What Are Governing Law, Agreed Jurisdiction and Arbitration Clauses? How to Design the Rules for Disputes in a Contract

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

Governing law, agreed jurisdiction and arbitration clauses are often placed at the end of a contract and tend to be put off in day-to-day contract review. However, these clauses form the foundation for deciding, when a dispute actually arises, which country's or region's law governs the matter and which court or arbitral institution will hear it. In domestic transactions they may look like boilerplate, but in cross-border transactions, SaaS and license agreements, they greatly affect the burden of dealing with disputes.

Legal staff who want outside advice on designing or reviewing dispute resolution clauses such as agreed jurisdiction and governing law can entrust this to our legal outsourcing, which lets them engage lawyers for day-to-day contract review and legal questions on a continuing basis.

Confirming the Governing Law and Applicable Laws

Governing law determines which country's or region's law applies to the formation, effect and interpretation of a contract. Under Japan's Act on General Rules for Application of Laws, the parties' choice of law is the principle (Article 7 of that Act), and for domestic transactions in Japan between domestic companies, it is common to designate Japanese law as the governing law. In contracts with overseas companies, several options become candidates, such as the law of the counterparty's country or the law of a third country.

When checking the governing law, do not only look at which jurisdiction's law is designated, but also check how far that choice will hold in relation to mandatory rules such as consumer protection legislation, and whether there are laws that apply directly regardless of the governing law chosen by the parties, such as those on personal information protection or export controls. In consumer contracts, the choice of governing law may also be restricted. In addition to the wish to "use Japanese law because we are familiar with it," make the decision with a view to the counterparty's location, the place of performance of the contract and even the prospects of recovery if a dispute arises.

Choosing Between Agreed Jurisdiction and Arbitration Clauses

An agreed jurisdiction clause is an arrangement that determines in which court litigation will be conducted if a dispute concerning the contract arises. Under Japan's Code of Civil Procedure, an agreement on jurisdiction must be made in writing or by electronic record for actions based on a certain legal relationship, and in domestic transactions, provisions designating the Tokyo District Court or similar as the court of first instance are commonly used. An exclusive jurisdiction agreement is, as a rule, an agreement limiting jurisdiction to the designated court, while a non-exclusive (additional) jurisdiction agreement is designed so that actions may also be brought in other competent courts. However, even with an exclusive jurisdiction agreement, there may be cases where statutory exclusive jurisdiction is separately provided for or where a court decides to transfer the case, so it is not settled that the dispute can never be heard in another court. In addition, there are special statutory rules on the effect of jurisdiction agreements in consumer contracts and individual labor-related disputes. Designate the court by considering whether it is a place your company can realistically deal with and whether enforcement is possible where the counterparty's assets are located.

An arbitration clause, on the other hand, is a clause under which disputes are resolved by the decision of an arbitrator, a third party, instead of a court. Arbitration is used in international transactions in view of the recognition and enforcement of awards abroad and the availability of a neutral seat of arbitration. Also check the scope of the arbitration agreement and the statutory form, such as writing or an electronic record. The seat of arbitration refers to the legal home of the proceedings and does not necessarily coincide with the venue where hearings are actually held. Confirm which arbitral institution and which rules apply, the seat of arbitration, the language of the proceedings, the number of arbitrators and whether an emergency arbitrator system is available. Note that even with an arbitration agreement, applications to a court for interim measures are not automatically excluded (Article 15 of the Arbitration Act). Also bear in mind that the scope of the non-public nature of arbitration proceedings and confidentiality obligations differs depending on the applicable rules, the parties' agreement and the content of the law, and complete secrecy is not uniformly maintained. Enforcing an arbitral award abroad also requires meeting the requirements of the laws and treaties of the place of enforcement, and it is important to take into account procedures such as obtaining an enforcement decision in Japan. Also distinguish the special rules for arbitration agreements covering future consumer disputes, such as the consumer's right to cancel, and the fact that arbitration agreements covering future individual labor-related disputes are void.

