulation, i.e., the applicable law had to be determined based on the Regulation.

According to Article 3(1) of the Regulation, the contract shall be governed by the law chosen by the parties. The choice shall be made expressly or clearly demonstrated by the terms of the contract or the circumstances of the case. By their choice, the parties can select the law applicable to the whole or to part only of the contract.

The choice of law may be made in the contract or a separate agreement, or implicitly, in the latter case, it must be apparent with sufficient certainty from the contract or the circumstances of the case.

In the present case, it was not disputed that the parties had not chosen any governing law expressly in their contract.

According to the Supreme Court, the fact that the plaintiff brought the case to an English court, which decided a part of the dispute under the English law, does not in itself mean that an implied choice of law has taken place. This is evidenced by the fact that the defendant raised an objection to the jurisdiction in the proceeding before the English court. The defendant, therefore, merely tolerated the English trial. Still, the proceedings and the law applied in them were clearly not based on an agreement between the parties. Therefore, the defendant was wrong to argue that he had accepted the English court’s jurisdiction and English law as applicable law.

The defendant asserted that terms used in their English agreement, such as “partnership” or “guarantee”, require classification under English law. This is contradicted by the fact that none of the parties is a practicing lawyer, the terms referred to are also used in everyday life in the course of business. On the other hand, the defendant did not state what legal institutions, expressly found only in English law or completely different special content, are connected to these terms.

Therefore, the Supreme Court agreed with the court of first and second instance that the choice of law between the parties concerning English law had not been made either in the agreement or subsequently in any other way. Therefore, according to the Regulation, it was necessary to take a position on the question of the law applicable in the absence of a choice of law.

If the law applicable to the contract has not been chosen by the parties, the Regulation determines the law governing the contract in several steps in Article 4. For certain types of contracts, it expressly provides for the law of the state to be applied. According to Article 4(1)(a), a contract for the sale of goods shall be governed by the law of the country where the seller has his habitual residence. Under Article 4(1)(c), a contract relating to a right in rem in immovable property or to a tenancy of immovable property shall be governed by the law of the country where the property is situated. Pursuant to Article 4(2), where the contract is not covered by paragraph 1 or where the elements of the contract would be covered by more than one of points (a) to (h) of paragraph (1), the contract shall be governed by the law of the country where the party required to effect the characteristic performance of the contract has his habitual residence. And according to Article 4(3), where it is clear from all the circumstances of the case that the contract is manifestly more closely connected with a country other than that indicated in paragraphs (1) or (2), the law of that other country shall apply.

Assessment of the contract – “non in rem”

The Supreme court did not agree with the court of first and second instance that the litigation’s applicable law is based on Article 4(1)(c). The defendant did not undertake to transfer ownership of specific immovable property expressly provided in the agreement, but as a result of a previous non in rem agreement, he undertook to offer and transfer the ownership of immovable property within the time and at the value specified in the agreement chosen by the plaintiff.

The contract between the parties shall not constitute a standard contract listed exhaustively in Article 4(1)(a) to (h) of the Regulation, which may give rise to the application of paragraph 1.

The defendant’s habitual residence prevails

It is a fact that the parties concluded the contract in English in London. However, it is more important that the defendant should have fulfilled the provisions of the agreement by providing real estate in Hungary. Therefore, the contract shall be governed by the law of the country where the party is required to effect the characteristic performance of the contract, i.e., the defendant has his habitual residence under Article 4(2) of the Regulation. The Supreme Court points out that the same would be the case if, based on the foregoing, it would have concluded that the applicable law was governed by Article 4(3) of the Regulation.

According to all the above, although for different legal reasons, the courts of the first and second instance did not act unlawfully when they applied Hungarian law to adjudicate the litigation. Since, under Article 12(1)(c) of the Regulation, the law applicable to the contract also governs the consequences of the breach of contract, the courts of both levels were also correct in assessing the consequences of the breach of contract in accordance with Hungarian civil law.

The Supreme Court also pointed out that it is not in itself decisive to determine whether an implied choice of law has been made in order to determine a claim arising from a contract, where and in what language the parties concluded the contract, or whether they used legal terms to be interpreted similarly.