Dispute Risks in English-Language Contracts and Small Transactions

Governing law and court jurisdiction or arbitration should be considered in combination, not separately. For example, there are cases where Japanese law is set as the governing law but a foreign court is designated as the competent court. Even if such a combination is valid, materials and expert opinions may be needed to explain the content of foreign law to the local court, which tends to increase costs and effort. Depending on the country where proceedings are conducted, the treatment of foreign law and the extent to which the parties bear the burden of proof and explanation vary.

In English-language contracts, initial drafts often include clauses making the law of the state where the counterparty is located the governing law and giving the courts of the counterparty's location exclusive jurisdiction. If you accept the courts of the counterparty's location or overseas arbitration in a SaaS or license agreement with a small contract amount, the burden of local attorneys' fees, translation costs and dealing with time differences alone may exceed the amount claimed, making it difficult to assert your rights in practice. Check whether the procedure suits the size of the transaction and the expected risks, including whether the same heavy procedure applies even to small disputes and whether interim measures such as provisional injunctions can be obtained separately. If the language of the contract differs from the language of the court or arbitration proceedings, also allow for translation and explanation costs. Even in domestic transactions, consider situations in which debt collection or interim relief is urgent, and check consistency with the clauses that set out the addresses and methods for notices.

Deciding the Negotiating Strategy and Keeping Internal Records

A negotiating strategy for dispute resolution clauses cannot be pushed through on the correctness of the legal arguments alone. Decide how far to request revisions based on the balance of power with the counterparty, the size of the transaction and the prospects of future debt recovery. If the transaction amount is small and overseas arbitration is not realistic, one approach is to propose changing to a domestic court or adding a step of simple consultation before litigation. On the other hand, for a large international deal, it may be reasonable to choose arbitration in a neutral country acceptable to both sides. In transactions with high business priority, a decision may also be made to give some ground on the dispute resolution clause and prioritize securing other key transaction terms.

If you have no choice but to accept the governing law or jurisdiction designated by the counterparty, record the risks accepted in internal records. Record in the contract review file, together with the position or department that approved it, which clauses you asked to revise and how, the reasons the counterparty refused, and what additional costs or uncertainty in enforcement may arise as a result. The purpose is to ensure that the background to the acceptance can be explained internally even if the person in charge later changes. In addition, reviewing whether the dispute resolution clause originally agreed still suits the current reality of the transaction when the contract is renewed or a memorandum is signed makes it easier to keep future response costs down. Where a master agreement and individual contracts are separated, as in M&A or business alliances, it is also essential to ensure consistency across all related contracts so that the governing law and jurisdiction do not diverge from contract to contract and split the handling of disputes.

Frequently asked questions

What does a governing law clause provide for in a contract?

It is a clause that specifies which country's or region's law applies to the formation, effect and interpretation of the contract. Its purpose is to make clear which law serves as the standard of judgment if a dispute arises. Under Article 7 of Japan's Act on General Rules for Application of Laws, the parties' choice of law is the principle, but it is understood that the choice may be restricted by mandatory rules such as consumer protection or by directly applicable laws.

What is the difference between an exclusive jurisdiction agreement and a non-exclusive (additional) jurisdiction agreement?

The difference is whether the court in which litigation is conducted is limited to the designated court. This is because an exclusive jurisdiction agreement is, as a rule, an agreement limiting jurisdiction to the designated court, while a non-exclusive (additional) jurisdiction agreement is designed so that actions may also be brought in other competent courts. However, it is understood that, even with an exclusive jurisdiction agreement, statutory exclusive jurisdiction or a court decision on transfer may come into play.

Even if a contract contains an arbitration clause, can a party apply to a court for interim measures?

Even with an arbitration clause, applications to a court for interim measures are not automatically excluded. This is because Article 15 of the Arbitration Act so provides. Note that the scope of the non-public nature of arbitral proceedings and of confidentiality obligations differs depending on the applicable rules, the parties' agreement and the like, and it is understood that confidentiality is not uniformly maintained.